Companhia Brasileira De Distribuição ($CBD)

Upcoming spin of Grupo Exito in <70 days will unlock significant sum-of-the-parts (SOTP) discount, with stub currently trading at a negative value.

Quick note: I originally shared this idea as a Twitter thread (below) and as a VIC idea (although I did not count it as one of my yearly ideas because I had already shared this on Twitter). As always, thank you for any comments + feedback + pushback.

https://twitter.com/ClarkSquareCap/status/1636128967928467456?s=20

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Thesis summary

CBD is a Brazilian holding company that is set to crystallize significant sum-of-the-parts value through the upcoming spin (on track for 2Q 2023) of its Colombian grocery chain, Grupo Exito. At the current price of $3.03/share (US ADR), shareholders are set to receive 4 shares of Grupo Exito, which trade on the Colombian stock exchange, worth $3.61 USD. In other words, the market is ascribing the remaining "stub" (GPA) a negative value, despite the fact that the stub cannot trade at less than 0 once it is separated; the stub includes multiple monetizable assets that should be worth >$0.50/share as well as the core GPA grocery chain that has c. 700 high-end grocery stores in Brazil. If you assume the stub trades at 0 and Exito is trading at the "correct" valuation, your upside from here is ~20%. At the current price, Exito is trading ~5.0x EBIT on 2023 numbers, which I believe is cheap relative to peers and where it has traded in the past. Ultimately, I believe that the stub and Exito should be worth at least >$6.00/share over time, which is at least a double from today’s price.

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Pão de Açúcar store in Brazil (part of GPA).

Business background

CBD is a holding company composed of the following assets:

GPA

• 699 grocery stores located in Brazil.

• 3 main grocery banners in Brazil

  • High-end grocery - Pão de Açúcar

  • Mid-tier grocery - Mercado Extra / Compre Bem

  • Proximity stores (neighborhood small grocery stores) – Mini Extra / Minuto Pão de Açúcar

• Additional business lines: gas stations (to be sold) + some real estate

Grupo Exito

• 603 grocery stores located in 3 countries: Colombia, Uruguay, and Argentina

  • Colombia (28% share) and Uruguay (43% share)

• 3 store banners in Colombia:

  • Exito - hypermarket (combination of supermarket + department store) - 210 stores

    • Non-food represents ~40% of sales (apparel, electronics, etc.)

  • Carulla Fresh Market - supermarket - 104 stores -  premium format (market leading)

  • Surtimayorista - cash and carry / low-cost stores - 42 stores

                        ○ Plan to add 25 stores per year

• Other businesses:

  • JV - private real estate vehicle - fondo inmobiliario colombia (own 51%) - worth ~$300m (at 50%; and 1.5x book value)

  • Credit card + receivables business

  • Loyalty points business

Cnova

• Cnova owns one asset: Cdiscount – a French e-commerce website attempting to be the Amazon of France. It is the 3^rd largest e-com site in France. GPA owns 34.2% (Casino group owns 65%) of the asset and has a preference to be the first to dispose of shares. On a change of control, GPA has the right to sell its entire stake. Cnova currently trades at ~13x 2021 EBIT (EV: EUR ~1,850m). Only 1% of shares are currently floated on the public market.

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Thesis

Significant sum of the parts value will be crystallized by an upcoming spinoff of Exito.

CBD holders will receive 4 shares of publicly traded EXITO (@ $4,000 COP/share) worth approximately ~$3.61 per share. At the market price, EXITO is being valued at roughly ~5x operating profit (EBIT) on my 2023 estimates, a wide discount to grocery peers and to itself.

This leaves a remaining stub trading at negative ~$0.60 per share with the following assets:

• PLUS: $390m USD ($1.45/share) – Shares of Cnova (117m shares @ EUR 3.0/share)

• PLUS: $250m USD ($0.93/share) – Sales of non-core assets expected to be completed in 2023/2024

  • Mid-point of mgmt. guidance of 1,000m-1,500m reais in non-core asset sales

• PLUS: $145m USD ($0.54/share) – Remaining 13.3% stake in EXITO that CBD will retain in order to de-lever

  • (173m shs @ 4,000 COP/share)

• MINUS: $430m USD ($1.60/share) of net debt at the CBD hold-co level.

• MINUS: $200m USD ($0.74/share) of taxes for asset sales (25% tax rate for Cnova, Exito, non-core assets)

Adding all of the parts gets you ~$155m USD in net cash (~$0.60 per share) while still placing no value on the core operating business, GPA. GPA has ~700 stores, R$16.3B in sales LTM, R$1.3B in LTM EBITDA (post-IFRS16), to which the market is ascribing absolutely no value.

Non-fundamental reasons for sum of the parts discount will be fixed with the spin-off, due to:

1. Improved liquidity:

   1. Grupo Exito – Only ~3.5% of the float is available on the public market. Post-spin, this should improve to >50% and will make Exito one of the most floated stocks on the Colombian stock exchange. Post-spin, we can expect increased liquidity, increased analyst coverage, and a likely multiple re-rating as Exito becomes investable for international funds as well as local Colombian pension funds.

2. Improved desirability of individual parts

   1. Geographic exposure: current CBD holders tend to be Brazilian funds and Brazilian retail, and there are likely equity investors who do not want to own CBD due to having significant Colombian equity exposure. On the flip side, Colombian investors might currently wish to own Exito but might not be interested in owning or capable of owning the ADR or the Brazilian security, PCAR3. The spin-off solves this problem.

3. Simplification of the corporate structure / financial statements

   1. Many moving parts in the financial statements make it hard to get a “true” picture of the underlying earnings power of the business, particularly for core GPA. Post-spin, the financials will be a lot cleaner and easier to understand. For instance, you can only see the cash flow statement for consolidated operations (which include Exito) and not for GPA by itself.

4. Improved focus + better, more aligned incentives + greater access to capital markets for Grupo Exito (for potential expansion, high ROIC projects, etc.)

 GPA is undergoing an attractive transformation which should make the equity more valuable over time.

1. Compelling de-leverage story within core GPA

   1. Pro-forma net debt at the end of FY22 came in slightly above $R 2,000m (down from R$3,500m in Q3 2022). Management expects to end FY23 at $R1,000m and FY24 at zero net debt.

   2. Debt paydown will accrete to the equity and you get an improvement in free cash flow generation through lowered interest expense.

2. Incremental margin upside through operational improvements (LTM ~7.6% adj. EBITDA post IFRS-16)

   1. Expansion and conversion project temporarily affecting CBD margins through SG&A deleverage (stores not earning at maturity, but costs are at 100%).

   2. The has been some temporary pressure (20-30bps on GMs) due to inflationary pressures, which I expect to be remediated over time.

   3. Management guidance laid out during Analyst Day (targets 8-9% adj. EBITDA margin by 2024; post-IFRS16)

3. Re-focus on store expansion with proximity format, which should drive accretive economics.

   1. Company set to build out 250 new proximity stores that are accretive to overall economics.

   2. Most attractive format. Low CAPEX investment, but higher density. Results in higher ROIC per box.

   3. Incremental opportunity = 250 * R$12m * 3% margins = ~R$90m incremental. At 5x EBIT multiple, that is an incremental $0.33 per share value to the stub.

4. Sales uplift from recent store conversions.

   1. 14 stores have been recently converted from hypermarkets (post-Assai sale). Another 50 or so have been converted into premium PdA stores.

Grupo Exito is a stable, high-quality asset, with a defensible competitive position that is getting stronger.

1. Exito has a leading market position in Colombia (28% share) and Uruguay (43%). With significant barriers to entry given high cost of building out infrastructure + distribution + building relationships with food and non-food brands.

2. Increasingly, grocery sales moving to omni-channel delivery model, which helps cement lead for incumbents (greenfield opportunity for delivery and/or online players not economically feasible; AMZN + Whole Foods).

3.  Same-store-sales growing at >20% in the last few quarters (mostly due to pricing). I expect that the company can continue to grow earnings in the low-double-digits for the foreseeable future (even if comps slow down to MSD) from a combination of gross square meters added (+3-4% year) + MSD comps + op. leverage. 

Incentives from majority owner, Casino Group, are to maximize the value of the parts (CBD, EXITO, etc.) to prepare them for a potential asset sale in order to de-lever within the next 18-24 months. 

1. Excess leverage: Casino Group leverage is ~6.9x and has EUR 1.5B of debt due in the next ~12 months, and an additional EUR 1.5B of debt due in 2025. To shore up liquidity, Casino Group has committed to an asset disposal program of at least EUR 1B by 2023 (of which, it communicated its intention to sell $500m worth of Assai). Re-org suggests that the EUR 1B disposal target will have to be raised, which means >500m of sales of CBD/Exito.  

2. History of successfully spinning and divesting assets

   1. Sendas / Assai spinoff was a big winner.

   2. Sale of hypermarket stores from GPA to Assai was done at a high multiple, creating value for CBD holders.

3. Possibility that Casino Group is thinking of selling GPA to a Brazilian competitor, either in whole or piecemeal. There were some news stories about 6 months ago regarding a potential sale of the PdA banner.

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Valuation

The valuation is very asymmetric given a negative value for stub

• Downside protection: If you assume that the stub (GPA) trades at asset value (c. $0.60) post-spin, Exito shares can decline over 25% before you lose any money.

• Arb: if you assume Exito continues to trade at 4,000 COP/share, plus the stub is worth asset value (c. $0.60), your upside is above 40%. At that price, Exito trades at ~5x EBIT, which is a low multiple for a high quality business.

• Mid to long-term: I believe that the stub (GPA) could be worth at least $1-$2 per share (net asset value + the operating business at a 4-5x EBIT multiple). Exito shares deserve to trade at a higher multiple (6-7x EBIT) in my opinion – in this case, the value of the 4 Exito shares could be worth c. $5.00/share. Putting it together, I believe the stub + Exito should be worth at least $6.00/share, or more than a double from today’s price.

I believe that the setup is attractive because it’s very asymmetric. Because the stub will go from a negative value to some positive value (I think “stub” GPA could start trading somewhere between $0.70 and $1.00 per share), you are protected from a good degree of losses if Exito declines. I have created this table below to illustrate some scenarios:

Below I share my SOTP on Grupo Exito including my estimates:

Current CBD sum-of-the-parts and cap structure:

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Trade structuring

• I recommend a long position in the common equity (ADR: CBD).

  • CBD (NYSE) ADTV is ~$3.5m per day

  • PCAR3 (Sao Paulo) ADTV is ~10m per day

• There might be additional opportunities to make money:

  • Creating the stub – if share prices stay where they are, there could be a possibility to create the stub post EXITO spin by going long CBD and shorting EXITO (through common or thru swap). The risk/reward is likely the most compelling with this option.

  • Adding to EXITO (common) post-spin – given shareholder dynamics, it’s likely that EXITO will trade down post-distribution. Given the appeal of the asset and the low valuation, I think this presents a compelling opportunity to add to the position.

  • Arbing EXITO shares – given that EXITO shares will be completely fungible across NY, Colombia, and Brazil, there might be an opportunity to buy shares of the Brazilian BDR and convert them to the US ADR or to the Colombian stock for a small profit.

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Timeline and key milestones

Things you need to see for the thesis to hold:

• CBD making progress on spin-off. Expected date for spin before end of Q2 2023.

• CBD making sales of non-core assets (2 real estate parcels, gas stations)

  • The company expects ~half of the proceeds to be realized in 2023.

• CBD making steady progress toward the 8-9% EBITDA (post-IFRS16) target towards 2024.

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