CBD: When the Catalyst Is Slapping You in the Face

Apr 20, 2023

I recently made my first purchase for the year, buying a core position in Brazilian holdco Companhia Brasileira de Distribuição (CBD:NYSE). I believe it has merely been caught up in the general market/SIVB sell-off and the price being offered is too good to pass up.

CBD is engaged in supermarket/retailing operations and is controlled by the French giant Casino, with 41% ownership. The business is made up of three components- the legacy Brazilian supermarket division (GPA), a 97% controlling interest in the Columbian retailer Grupo Éxito and a 1/3 stake in French online retailer Cnova.

The holding structure is debt heavy and a little confusing, possibly explaining the current discount, but management is taking steps to simplify the situation.

Essentially, the Éxito stake trades on the Columbian Exchange for the equivalent of R$5.8b and Cnova trades in Paris, with the 1/3 stake being worth a further R$1.9b. Management has also recently sold their Hypermarket division and will be channelling the proceeds into de-leveraging. Rendering net debt effectively at R$2b, providing a net asset value of R$5.7b for these two assets alone (all figures will be in BRL, current BRL:USD=.20).

CBD is currently available at a market cap of R$4b and management have decided to get aggressive about closing the gap. They are mid-way through the process of spinning off 87% of their Éxito stake into another public entity that will be NYSE listed. This is scheduled to occur in Q2, so the catalyst is almost upon us.

Once this happens, Éxito will be unconstrained to trade at a higher valuation as it is the dominant chain in Columbia and currently sells for only 4.2x EBITDA, partly due to low float/liquidity.

Additionally, there is still GPA, the legacy Brazilian supermarket chain within the group we haven’t even accounted for yet, that did R$1.2b in EBITDA last year. 2022 results were weak, but the company is obviously worth something. I would propose a very modest multiple of 3x for this business, although believe it could certainly go higher in a better environment. As we have already accounted for group net debt, this would be pure equity value adding another R$3.6b to our NAV.

There will be some fees and taxes to be paid during the restructuring, but CBD looks something like paying R$4b for R$9.3b of conservatively calculated assets (a 57% discount).

As a framework for just how prudent the above numbers are, consider that Brazilian peers Grupo Mateus, Atacadão (Carrefour Brasil) and Assaí all trade between 6.5-10x EBITDA today, even with Latam sentiment where it is.

CBD reminds me of First Pacific (another portfolio holding), as it has two layers of safety. A deep discount to NAV, and that those NAV components are also highly undervalued.

The business

The company is a retailing conglomerate and one of the largest food retailers and employers in South America. The company has a large footprint with 699 stores in Brazil and 602 stores across Columbia, Argentina and Uruguay via Éxito. The company is led by Marcelo Pimentel, who has been since early 2022.

The Brazilian business (GPA) has rationalised over the last few years, with the succesful spin-off of its wholesale, self-service business Assaí, to allow it to concentrate on its more premium and digital offerings. 71 hypermarket stores (Extra Hiper) were then sold to Assaí, allowing GPA to de-lever significantly, with the last associated payment recieved in Q4.

GPA has been struggling and could be considered a turnaround. Margins were squeezed in 2022, with same-store-sales improving 6.6%, but Adj. EBITDA falling 16%. Double-digit inflation in Brazil was an obvious headwind.

Despite this, SG&A was well contained and I believe GPA will perform much better with the focus of a stand-alone business. The stated target is 300 new stores opened between 2021-24, of which 72 were opened last year.

GPA’s premium brand Pão de Açúcar will be the main driver of growth, with a focus on their smaller proximity stores Minuto Pão de Açúcar. Their traditional “neighbourhood” style supermarket brands Compre Bem and Extra are being refitted and converted where strategically appropriate.

By contrast, Éxito is a high quality asset. In addition to retail operations, the company owns substantial real estate, has modest leverage and pays a nice dividend. It is the Columbian leader in retailing, digital food sales and mall operation, with 34 thousand employees across its network.

Obviously Columbia isn’t many investors jurisdiction of choice, but it is a resource-rich economy, sentiment and the currency are both at extreme lows and the people need to eat.

The spin

In September last year, CBD announced its intention to spin-off 83% of its holding in Éxito, a free float of just 3% was untenable and an impediment to the stock price. The complexity of the holdco, was also clearly obscuring GPA, with the market essentially assigning it a negative valuation.

CBD is listed on both the Brazilian exchange (CVM) and the NYSE. Éxito will mirror this set-up, allowing NYSE-holders to receive NYSE-listed shares. So far, neccessary approvals have been obtained from the creditors and the Brazilian SEC, with US approval is expected during Q2.

Until the process is concluded, CBD will continue banking dividends from Éxito and management have flagged their intention to take advantage of their improved balance sheet with share buybacks. A post-spin puke may actually be in long-term investors’ favour.

Joel Greenblatt has famously described the dynamics of spin-offs (spun-off securities are orphaned and sold off indiscriminately), but they may be less relevant here. CBD may prove to be a rare situation, where the spun-off asset is by far the sounder business and seen as more desirable by the market. Anyway, I won’t speculate too much on that side of things. Come what may.

Risks

Firstly, Groupe Casino could be considered a risk on its own. It is controlled by Frenchman Jean-Charles Naouri, who is a fan of leverage and the sort of opaque holding structures that would make Bolloré blush. Many Casino companies have been poor performers in recent times and his holdco Rallye was the target of a short-report by Muddy Waters in 2015.

However, as management is actively simplifying the structure at CBD, I don’t believe there is any cause for alarm. Many European investors may be wary of Casion assets, but the valuations of the two businesses should speak for themselves.

Secondly, the Éxito spin is currently going through the approvals process. If this were to be blocked for any reason it would likely be a set-back to the share price.

While the tanking of a near-term catalyst would be disappointing, I think management has demonstrated their determination to recognise value here. There would be other potential options, such as monetising the Cnova stake or share buybacks that would take a little longer, but lead in the right direction.

I have deliberately chosen to value CBD, as it is currently. The spin-off will be a pleasant bonus.

And finally, of course these are South American assets, mainly under the regimes of newly elected leftist governments, but I just don’t think there are many foreign investors left to sell. Sentiment seems about rock-bottom and I don’t believe supermarkets are an industry that will see drastic political interference.

On the flip-side, these operators have navigated high-inflation environments for a number of years now and may flourish if interest rates are peaking in Brazil, as hoped.

In fact, my next planned post is on why I believe Brazil is the Trade of the Decade.

Valuation

Inversion is an interesting way of considering CBD’s valuation. What needs to be true to actually lose money here?

If we assume a scenario where:

Cnova collapses to zero
GPA trades for a preposterously low 2x EBITDA post-transcation ($R2.4b)
Éxito falls even further below its current historical low valuation to 3x EBITDA ($R4b, it carries modest debt)
Net debt net blows out to $R3b
The market applies a 20% holdco discount

The resulting market cap would be $R2.7b. A mere 32% downside risk in an unrealistically bad, worst-case scenario.

Now a bullish scenario, reflecting improved sentiment, but nothing historically crazy:

The Cnova stake at current market value ($R1.9b)
GPA trades at 4x, still at the very low end of global peers ($R4.8)
Éxito returns to 6x EBITDA, a valuation it has often traded at ($R7.8b)
Net debt at post-transaction estimate of $R2b
There is a negligible holdco discount, as the structure has now been greatly simplified

Fair value would be $R12.5b, just over 200% upside. A reasonable risk/reward, in my view.

While sum-of-the-parts analysis is currently on the nose, this is the type of simple investing that makes sense to me.

Guy

PS. There seems to be some shadow-banning of Substack posts on Twitter at the moment, so if you enjoyed this post, please share it with anyone you think might appreciate it. All feedback welcome as always, thanks for reading.

I hold a core position in CBD:NYSE shares

As always, this isn’t investment advice. Please do your own due diligence and seek professional advice if you’re unsure about your finances.