2023-10-16 23:29:35 ET
Summary
- Dino Polska is a leading grocery retailer in Poland with over 2,300 stores and a proven track record of growth and profitability.
- The company's competitive advantages include its scalable operating strategy, efficient supply chain, and standardized store format.
- Despite regulatory and competition risks, Dino Polska is a 'Buy' recommendation due to its solid competitive advantages and proximity to a 30% margin of safety.
Introduction
Dino Polska ( DNOPY ) is a leading grocery retailer in Poland. Dino Polska's competitive advantages, financial performance, and potential for growth make it a unique opportunity for investors looking for exposure to the Polish market. With over 2,300 stores across Poland, Dino Polska has established itself as a major player in the grocery retail market. The company's founder, Mr. Biernacki, owns a majority stake in the company and is known for his entrepreneurial vision and unique approach to the market. Despite the highly competitive nature of the grocery market, Dino Polska has managed to maintain its position as a leading retailer by offering customers a convenient shopping experience with low prices and a wide range of products. That's why I think the company is a 'Buy.'
I highly recommend you read the market study made by Sohra Peak Capital Partners , as I consider it gives a comprehensive view of the whole grocery market in Poland.
business Overview
Dino Polska is a leading Polish grocery retailer with a network of medium-sized supermarkets close to customers' places of residence. The company's business model combines the advantages of medium-sized stores with the ability to open new stores quickly and an attractive product range at competitive prices.
Dino Polska has a proven capacity to open new stores, having grown its network by 77% in the past three years. The company's network expansion has been accompanied by significant like-for-like revenue growth.
Dino Polska's operating strategy is based on a standard store design, equipped with parking places and supplied with fresh products every day of the week. Most stores have a sales floor area of approximately 400 square meters and offer customers about 5,000 stock-keeping units, mostly well-known branded and fresh products.
Dino Polska's business model is scalable to a large extent. It comprises centralized management supported by IT systems, a logistics network based on seven distribution centers, and a transportation network managed by Dino. The company sources most products directly from producers or prominent representatives, allowing it to make purchases on favorable terms.
Dino Polska's profitability is consistently enhanced by its business model, operational leverage, and store network maturation.
Poland Market
We must understand Poland's demographics and economy before understanding Dino's competitive landscape and advantages. First, Poland removed communism after 1989 and installed a capitalist model based on strong institutions, low taxes, and industrialization. Poland is sometimes referred to as the ‘New Germany.’ In fact, it holds the fifth position in industrial output in the EU. In addition, Poland has grown rapidly in the previous decades without experiencing a contraction of GDP until covid-19. Its growth has been faster than most EU members, surpassing its peers in 2023.
In this sense, Poland has lower taxes than other OECD countries at the corporate and labor levels. Likewise, its public debt was only 49.1% of GDP in 2022, so the government can borrow cheaper and run deficit budgets without causing fear among investors.
Furthermore, according to U.S. News , its manufacturing cost is cheaper than all the Western European countries identified in the above graph, which puts Poland in an advantageous position relative to its wealthier European peers. Nevertheless, there are some threats to its industrial segment and the economy overall: first, being a middle-income nation makes it vulnerable to brain drain from other wealthier countries; second, Poland is competitive inside the EU market, but there are non-members with lower manufacturing costs that face tariff or any additional trade restriction, making Poland vulnerable to new trade agreement by the EU with non-members. The dependence of Poland on trade diversion is seen when we look at the destiny of its exports.
Compared to Western European countries, Poland has a limited capacity to produce goods of high technology complexity, which puts it in a vulnerable position compared to cheaper countries. For instance, Poland ranks 28 out of 131 in the Economic Complexity Trade , which measures a country’s capacity to produce and export products that require a high level of knowledge or skill. Nevertheless, Poland’s education system ranked 23 out of 163 countries, according to U.S. News ; besides, Poland ranked 20 out of 96 in the Economic Complexity Technology , which measures the ability of a country to develop complex patentable innovations. Hence, I believe Poland could reach its Western peers, as its economy produces more complex products and it’s less dependent on cheap production, which is getting expensive as its living standards improve rapidly; moreover, I see unlikely that the EU will drop trade restrictions, as France opposes to any new agreement as it is interested in protecting its national production. However, the stagnation of the European members could lead to stagnation in Poland's economy, as exports represented 61.72% of GDP in 2022, according to Tradingeconomic . Likewise, If it fails to transition from a middle-income country to a high-income country (middle-income trap), its economy could be badly hurt. Finally, according to Statista , Poland’s economy will continue to grow but slower than before.
Now, talking about demographics, like many developed countries, Poland is and will face the decline and aging of its population in the following years, which will hinder general economic growth. However, almost 40% of Poles live in rural areas, and this percentage has remained stable since 1989. This factor is crucial as Dino proliferates in small towns rather than big cities; hence, a declining rural population would be a warning size.
Furthermore, Poland has one of Europe's most overcrowded living conditions, leaving less space for big kitchens than in other European countries. For instance, in 2018, there were 380 houses for every 1,000 residents, while the EU’s average was 480. However, the government expects to close this gap by 2030. The smaller space for the kitchen forces residents to buy many times a week. I think most of those purchases are small based on Dino’s basket value of ~$11. These factors are essential, as Poles tend to give convenience a high value when shopping.
Polish Grocery Retail Market
The Polish grocery retail market comprises Hypermarkets, large supermarkets, proximity supermarkets, discounters, convenience stores, soft franchises, and traditional stores. Traditional stores (mom-and-pop) have been giving market share to modern stores, mainly to discounters and proximity stores, as it’s hard for them to fight against the lower prices of discounters or supermarkets (lower purchasing power) and to have better locations than proximity supermarkets and convenience stores. Consequently, the number of traditional stores has decreased consistently, while discounters, proximity supermarkets, and convenience stores have begun to dominate the market. Many traditional stores have joined soft franchises to receive professional help and remain competitive.
In the image below, we can see the consumer trends in the last decade and how different types of format stores have positive impacts on those trends. Proximity supermarkets are better tailored to trends, as they offer a broad enough assortment in close locations. Still, prices tend to be higher than discounters or other supermarkets. However, Dino’s price policy is to tie the prices of the closest discounters at least. Consequently, it’s unsurprising that proximity markets have been gaining market share and that Dino has been growing faster than any other store.
Dino Competitive Advantages
Management
The founder, Mr. Biernacki, owns 51.16% of Dino Polska and is an excellent capital allocator. His entrepreneurial vision is unique in the market, as he transformed a small-scale company with roughly 111 stores in 2010 into a large-scale company with over 2300 stores. The former is surprising, knowing that the grocery market is highly competitive, especially for the dominant position of discounters, which, through its private labels, scale, and logistic efficiency, offer lower prices than other types of retailers can barely equalize. Moreover, not a single store has ever been closed, indicating the success of selecting store locations.
Mr. Biernacki only raised capital once in 2010, when he changed Dino’s growth strategy by changing a rental model for a real estate owner model with standardized stores built by Mr. Biernacki’s company (Krot-Invest company). I think owning property provides certain advantages, such as lower costs as there is a third party’s markup and higher efficiency as stores and building process is standardized, lowering the costs of building new stores.
The high return on invested capital is crucial, as the company doesn’t generate any free cash flow because all the cash flow from operations goes to capital expenditures. Consequently, the returns on those investments must be higher than investors’ opportunity costs. From my perspective, the high double-digit return offers an attractive return that is challenging to equalize with other types of investments. Thus, I think investors’ money is in good hands in Dino Polska and its management team. Furthermore, Mr. Biernacki has achieved high growth without dilution or M&A, just organic growth, and it’s likely to continue this way.
Finally, currently, the company does not have a CEO, as the management keeps looking for someone inside the organization. However, Mr. Biernacki remains active in the operations and strategy of Dino.
Scale and Bargaining Power
Dino’s assortment relies on high-quality regional brands across Poland, as these regional producers are relatively small. Hence, Dino, as one of the largest grocery store networks, has considerable bargaining power toward suppliers and can get significant discounts thanks to its scale. One demonstration of the former is that Dino has a negative cash cycle, so it can negotiate with suppliers for extended payment periods. A negative cash cycle allows the company to put cash into higher-return projects (instead of financing its working capital) and reduce the need for external financing.
Meat Processor
Unlike discounters, Dino and proximity supermarkets have a fresh meat counter. Dino even owns a meat processor (Agro-Rydzyna). Meat is an essential component of the Poles' diet, as the consumption per capita in 2021 was 75.1 kg, approximately 200 g per day. I believe owning its meat processor allows Dino to manage the logistics better and retain a larger markup than other companies. Furthermore, the company is expanding the production capacity of Agro-Rydzuna, so we could expect higher revenues from the meat counters.
Convenience
Dino's opening strategy is to build stores that can serve 2,500 people in a catchment area of a 2 km radius (12.57 km2). Sohra Capital determines that every Dino store is within the average acceptable walking distance (2.3 km), resulting in higher convenience than discounters or other supermarkets. Moreover, as Dino’s stores are made to serve 2,500 people, they can be easily opened in the smallest towns, where discounters have it difficult as they depend on a larger catchment area. In this sense, discounters do not offer the same level of convenience as Dino, as they rely on larger catchment areas, forcing consumers to drive to its locations (making the shopping more expensive).
Assortment
Convenience and mom-and-pop stores may offer the same degree of convenience for consumers. However, these stores lack sufficient assortment to satisfy all the consumers’ needs. Thus, Dino has a competitive advantage over them as the sole convenient provider of a whole assortment, especially in small towns where discounters are less common. Nevertheless, discounters can offer international brands and quality private labels that Dino doesn’t provide (private labels) or a higher price (global brands products).
Price
Dino seeks to tie prices with the lowest-price discounter in a location. Hence, it offers better prices than convenience and mom-and-pop stores while providing the same degree of convenience than them. Likewise, even if discounters offer similar prices, they do not have the same level of convenience; thus, they play in a disadvantageous position compared to Dino, which simultaneously offers low prices and convenience. Comparing Dino’s prices with the competition, we have that Dino provides the best prices in Poland:
I believe the trifecta of convenience, assortment, and price sets Dino apart in the rural grocery market. Being the most convenient store is a strong value proposition as Poles highly value their time and tend to buy in small quantities; moreover, as it has the lowest prices in every location (along with discounters), consumers do not have to choose between getting better prices in a far location or buying in a convenience store or proximity supermarket; the election always will be buying at a convenient Dino store with low prices. Dino has enough assortment of products to satisfy consumers' needs, which sets it apart from mom-and-pop and convenience stores with limited assortment. In this sense, it’s important to clarify that Dino carries ‘enough’ assortment of products. Still, it doesn’t have the most extensive assortment, as this results counterproductive as 88% of Poles have to-go products with only a few deciding in the store.
In this sense, one of the closest competitors to Dino is Biedronka, a discounter with an average-size store of ~700m2, low prices, and a wide assortment. In 2022, Biedronka had 3,395 stores ; its stores have larger catchment areas than Dino’s, indicating lower convenience. Moreover, as its stores are bigger, its capacity to select attractive locations is lower than Dino, whose stores can fit in more locations due to their smaller size. Finally, like other discounters, Biedronka doesn’t have a fresh meat counter, which is a disadvantage, knowing that consumers eat a lot of meat and want that meat as fresh as possible.
Lastly, I believe the barriers to entry are middle, as a new entrant cannot match Dino’s scale easily, as the construction of new stores takes up to 2 years owing mainly to bureaucratic permissions, which are issued after 17 months. In this sense, new entrants will have to endure losses as they will be forced to sell as cheap as discounters (or Dino) to attract clients. Thus, they won’t be able to offer the same prices and level of convenience as Dino, so it will obtain a positive return on investment in the best scenario. Of course, this deters new entrants from deploying significant capital to match Dino’s network. Nevertheless, other players could try to copy Dino’s strategy, but a crucial part of Dino’s strategy is owning standardized stores (as owning ends up being cheaper than renting), which requires a lot of investment and time.
Financial Performance
The aforementioned competitive advantages are reflected in outstanding financial performance in the last decade. First, stores grew at a CAGR of 24.9% from 2013 to 2022.
Seeing the map, there are opportunities to keep expanding in the eastern part of the country and to keep increasing the number of stores in the south and north.
Moreover, the company has increased its Like-for-Like ((LFL)) revenue higher than food inflation since 2013.
Consequently, its revenue growth rate has been faster than the number of stores opened. In fact, the annual revenue growth rate was 32.31% in 2014-2022. Furthermore, as the company kept gaining scale and expanding, its margins expanded until 2020, but in 2021, the margin compressed due to the new 1.4% tax on sales. In 2022 and 1H23, the gross margin was squeezed, driven by higher merchandise costs that the company couldn’t transfer to clients—indicating the stiff competition the company faces, especially from discounters, making it impossible to transfer rising costs to customers without losing customers. Furthermore, inflation rose in the last year and remained at 9.8%, making customers more conscious about prices.
Analyzing those indicators, Dino’s growth strategy (based on store network, LFL, and profitability) has worked seamlessly in previous years. In every aspect, the management strategy has had an exceptional performance. On the same page, the management team believes it can improve margins through improvement in supply chain management, which may enhance margins. I believe margins will improve as inflation relaxes; moreover, the management has done excellent work applying the growth strategy, and I think there are still growth opportunities to keep increasing the number of stores, revert the negative trend in profitability, and increase the LFL sales.
Other Risks
Currency Risk
Dino Polska generates all its revenue in Poland, so it operates uniquely in Zlotys. This currency has depreciated against the dollar in the last ten years. Moreover, the Polish government has cut its interest rates ; thus, capital outflows may happen as they look for better returns in other countries (i.e., the US), further depreciating the Zloty. On the same page, the Polish current account has recorded more deficits than surpluses, and if this tendency continues, it could even depreciate the currency more.
Regulatory Risk
In 2021, the government issued a new federal tax on sales of 1.4% for large retail enterprises and 0.8% for small enterprises with revenue lower than 170 million PLN. Furthermore, Dino can’t open on Sundays; only mom-and-pop stores can open on Sundays. Hence, further regulation or higher taxes could affect Dino’s profitability, which was affected in 2021 due to the introduction of the abovementioned sales tax.
Interest Rates
The firm is paying more interest in 2023, even if its debt is lower than in 2022. Higher interest rates affect the returns on new stores, which is one of the reasons management decided to slow the new store construction. If interest rates remain high, the growth rate may be slower as the company relies on debt and cash from operations to keep its network expansion. However, I think it’s slightly improbable to see high interest rates (as in 2022) in 2023, as the central bank cut its interest rates and the market responded to the cut with a fall in the yield of the 10-year government bond.
Growth Limits
Sohra Capital estimated that Dino’s total addressable market was higher than 10,000 stores; currently, Dino has 2,340 stores across Poland; hence, there is plenty of room to keep growing. However, it’s easier to double the store network when there are only 300 stores than when there are over 2,000. Consequently, it’s plausible to expect lower growth rates than in previous years and a limit to growth in the long term, when the company will have to return cash flows to shareholders because there are not enough attractive projects in the market. Even so, I don’t expect cannibalization among stores, as they are meant to attend small areas, so the probability some steal market share from others is negligible. For instance, the following graph shows the number of stores per 100,000 inhabitants; most of the east remains unexplored, and even concentrated markets still have room to grow as every Dino store is meant to attend around 2,500 people, so it will be necessary on average 40 stores for every 100,000 inhabitants. Of course, this number of stores won’t be attained as many Poles live in big cities without Dino stores.
Valuation
The average ROE since 2015 is approximately 28.78%. Still, in recent years, the ROE and ROIC have been increasing, and I think it is probable that they will keep rising as a significant portion of stores (525 stores) reach maturity. Generally, mature stores have a higher EBIT margin; thus, in the coming years, it’s highly probable that margin and ROE will expand.
Hence, from my perspective, using the ROE to project the growth of EPS is already conservative enough. Furthermore, I will expect multiple compression as the company won’t be able to sustain the current growth rate because it will have an already extended store network. The terminal value will be a P/E of 22, and the discount rate is 16%. Notably, the company has a solid competitive advantage; however, it doesn’t have any pricing power, and it’s challenging to pass rising costs to customers. Hence, the competition risk remains worrisome.
For 366 zlotys, I think Dino Polska is undervalued, but the margin of safety is not enough yet (>30%); however, it’s close to 30%. Given the substantial competitive advantages and the proximity to 30%, I will say Dino is a ‘Buy’ because the model uses a conservative ROE to project EPS.
Conclusion
Dino Polska is a leading grocery retailer in Poland with a proven growth and profitability track record. The company's competitive strengths include its scalable operating strategy, efficient supply chain, and standardized store format. Despite some risks, such as regulatory and competition risks, Dino Polska is a 'Buy' recommendation due to its solid competitive advantages and proximity to a 30% margin of safety. However, the competition risk remains worrisome, as Dino Polska does not have any pricing power, and it is challenging to pass rising costs to customers. Dino Polska's competitive advantages and proven business model make them a strong player in the Polish grocery retail market. The company's undervaluation and potential for growth make it an attractive investment opportunity for investors looking for exposure to the Polish market.
For further details see:
Dino Polska: Competitive Advantages And Upside Potential Make It A Compelling Opportunity