ASAI - Companhia Brasileira De Distribuicao: Update On Exito Spin-Off

2023-09-04 06:44:21 ET

Summary

• GPA's spin-off from Grupo Éxito has led to initial volatility in share prices, but potential catalysts like non-core asset sales and improving operational efficiency are on the horizon.
• Efforts to reduce expenses and restructure operations are already showing positive results, with a potential increase in EBITDA margin by the end of 2023.
• Despite the long-term potential, it's advisable to exercise caution in the current market environment for GPA and wait for short-term volatility to settle.

In my recent article about Companhia Brasileira De Distribuição ( CBD ), operating as GPA Brazil, I highlighted several key factors that could potentially lead to a significant increase in the company's share value. One of these factors was the spin-off of the Colombian group Éxito.

Now that the spin-off has been successfully executed, GPA's shareholders own shares in Grupo Éxito ( CBD.WI ). This combination has resulted in gains for holders of GPA's ADRs rather than losses.

Despite being considered an attractive investment when assessed using EV/EBITDA multiples, and in light of the considerable challenges it will face, GPA's shares have appreciated following the separation from Éxito. Furthermore, other upcoming events could positively impact the value of these shares. However, I believe this is a moment that requires increased caution.

Therefore, I decided to observe the situation from the sidelines without taking action until the uncertainties subsided.

The Éxito spin-off

The shares of GPA dropped by approximately 20% following the company's announcement of the official separation of its Brazilian assets from its former subsidiary, Grupo Éxito.

However, some important points need clarification before shareholders become concerned about the potential negative impact on GPA's shares.

The retailer distributed 1.08 billion Éxito shares to its shareholders at a ratio of 4 Éxito Brazilian Depositary Receipts (BDRs) for each Grupo Pão de Açúcar share traded on the Brazilian stock exchange under the ticker "PCAR3". For holders of Level II American Depositary Receipts (ADRs), each ADR now represents 8 ordinary Éxito shares. This transaction was executed through a capital reduction of approximately R$7.13 billion, with GPA distributing approximately 83% of Éxito's shares while retaining a minority control of 13% in Éxito (with the possibility of future monetization).

In practical terms, investors who held positions in CBD ADRs (or in the PCAR3 ticker in Brazil) until the cut-off date received the new assets in the proportion of Éxito Group's ADR or BDR, with one Éxito ADR allocated for each GPA ADR, as specified in the company's announcement .

"Holders of GPA ADRs, in turn, will receive one ADR of Éxito for every 2 GPA ADRs, and the Éxito ADRs will be traded on the New York Stock Exchange (NYSE) as of August 23, 2023, and continue up to August 28, 2023, inclusive, on a "when issued" basis under the ticker symbol 'EXTO WI.' Éxito ADRs will be traded regularly on NYSE as of August 29, 2023, under the ticker symbol 'EXTO.'"

Adding the closing price of the Brazilian retailer's shares on August 22 at $1.21 to the value of Grupo Éxito's ADR of $5.77 (considering that each ADR will represent 8 common shares in Éxito) would give something around $0.72, so this would mean that GPA's old share price should be around $1.98 per share - something very close to the all-time high reached in mid-2021.

The movement is similar to when Assaí ( ASAI ) split from GPA in March 2021, causing ASAI's assets to jump at the opening and GPAs to fall sharply.

Catalysts for the short and medium-term

GPA is actively taking steps to improve its cash flow, which is crucial considering its substantial, high-leverage position. The spin-off of Éxito stands out as a significant milestone in this endeavor.

The second aspect pertains to operational leverage and margin improvement. The company's growth strategy involves expanding its Minuto Pão de Açúcar and Mini Extra stores, to open 100 new stores this year. In the second quarter, they successfully launched 23 new stores, marking a 25% increase compared to the previous year. This progress positions the company well to achieve its growth plan, which is expected to contribute to a 15% increase in revenue.

Furthermore, in the same period, GPA's selling, general, and administrative expenses totaled R$926 million in Q2 2023, demonstrating a slight decrease compared to the previous year, and this trend is expected to persist. The most noticeable reduction in expenses is in general and administrative costs, which decreased by 7.5% compared to the previous year. This decrease can be attributed to restructuring efforts at the company's headquarters following the sale of the hypermarkets and improved operational efficiency, resulting in cost savings.

With the newly implemented strategies aimed at boosting the display and sales of perishable goods yielding positive results and considering the resurgence of premium supermarket flows (previously focused on the cash and carry wholesale model), the company anticipates that by the end of 2023, GPA should achieve an EBITDA margin of 7.0%, representing a 40 basis point increase year-over-year. The bull case is GPA approaching 8.0% by the end of 2024, although this projection falls slightly below the company's guidance.

Additional catalysts that could positively impact GPA's shares in the short to medium term include the sale of the 34% stake in CNova (Casino's European e-commerce arm) and the divestment of the gas station operations. Moreover, real estate transactions, such as the sale of the headquarters in São Paulo and the sale of land in Rio de Janeiro, may also positively influence the company's performance.

Investment risks

GPA is currently undergoing a turnaround process, focusing on adjusting the value proposition for each banner to enhance profitability. The primary lever in this effort is the gross margin.

Despite ongoing efforts to restructure operations and renovate stores to increase productivity, recent results indicate a weaker trend in its Brazilian operations – particularly in terms of profitability. As the company has pointed out, this challenging trend should persist in the upcoming quarters.

However, if the execution of new banners strategies proceeds as planned, GPA's valuations could become somewhat attractive at this juncture.

Currently, GPA's shares are trading below the $1 mark, and the company carries a net debt of R$2.9 billion along with lease obligations totaling R$4.18 billion. Given these figures, GPA's stock is valued at 5.5 times its projected EV/EBITDA ratio for 2024. This valuation is nearly 50% lower than the industry average and approximately 20% below the five-year historical average.

The bottom line

In my last coverage of GPA, shortly after the Q2 earnings, I had a bullish stance on the stock due to several catalysts that could potentially create value for the company in the short term.

With the recent spin-off of Éxito moving forward, one of the most significant catalysts, it has indeed added substantial value for GPA shareholders. The combined value of the two separate assets is now approximately $2 per share of CBD stock, close to the historic highs in 2021.

From a long-term perspective, GPA shares still appear to have significant potential. However, at this moment, I believe that holders of GPA's shares following the spin-off have already benefited considerably. This is particularly true when considering the current valuation of Grupo Éxito's ADRs. It's possible that this valuation already reflects the anticipated impact of the spin-off.

While GPA remains heavily leveraged, and its core assets are in a recovery phase with associated execution risks, there are still some positive aspects to consider. This includes the potential sale of non-core assets at premiums compared to their current market values, particularly the remaining 13% stake that GPA holds in the Éxito Group.

Despite anticipating other catalysts, I believe it's a prudent time to exercise caution. Therefore, I prefer to remain on the sidelines until the short-term volatility subsides.

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