2023-08-14 13:28:11 ET
Summary
- Dino Polska S.A. is a top supermarket chain in Poland with 5% market share, but has room to grow.
- The company's scale economies shared model and consistent store growth contribute to its success.
- Despite recent headwinds, Dino Polska has shown profitable operations and attractive returns for investors.
Thesis
Dino Polska S.A. (DNOPY) is one of Poland’s top supermarket chains, but it only has roughly 5% market share. With still plenty of room to grow, I believe this company is poised to continue producing profitable growth with consistent store growth. Its scale economies shared model is the key to its success, and it continues to pursue it adeptly. My modelling assumptions assume a moderate unwinding of the headwinds Dino Polska faced over the past 18 months and yields a 23% by the end of 2024, using an exit multiple of 21x one-year forward EV/EBIT. This return profile is attractive.
Overview of the business model
Dino Polska is one of Poland’s top players in the supermarket industry. The company was founded in 1999 and has rapidly grown its store footprint, offering branded products at “everyday low” prices. The company owns and operates 2272 stores, and each is, on average, ~390sqm . 51% of the company is owned by its founder, Thomas Biernacki, that currently sits on the board of directors. Roughly 42% of the company’s sales come from fresh food, 46% from other food and 12% from non-food products.
Recent performance
DNOPY has grown revenues by 34% annually over the past five years and EPS at 38%. Currently, the company makes run-rate revenue of 22 billion PLN (roughly $4.8 billion). Over the long term, stock prices follow fundamentals, and thus Dino Polska has crushed its Warsaw Stock Exchange Benchmark ( WIG ). DNOPY returned 33% annual returns over the past five years, compared to the negligible 1% annual return of the index. This outperformance is driven by the company’s growth of stores, which grew from 511 in 2015 to 2272 today , growing 26% annually.
Although the company is modestly geared, the Net Debt/EBITDA has always been kept within reasonable limits of 0.5-2.5x and is currently at 0.77x. Management has been prudently allocating capital to pay down debt that is used to fund growth. Capex to sales has always been between 7-10% of sales. That drove FCF to negative territory, yet the company has healthy Cash Flow from Operations that make for ~7% CFO/Sales margin.
In sum, the company has profitable operations and chooses to allocate capital to fund its store-count growth. The company’s brand is gaining significant traction with consumers, and in the following section, I will explain why. Before that, I will highlight a few contemporary headwinds the company is facing.
First is the war in Ukraine, which has had two positive and negative effects. On the positive side, ironically, demand has picked up due to refugee migrants crossing the Polish border. According to data from the United Nations, 6 million Ukrainians crossed the border to Poland. However, the negative impact relates to that impacting the rest of the world, namely inflation. Food inflation ((CPI)) reached 20% in 2022 and modestly decelerated to 17%, yet still high.
The second large issue is interest rate hikes by the national bank of Poland. Rates have climbed from 0% in early 2022 to 6.75% today. That caused a headwind in shopping baskets but has also influenced DNOPY’s ability to use debt to finance its expansion.
Competitive advantage
If you have ever studied the legendary investor Nick Sleep , you would know what he thinks is the most potent competitive advantage alongside network effects . He calls it Scaled Economies Shared . This simply means, as a business scales, scale savings are passed on to the customer in the form of lower prices. While most companies prefer to keep the benefits generated from scale, some decide to pass them to the consumer. The customer reciprocates in two ways, spreading their satisfaction through word of mouth and purchasing more goods. A great example of this strategy is Costco (COST) in the United States. That’s exactly Dino Polska’s strategy. The company made a name for itself in guaranteeing the lowest prices in the market while delivering decent quality products to consumers. This strategy led to steady and increasing ROIC, that is now at ~22%.
Factors generating value ahead
Inflation moderation
Although inflation is still high, there are signs of meaningful deceleration, which lead me to believe that there is light at the end of the tunnel. In fact, food CPI is, for the first time since 2021, exceeding food PPI in Poland. Consequently, cost inflation should begin to moderate, and so will DNOPY’s margins. A sidekick to this catalyst is the 5% increase in the minimum wage that took place in July 2023. Although food inflation was high, Dino Polska continued outperforming inflation with like-for-like sales growth that was, on average, ~8% higher. This is reflected in its robust profitability, outperforming that of the industry and peers.
The margin expansion is aided by Dino Polska’s store ownership, avoiding rising rents, but also by the fact that it has solar panels on ~80% of its stores.
Room to grow profitably
Despite its great success, Dino Polska only has ~5% market share with low levels of geographical penetration. Stores are usually located in villages, small towns and suburbs.
There is significant room for expansion in East Poland, and Capex to Sales has been historically depressed compared to the long-term average. I expect DNOPY to reaccelerate its footprint growth as soon as the macro picture improves materially. Store growth should return closer to its historical average of 23% compared to 19% last year. This should fuel growth of 27% annually over the next five years.
Valuation
As established above, this business model has a proven track record of insulating the impact of inflationary shocks, resiliently pursuing store growth and having strong operational capabilities evidenced by strong margins relative to peers and excellent returns on capital.
My model assumes a fairly reasonable 27% average growth rate through 2023 and 2024, with (conservative) 8% operating margins. I say conservative because, as explained above, the company is recovering from unfavorable headwinds linked to cost and demand. To arrive at the target price, I applied a 1-year forward EV/EBIT 2024 exit multiple of 21x, which is marginally lower than the 22x five-year average. That yields a target price of PLN 530, implying a 23% upside from today.
Risks
Ukraine war
This is the main and biggest risk. Another wave of aggression can cause an uptick in inflation, which will eventually lead to margin pressure (again) for Dino Polska. In such an event, the downside will not be detrimental, as evidenced by the past 18 months. However, the exit multiple will likely be depressed, leading to modest returns.
Competitive pressures
Biedronka, LIDL and Carrefour have a strong presence in the Polish market, and they may pose intensifying competitive pressures against Dino Polska. Particularly, Biedronka has approximately 20% market share and has strong levers to pull when it comes to competitive pricing. Intensifying competition will likely lead to a slight deterioration in margins below my current assumption of 8% by 2024.
Conclusion
Dino Polska's exceptionally successful scale economies shared strategy has served shareholders beautifully since it went public. Investors enjoyed a 48% annualized return since going public. The short-term headwinds obstructing Dino Polska's ability to perform are beginning to unwind, and the upside is becoming more visible and attractive.
For further details see:
Dino Polska: The Rising Star Of Polish Supermarkets