EUR 850.00 For Business Accounts Only

Morningstar | Weakness in Several Regional Markets Masks Dufry's Underlying Profit Improvement; Shares Cheap

We are maintaining our fair value estimate for narrow-moat Dufry as the company reported nine-month results slightly below our expectations, with 4.6% sales growth versus our 7% full-year forecast. We expect to revise our 2018 sales forecasts downward to reflect the challenging situation in Latin American markets (Latin America contributed 20% to revenue in 2017 and has declined 2.8% year to date) and lower growth in Spain driven by the decline in British tourism. This would have only a single-digit negative impact on our fair value estimate. We believe the shares are undervalued.

The company delivered further operating margin improvements in the third quarter, despite slightly negative organic sales development (down 0.7%). Despite concession inflation running above our expectations (at 40 basis points), it was offset by 50 basis points of gross margin improvement (versus the 40 basis points we expected for the full year) and operating savings under the BOM program, which generated a 30-basis-point improvement in selling and administrative expenses.

Higher-than-expected concession inflation is two thirds due to the Spanish contract, which has fixed costs through minimum annual guarantee payments, while revenue was hit by a negative mix of passengers (more local travelers and fewer British tourists, who spend 5 times as much as the locals), hurting the margin. The contract was signed five or six years ago and is up for renegotiation by the end of 2019-20. Should the current situation persist, we believe the contract could be renegotiated at more favorable terms (shop layout reorganization), which could lead to performance improvement. Hence, we don’t believe that current concession cost increase is due to a broad-based pickup of underlying concession inflation, and we remain comfortable with our 20- to 25-basis-point concession inflation forecasts over the next five years (excluding Spanish operations, concession inflation was 10 basis points year to date).

Organic growth in the Southern Europe and Africa region, which includes Spain, was 5.2% negative in the quarter. U.K. and Central Europe increased 0.2%, negatively affected by the termination of the Geneva contract (4.2% organic growth excluding Geneva), Eastern Europe, Middle East, Asia, and Australia region’s organic growth decelerated in the third quarter to 4.4% versus 22.1% organic growth achieved in the first half. North America continued its strong performance with 7.1% organic growth in the quarter and 7.5% over the nine months.

The company forecast EBITDA margin between 12% and 12.3% versus 12.3% in the first nine months, 12% last year, and our 12.5% outlook, given difficulties in several markets and the start of lower-margin cruise line contracts.