M.Video - Gross Margin Pressure, but Strong FCF and Dividends

M.Video's gross margin got squeezed in 2H20, as it procured goods in the spot market amid merchandise shortages. FCF came in at R9.5 bln (it was negative in 2019), and the company will pay out 100% of adjusted net income (R12.2 bln) in dividends, for an 8% dividend yield. So far this year, revenues are up 24% y-o-y, but we expect more pressure in 2H21 due to base effects. We have upgraded our financial forecasts to factor in the results and strategy, raising our mid-term EBITDA forecasts 8% on average. While we do not have a target price due to the stock's poor liquidity, we highlight that it trades at a discount to peers, while a sustainable dividend stream should provide downside protection.> Gross margin under pressure in 2H20... Consolidated revenues were in line with the earlier reported trading update at R244 bln, up 20% y-o-y (excluding VAT). The gross margin sank from 25.7% in 1H20 to 21.6% in 2H20. The seasonal H-o-H compression was more pronounced than usual due to a number of factors, primarily a higher share of spot purchases (versus bulk purchases at the start of the season) and sales mix changes (higher sales from the digital category and lower services revenues). M.Video is switching to pre-purchasing inventory, which should help the gross margin recover in 2021.> ... but strong opex control and solid FCF. SG&A expenses excluding D&A decreased from 18% of revenues in 2H19 to 17.1% in 2H20 despite the extra Covid costs. The EBITDA margin decreased from 7.7% in 2H19 to 5.5% in 2H20, partially mitigating the gross margin compression. Capex amounted to R10.4 bln in 2020, flat y-o-y, while OCF grew to R19.9 bln, up from R6.3 bln in 2019. FCF in 2020 was R9.5 bln (versus negative in 2019). > Ambitious five-year targets reiterated. These include raising GMV from R0.5 trln in 2020 to R1.0 trln in 2025 (with up to 5% coming from 3P), which implies a 15% CAGR. This would require opening 500 stores and entering 100 cities. As half of the stores are to be in a small format (250 m2 Eldorados), this would only entail 5% space expansion annually. The EBITDA margin should stay at 5-7%, with capex not exceeding 2% of GMV (spent mostly on IT). This should allow M.Video to distribute 100% of its net income as dividends. > We raise our EBITDA forecasts 8%. Having incorporated the 2020 results and the strategic plans, we upgrade our 2021E-24E EBITDA forecasts by 8% on average and our FCF forecasts by 7%. We are still below the company's targets, as we expect a more challenging market. The stock trades at a discount to global peers, and we think the 1H21 financials will be strong.