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.

Valuation

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.