Saturday, 19 August 2017

Zooplus; The AMZN of Pet Supplies?

Is Zooplus (ZO1) the Amazon of pet retail? The online pet retailer has c3.5% of the 25bn EUR pet supplies market and 50% of the online market. Sales have a 5-year CAGR of over 30% and are set to top 1.2bn EU in 2017 according to management estimates. ZO1 is an interesting case study to analyse the potential benefits of scale for groceries.

Firstly, the potential business unit growth is promising. The EU online market is currently 6.8% of the total which is far below the US rate of 12% of total dog owners buying online. It seems the EU market is years behind the US and due to high density, higher use of public transport and favourable demographics, it is reasonable to expect a much higher proportion of Europeans to ship pet food online. Assuming ZO1 maintains 50% of the online market and the EU industry online market share expands close to US ratio over the next 10 years, we can expect ZO1 to earn around c2.5bn EU in 2025.

ZO1 currently has a 25% gross margin and 2-3% operating margin with 1bn EUR in revenue. The bull thesis comes from assumptions on how increased scale will drive operating margins. Let’s explore the reasons for given by management in the recent presentation.

Procurement savings
With scale comes procurement power. Can ZO1 really benefit from scale over manufacturers? Brand owners know that customers are fairly loyal to the brand due to the risk of uncertainty from switching brand to something your pet is not used to. If Zooplus are heavily weighted to the largest brand would this reduce their potential sourcing scale? Pets at Home COGS is 45%, which is 25% lower than ZO1. A founder of a UK online player commented:

‘ there is no extra scale Zooplus is going to get from those brands. In this sector, it is hard to pull the brand power. Pets at Home makes most of their money from services, I think partly for this reason’.

Private label mix
ZO1 total product mix is c82% pet food, 18% non-food supplies. Pets at Home has a gross margin of 55% which explains the potential upside for ZO1 when shifting away from food.

Lower unit economics
ZO1 all-in logistics cost is currently 20% for the group but c15% in Germany where they claim to be at ‘full scale’. But when diving into ZO1’s logistics infrastructure, it seems the unit logistics costs are down to efficiencies in labour and overheads intra-warehouse. ZO1 use an ‘arms-length third-party’ courier, which all other online players seem to use for the UK market, and thus will limit the potential to reduce unit costs.

The same expert commented:

‘ we’re using the same couriers and packaging suppliers, so it is hard for Zooplus to get any real scale there’.

There are obvious scale efficiencies when comparing the 15% logistics costs of Germany vs the Group’s 20%. But can we assume that as you build out more DC’s in dense countries, this 5% saving will flow straight through to EBIT? Reinvesting scale advantages to improve the customer offering has long been a trait of traditional retail businesses (see Amazon Prime, supermarket loyalty schemes).

Overall, it seems the growth and spare capacity is there for ZO1, but the potential for margin expansion is limited. If long run operating margins double to 4% on 2025 revenue of 2.5bn EUR,  ZO1 will earn 100m EUR in EBIT which only gives 25-50% upside over 10 years on 12.5-15x terminal multiple. However, Patt, Zooplus’ CEO, has recently put his money where his mouth is as he recently purchased $220k of stock at average price of 119EUR.

Disclosure: this post was written Feb 21st.

Tuesday, 25 July 2017

FEVER TREE; 'the tonic that makes a gin and tonic'

Fever Tree (FEVR:LON)

Disclosure: this post was written around Feb 2017 but wasn't published as I had not received consent from my new employer.

Fever Tree is the ‘tonic that makes a gin and tonic’. The company was set up by a former distiller who realised the best gin with a poor tonic is a poor gin and tonic, hence he set out to make the best tonic water.

Business model

FEVR has an ultra asset-light model as they outsource all bottling, packaging and distribution to third parties. They have around 30 staff for production and sales and marketing. The model is hugely scalable. FEVR partners with distributors in globally to market and sell the product.

Normally, the brand and the distributor will share the marketing expense. So FEVR will put up around 5% of the total value of product given which would then be matched by distributor. This 10% is then spent on marketing and shifting the goods. The gives FEVR huge scalability with minimal capital required. The adjusted ROIC (subtracting out intangibles) was 43% and 49% for 2014 and 2015 respectively. A FEVR distributor also recently commented, ‘one thing I love about these guys is nothing is ever sold on promotion. Ever’. Although it is still early days and you wouldn’t expect discounts or promotions for such a premium band, it’s reassuring management are putting the brand first.

The brand has grown 100% in 2016 in the UK, its largest market. The company is nowhere near at scale in US and has only dipped its foot into Asia and China.

There is also no assumption on cross-selling into darker soft drinks.

Total addressable market

The global tonic market is set to grow to 1150 K MT by 2021. With roughly 1150 litres in a metric tonne this equates to around 1.15m litres of tonic globally addressable for Fever Tree.

Fever Tree sold around 47-50m litres in 2016, giving them around 4-5% market share globally today. The average price per litre sold is £2.1 and on 2015 operating margin of 30% this gives £0.64 operating profit per bottle. Also, once this brand begins to scale globally, pricing power can potentially improve margins further.

If FEVR grow litres sold by 30% for the next 4 years to reach 100 litres sold worldwide. At an operating profit per litre of 0.78 this equates to £100m operating profit in 2020.

With a company with c 45-50% ROIC - this would equate to a 25-30x nopat multiple which gives an EV of £2740. This gives 14% 4 year annual return of a tried and tested premium brand. Also, although investing in a company wishing it to be purchased by a strategic is not clever there are not many premium brands that would fit into any of the majors' portfolios like FEVR. However, he price a strategic would pay and thus the valuation floor in this scenario is a different conversation.


What do long run economics look like?

COGS - purchased inventory which makes up raw materials, bottling, distribution and outsourcing manufacturing. It’s all outsourced. This will enable FEVR to benefit from localised bottlers and manufacturers and scale to different regions maintaining very similar unit economics as we see today. Possibly slightly lower GM for larger regions due to higher distribution costs.  

Admin expenses are labour costs and overheads which do not scale as business grows.

Assumptions: Where can I be wrong?

FEVR is obviously a huge valuation. £1.6bn is 16x revenue. But are there any reasons US consumers won’t buy into FEVR?

Litre growth is key here. Units sold.

I am assuming:

  • The long run economics look similar to today’s number due to scalability of the business model.
  • The quality and premium nature of the brand will enable it to grow worldwide. Premiumisation is a global trend and consumer tastes towards premium tonics are not vastly different regionally.
  • I am not assuming any growth in new products.
  • Litres sold will treble in 5 years. Litre growth has slowed slightly to 63% YOY last year. Is a growth rate for the next 5 years of 30% too high? We will see.

Sunday, 15 May 2016

Capital returns: concentrate on the supply side

Capital returns is a must read for anyone serious about investing and business in general. The book exemplifies that capital investment drives investment returns and, therefore, investors should be concentrating on the supply side more than the demand side. Mean reversion is driven by investment; as capital enters an industry earning over the cost of capital, returns revert to normal.

The book is a hand-picked collection of investor letters by Marathon from the past decade. The letters cover specific events on the micro and macro level, emphasising the power of capital in shaping changes in competitive advantages for industries and businesses. The essays are mostly case study based and cover a wide range of situations including the GFC, Spanish property bubble, China and Ireland's banking crisis.

'Everything (including investment) should be made as simple as possible, but no simpler' 

Why try and predict the many different, fast moving variables attributable to future demand when we can analyse the slow-moving parts of the supply side? Entrants and exits into an industry happen a lot slower and less frequent than product launches or price moves. Capital expenditure and asset growth is easier to track and forecast than revenue growth. Consumer preferences and habits are fast moving and ever-evolving but the structure of industry's and companies are slow moving. The supply side is notably easier to analyse yet it's seemingly overlooked by the sell side and market commentators.

Human nature follows trends, scared to miss out on the excess returns neighbours may be earning. Managers are under the same herding bias when allocating shareholder capital. Good management capital allocation decisions are paramount to shareholder performance in the long run. Marathon look for counter-cyclical allocators, those that are able to scoop up assets at the bottom of the cycle or who raise at the top.

Management of one company I follow fits the criteria well: TGS NOPEC. Operating within an industry that is currently consolidating and seeing huge capital outflow the company has ramped up capex to buy cheap assets and gain market share. Tracking management's allocation decisions throughout the cycle can prepare one for making a move when the demand side is clearer.

Finally, one good question the book implies investors ask oneself is: how much capital would a serious competitor need to gain market share over X company? Not only how much would they need, but how would they need to allocate this capital to gain a similar competitive position over company X?

Notes from the book here

Disclosure: No position in TGS.

Thursday, 24 March 2016

Phil Fisher's Common Stocks and Uncommon Profits Review and Notes

Charlie Munger said he 'always likes it when someone attractive to me agrees with me' when asked his view on Phil Fisher. I don't believe Fisher's views on investing instigated Munger's multidisciplinary model approach but both of their views on investing in quality businesses are sure aligned. 

Fisher follows a thorough bottom-up research process and believes in knowing any investment you have better than others. He chases previous employers, contacts suppliers and evaluates every product line of every firm that passes his initial investment checklist. He is a growth investor, but not in the modern day meaning of buying factor-based momentum stocks. A business analyst not a financial analyst. 

Fisher writes in a clear, succinct manner shedding great insight into how to research companies independently. He provides a clear 15 point checklist of what to look for in high-quality, growth stocks that is useful as a checklist before any long term investment:

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets. 

2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? 

3. How effective are the company's research-and-development efforts in relation to its size? 

4. Does the company have an above-average sales organization? Expert merchandising needed to exceed sales targets.

5. Does the company have a worthwhile profit margin? 

6. What is the company doing to maintain or improve profit margins?  "It is not the profit margin of the past but those of the future that are basically important to the investor." 

7. Does the company have outstanding labor and personnel relations? Happy employees, higher productivity. 

8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Pay attention to incentives.

9. Does the company have depth to its management? Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers. 

10. How good are the company's cost analysis and accounting controls? 

11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Understand determining factors for different industries. 

12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. 

13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth? 

14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur? 

15. Does the company have a management of unquestionable integrity? 

Full notes to the book are here

Thursday, 25 February 2016

Global Trade and the Prisoner's Dilemma Game

 Global trade volume is decreasing. Export volumes seem to have peaked, not just in one economy, globally, towards the end of 2014.  Although the declines are not as large as those in 2008, a huge 18% peak to trough globally, the widespread pressure on exports is weighing down growth and instigates the type of crazy monetary policy we have seen lately.

Extra-EU trade volume, trade exported outside Europe, has increased 1.5% over the last three years.  However, the value of this volume is 8% lower due to the real EU effective exchange rate falling 5.2% in the same period. Global trade is structurally challenged. How vital are exports to economies?

Central banks seem to be in a huge game of prisoner’s dilemma. Central banks worldwide are competing to maintain domestic growth and they are doing ‘whatever it takes’ to achieve it. They are all in a situation where if they do not devalue their currency, defecting in the prisoner’s dilemma, and expand policy, other central banks will do so and therefore they will lose the game. However, now it seems we are in a situation whereby all central banks are easing and devaluing, prisoners are defecting, and global output is therefore structurally lower; all payoffs for players are lower.

And once you leave the Nash equilibrium, it is not easy to get back there!

Thursday, 18 February 2016

Are the hedge funds shorting London Property market wrong?

Berkeley Group Holdings recently fell around 15% after a few hedge funds shorted the London housing market in the midst of panic. The funds believe there are pockets of oversupply in London and pressure from emerging market demand that will cause a supply-demand imbalance. The FT also recently released news that the price per square foot for prime London property dropped from £1,839 to £1,813 last year, indicating signs of a reverse of the excess demand in the market we have seen.

Are these macro funds playing on recent macroeconomic developments such as the effects of falling oil prices on emerging, most probably Russian and Chinese, demand for London property and FX devaluations? These short sellers led me to check some numbers to test the potential damage to Berkeley.  

The two driving factors in any homebuilders’ margins are the cost of land and final sales price.

Figure 1 shows the average selling price was £575k in 2015, up from £280k in 2012. This is huge and unsustainable growth in prices. BKG also mention 2015 average selling price was driven by sales mix at the very top end of the market.

Land costs as a percentage of final selling price peaked in 2014 at 17.3% and is 15.2% on average over the last 5 years. 
Figure 2 shows the upward trend of land cost in absolute values. The average value of land between 2012-15 was £66,000. This is nearly double the average over the previous 8 years. This is mainly because in 2013 and 2014 they purchased 5,500 plots of land in London for on average £121,000. These were all in prime spots, Canary Wharf, Dockland’s Wimbledon etc. I believe these are the purchases the hedge funds believe are bought near the top of the cycle and, therefore, will depress earnings.  However, this represents only a small portion of the land held by BKG.

Figure 3 above shows the growth in plots in BKG land bank which can be misleading. The huge jump of around 10,000 plots in 2015 is due to the long-term options they purchase through time finally being approved for development. These are plots of land that are bought years earlier, at cheap brownfield prices, and are now ready to begin development. This is where BKG earn their superior margins.

So how much damage can the £600m purchase of land at, potentially, the top of the cycle do to future earnings? We don’t get the margins for individual projects although we can make some rough estimates. Figure 4 below shows the average price for new dwellings fell max 15% and 9% in London and the South East respectively during the financial crisis.

Rightmove show the average current prices of Greater London to be around £610,000 and at the top end, which Berkeley certainly will be supplying with the £600m of acquisitions, £1.5m.

If we assume one plot is minimum one home. This means the most recent acquisitions of £121,000 per plot in Greater London were the land cost for each home. At a 33% discount to the average price in London, the selling price would be £400,000 for these plots. This gives them plenty of room to not actually destroy value with this purchase even in worse case scenario.

Can these external macro factors really disrupt Berkeley’s fundamentals?


BKG look to sell houses forward to reduce risk. They currently have around £3bn of forward sales due in the next 3 years under UNCONDITIONAL contracts. These forward sales increased by £685m from 2014 to 2015, an increase of 30.1%. Forward sales have a CAGR of 29% over the last 5 years. Customers are increasingly buying homes from Berkeley before they are even built. Berkeley currently holds £920m from deposits on these forward sales, around 30% deposit rate.

Berkeley’s customers include housing associations, providers of student accommodation, investors and first-time buyers. In 2014 BKG opened international offices in Dubai and Beijing because over the five years to 2014 £1.2bn in sales had come from overseas. After all, BKG have got properties available in London for up to £23m!!

The Residential Institute for Chartered Surveyors residential market survey provides a good indicator of the industry supply and demand balances. The February 2016 release concludes:

  • London has seen an uptick in new sales listings in the last few months.
  • New buyer enquiries rose for 10-month. Demand is being bolstered by buy-to –let investors before the 3% surcharge policy in April.
  • 50% of surveyors also believe this charge will cause a slowdown in investment after the surcharge.
  • Excess demand oversupply persists, prices remain firmly in up-trend. 72% more surveyors believe prices will continue this trend.
  • 65% of surveyors believe London and South East is above fair value to some extent. However, this number has not changed in 6 months.
  • South East region is increasingly under-supplied.

This survey provides great insight into real industry trends and developments. The April 3% Stamp Duty surcharge for buy-to-let will cause rapid demand in Q1 which will likely fall thereafter. Prices will lag and, therefore, I believe that towards the end of 2016 we could see a larger slowdown in prices in London (which will then encourage first-time buyers who seem to be waiting).

This survey provides great insight into real industry trends and developments. The April 3% Stamp Duty surcharge for buy-to-let will cause rapid demand in Q1 which will likely fall thereafter. Prices will lag and, therefore, I believe that towards the end of 2016 we could see a larger slowdown in prices in London (which will then encourage first-time buyers who seem to be waiting).

It’s clear that Britain needs more homes to meet rising demographics and population growth in the long term. In 2010, and later extended in 2014, the government set a target to build 1m homes on brownfield sites by 2020 in total. There is plenty of support from the government helping Berkeley build the houses on brownfield land although they are still well below target building only 176,000 total in 2015. The ONS also estimate there is around 2800 and 6000 hectares of brownfield land available for dwellings in London and the South East respectively. 

On the whole, I feel the macro funds are making a bold bet against the fundamentals of the housing market. Also, I think there is a slight chance this was a very short-term trade from the hedge funds to take advantage of short-term panic. There are definitely pockets of fair-overvalued properties in London and even recent scares of oversupply. However, I feel there is still a huge fundamental imbalance of demand and supply that persists and, unless there is a recession precipitated by some kind of China hard-landing, Berkeley should be somewhat protected. I will be keeping a close eye on the RICS report in 2016.


Simply discounting the £2 dividends you’re almost certain to receive annually at a cap range of 8-10% gives around £5 NPV today. Last year EPS was £3.13, assuming this does not grow in 3 years and using a multiple of 10 gives £35 as a back of the envelope value.

Book value is £1.76bn and priced at 2.4x. Very pricey relative to comparables, although not when you consider the assets booked at cost.  BKG has 38,000 plots of land booked as cost on their balance sheet. This equates to £5.15bn in future gross margin at an average selling price of £456,000.  At a price of £400,000 this equates to £4.56bn, roughly their market cap today. I will take the option that the average selling price will be above £400,000 and Berkeley management will continue to be purchase cheap brownfield land in the future.

Wednesday, 27 January 2016

Robert Cialdini - Influence Book Review and Notes

I recently read Robert Cialdini's 'Influence - the psychology of persuasion' as the first leg of my '1 non-investment book a month' challenge.

For me, this book is up there with Kahneman's 'Thinking fast and slow'. It's excellent in every way. The author sets out to explain the factors that influence us in all different types of decisions we make. He mixes everyday decisions, historic events and includes readers' letters to explain each 'weapon of influence' that humans are under. 

Why do we feel the need to give back to those who give to us? How do social systems influence decision making? 

Why do we struggle with perception and perspective? 

How powerful is social proof? Why do investors 'follow the herd'?

How does your measure of utility value correlate with availability of the product? 

The author covers a wide range of biases we face in decision making, both complex and basic. As always, there are many strong links from psychological tendencies to decision making within investment that provide a different insight into cognitive biases. 

I can imagine the book worked wonders for salesman or marketers, but also sets a nice foundation for everyone to make better decisions. No wonder it is one of Charlie Munger's favourite books!

I have attached my brief notes here.