DP Eurasia – Lots of adj. EBITDA, still waiting on big profits #DPEU
For the second day in a row, I am reporting on a holding in my portfolio whose profitability is in doubt. This feels quite unusual!
In my defence, DP Eurasia is my smallest holding, and CMC is only a little bigger (each c. 1%). And I remain excited about the prospects at both of these companies.
That said, I would have been much happier if DPEU had posted a profit yesterday. Instead, it posted a small pre-tax loss of of 4 million Turkish Lira (TRY).
Positive Thinking (and Reality, I Hope)
The good news is that if we move a little further up the income statement, things don’t look nearly as bad. Operating profit was a juicy 53 million TRY.
And if you are happy to focus on adjusted EBITDA, this metric increased by 22% to 111 million TRY.
When you look at it in those terms, the market cap is a lot more understandable (latest share price 87.1p, market cap £127 million or 930 million TRY).
We should also factor in outstanding net debt of 187 million TRY, or 155 million TRY if you add back in a loan deposit made by the company to its lenders (this is how we get “adjusted net debt”).
DPEU’s enterprise value is therefore in the region of 1.1 billion TRY. The trailing EV/EBIT ratio is 20x, while the trailing EV/EBITDA ratio is 10x.
Those are rather hefty ratings, but this is a growth stock with serious expansion plans in Russia. It’s also performing well in Turkey, despite experiencing what is widely reported to be an economic meltdown plus political uncertainty.
It was trouble in Turkey, especially US President Trump’s tariffs, which sparked the greater than 50% collapse in DPEU’s share price over the past year:
So what happened?
DPEU performed reasonably well in comparison to its guidance in 2018.
This was the guidance for medium-term growth that was given a year ago:
- Turkey: 23 new store openings, less than guidance but this makes sense given the turbulence in the country.
- Russia: 58 new store openings, at the top end of guidance.
- Like-for-like system sales growth: 9.3% in Turkey and 16% in Russia, both at the top end of guidance.
- Capex: 37 million in Turkey, above guidance, and 555 RUB in Russia, above guidance.
Capex was the big “miss” in the sense that the company incurred significant additional expenditures which had not been forecast by management.
The explanation was as follows:
‘…management took advantage of additional growth opportunities. In the Turkish segment, the Group saw an opportunity to acquire some franchise stores and to open corporate stores. In the Russian segment, the Group opened additional corporate stores compared to the management guidance.’
Acquiring franchised stores is not something I would see as ideal, as a large part of my attraction to this company is its ability to generate earnings from franchisees. But I can accept that conditions in Turkey weren’t ideal, and spending an additional 7 million TRY than planned on acquisitions and growth is not a big problem.
The 555 billion RUB spend in Russia sounds like a lot, but at an exchange rate of £1 = 85.5 Russian Roubles, it only amounts to £6.5 million. The overspending was only an extra £2 million, and it enabled the company to reach the very top end of its guidance with a heavy mix of corporate stores. So I’m not overly concerned about this.
Management expectations for the medium-term are for more of the same in terms of growth.
As you can see, this is not much different compared to last year’s guidance. There is a range for Turkey store openings which is more in line with 2018’s actual result, and RUB capex guidance is also increased to reflect a figure closer to 2018’s result.
So I think it’s fair to say that operationally, things went roughly according to plan in 2018, and the plans for the future aren’t radically different.
In the short-term, however, the company has reduced its guidance for like-for-like growth in Russia, after several years of extraordinary growth. It cites increased competition in Moscow as a factor.
So why the loss?
The loss was caused by these items (highlighted in yellow). Without them, the company would have reported a tidy profit.
Foreign exchange losses and financial expense are both related to the company’s Euro-denominated debt liabilities. The explanation given is as follows:
The reduction in adjusted net income was primarily driven by the movement of the Russian rouble against the Euro prior to the Group’s refinancing of its Euro denominated bank loans in Russia with a Rouble facility and increased bank loan interest rates in both Turkey and Russia… In the coming years, management expects foreign exchange results will be less volatile due to the fact that the Group no longer has any hard currency bank borrowings.
It’s reasonable to be sceptical about this, but I do think that the signs are positive that FX-related losses will lighten in the years ahead.
In July 2018, the company changed its debt facility from Euros to Roubles. There was indeed a severe appreciation in the value of EUR against RUB through 2017 and H1 2018 – very unhelpful when you are selling pizzas in Russia!
The new RUB facility demands an interest rate of 9.7%. I would be pleased to see the use of this facility reduce slightly in 2019, but it depends on how much capex the company ultimately goes for.
Meanwhile, TRY bank borrowings charge the extreme rate of 24.7%. We should bear in mind that Turkish inflation is officially running at c. 18%.
Under “Subsequent events”, the announcement states:
DP Eurasia shareholder Fides Food Coop. sold 14,357,241 shares with the Unit Price GBP 1.05 as of 1 February 2019.
I can’t find any RNS in relation to this share sale, and have contacted the company’s advisers for clarification.
I continue to hold a small stake in DPEU, on the basis that it still has interesting potential for high returns.
At the time of publication, the author has a long position in DPEU.