SVN Capital Writeup: Dino Polska S.A.
Dino Polska (WSE: DNP; “Dino”; Market Cap. – PLN 34.2 billion; ~ 3.8 PLN / USD) is the latest addition to SVN Capital’s portfolio. In April 2017, Dino, a Polish food retailer founded in 1999, was listed on the Warsaw Stock Exchange in Poland. Since then, it has generated a 747% (CAGR: 63%) return for its shareholders.
As I started learning more about Dino, I was reminded of Walmart and its strategy of growing in small-town America. Sam Walton, in his autobiography Made in America, wrote, “Helen Walton laid down the law – ‘Sam, we’ve been married for two years and we’ve moved six times. Now, I’ll go with you any place you want so long as you don’t ask me to live in a big city. Ten thousand people is enough for me.’ So, any town with a population of over 10,000 was off-limits to the Waltons.”
Later in the book, Sam says, “We never planned on actually going into the cities. What we did instead was build our stores in a ring around the city—pretty far out—and wait for the growth to come to us.”
Tomasz Biernacki, the 47-year-old founder of Dino, seems to be following Walmart’s early example, setting up his stores in small-town Poland.
In this report, I will review Dino Polska by asking the four main questions:
· What does Dino Polska do? Dino is a food retailer in small-town Poland.
· Is it a high-quality business? Yes, the business generates a high return on capital in cash of almost 21.0% (average since 2014), with little debt, and has a terrific opportunity to more than double its store base within the next five years.
· Is it run by a competent management team? Yes, Dino is an owner-operated business in which the founder, Tomasz Biernacki, owns 51% of the outstanding shares, and management’s capital deployment decisions have been sound.
· Is it available at a reasonable valuation? Yes, at our average cost of low PLN 300, Dino is trading at a free cash flow (FCF) yield of ~5.0%.
Before I get started with the above analysis, let me explain why I find Poland to be an attractive market.
Poland was once the largest country in Europe. It has been an independent country only for 50 of the last 225 years. In fact, from 1795 to 1918, Poland vanished from the map of Europe as Austria, Russia, and Prussia partitioned the country. Later, Poland lost approximately 25% of its population during the Holocaust. For the next 44 years, it was plunged into communism as a satellite state of the Soviet Union.
However, beginning in 1990, under the leadership of Lech Walesa, the first democratically elected president, the country began to break the shackles of communism and grow into a free-market liberal democracy. In fact, since 1990, Poland has grown at the second-fastest rate to affluence (second only to South Korea). Poland was the only EU country to avoid a recession during the 2008-2009 economic slowdown, in part because of the government’s fiscal policies. Look at the World Bank chart below.
Today, Poland is the size of New Mexico and has about 40 million people. Poland has the sixth largest economy in the EU and has long had a reputation as a business-friendly country with sound macroeconomic policies. So, how did Poland do it? The primary ingredients for this eye-popping performance were the following:
· attracting foreign investments by implementing Germany’s corporate governance laws;
· a strong sovereign balance sheet where public debt is barely 50% of GDP;
· providing quality education with 9 out of 10 citizens completing secondary education; and
· moderate taxation with companies being taxed 19% while individuals are taxed at either 18% or 32%.
Since cities offer better economic opportunities, most countries urbanize as they grow. Poland has not. The urbanization rate in Poland is only 60% (see the flat green line in the middle of the chart below) while most of the developed countries cluster around 80%. Even Ukraine, a poor neighbor, has more than 70% urbanized population.
In a book titled A Country in The Moon, the author Michael Moran writes about his cultural journey through Poland:
Since the eighteenth century at least, Poles have considered themselves predominantly Western and Christian, although this was not always the case. Echoes of Roman Byzantium remain. The result is their psychology often appears stranded in a world located somewhere between East and West [emphasis mine]. Perceptions abroad dwell almost exclusively on the murderous legacy of the Second World War and of forests soaked in blood. Some young Poles think Chopin is a type of vodka or an asteroid or an airport. I was asked recently by a young Australian Pole, “What is communism?”
The above paragraph captures the contrast between perception—particularly in the West—and reality on the ground in Poland. My view is that Poland is just as interesting as any of the Western European countries and offers terrific investment opportunities. Dino is my second investment in Poland; the first was LiveChat Software (WSE:LVC).
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What does Dino Polska do? Dino Polska, founded in 1999, is the fastest-growing grocery store chain in Poland, from 111 stores in 2010 to 1,532 stores as of June 30, 2021 (CAGR of ~30%). The company’s headquarters is in Krotoszyn in West Central Poland from which Dino has continued to march east at a blistering pace (CAGR of Revenue since 2014 is ~30%).
Poles have one of the smallest living quarters within the EU, with the second-highest average household size at 2.9 and the second-lowest average rooms per person at 1.1. Due to a lack of storage space and the need for fresh products, Poles seldom buy in bulk. Instead, they visit grocery stores as frequently as people in the West visit their refrigerators, to buy small amounts; the average basket value of purchases at Dino is ~PLN 40.00 (~$10.00).
Poland is unique in that only 28% of the population lives in towns with more than 100k residents. Approximately 2/3rd the total population lives in towns with less than 50k residents. This dynamic plays well into Dino’s strategy of opening stores in small Polish towns. The type of stores Dino operates is called “proximity supermarkets.” As the name suggests, the stores operate in residential areas where many of the customers walk or bike to a nearby Dino.
One of the unique features of the business model is its consistency, which allows the company to operate efficiently and expand effectively across the country. A typical Dino store:
· is ~400 square meters (~4,300 sq. ft.);
· sits on owned land (~90% of them);
· is built by an internal construction team;
· carries ~5,000 SKUs; and
· caters to 3,000–5,000 people.
Dino stores are relatively small and stuffed with lots of items (e.g., for comparison, a Trader Joe’s store in the US is about twice the size (8,000–15,000 sq. ft.) and carries about 4,000 items).
Each Dino store sits on a 2,000–3,000 square meter plot and has about 10–15 parking spots. These lots are former agricultural plots acquired from local farmers. It takes about one and a half years to get the permits and another six months to build and train the employees which costs about $1.5 mill per store before a store is opened. According to management, they are currently sitting on the largest land bank in the history of the company. Also, it takes about three years for a store to break even. Given the blistering pace at which the company has been opening new stores, more than 50% of the current ~1,600 stores are less than three years old and are yet to break even. It means that in five years, Dino’s profits could possibly more than double just from the existing store base, without any new store growth. It also means that Dino’s margins and return on capital are being weighed down by all the new stores and are likely significantly higher than they appear now.
Another differentiating factor in Dino’s business model is meat processing. Back in 2003, Dino acquired Agro-Rydzyna, a meat processing company that is a producer and supplier of fresh pork and cold cuts. Poles do not like to eat out; eating out as a share of total household expenditure in the EU is the lowest in Poland. The daily routine for Poles is to purchase fresh meat and prepare meals at home. Most of Dino’s competitors offer meat in vacuum-packed plastic wraps. Fresh food products, including meat products, account for 38% of total revenue, other groceries account for 50%, and the balance is from non-grocery products. Dino plans to spend PLN 1.2 bill to open up another meat processing plant to support its growth.
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Is this a high-quality business? Dino has a 3.5% share of Poland’s food retail market, while Biedronka—the largest grocery chain—controls ~24%. The food retail market in Poland is littered with hypermarkets (Kaufland, Auchan), discounters (Biedronka, Lidl, Aldi, Netto), convenience stores (Carrefour, Zabka), and proximity supermarkets (Dino, Delikatesy Centrum, Polomarket). However, Dino has carved out a niche by focusing on small towns and:
· the convenient-proximity format;
· an efficient logistics network capable of daily fresh deliveries; and
· its own meat processing plant, ensuring the highest quality.
Most of Dino’s competitors are either the discounters with much bigger store sizes, located in bigger cities focusing on catchment areas with 20k–40k residents, or the small mom-and-pop stores that don’t offer daily fresh deliveries or high-quality meat. Dino fills the void left by this dynamic.
Here is a look at Dino’s strong operating performance:
· 10-year average like-for-like sales (or same-store sales) was 11.1%;
· average operating income growth since 2014 was 41%;
· average FCF (assuming capital expenditure = depreciation) growth since 2014 was 28%;
· net income increased from PLN 66 mill in 2014 to PLN 644 mill in 2020, increasing an average of 47% per year since 2014; and
· average return on capital, in cash, since 2014 was 21%.
Since Dino has opened ~1,000 new stores over the last five years, and since it takes about three years to break even, it has created a coiled spring effect; and I expect the operating performance over the next few years to be even stronger.
Dino’s business model has incredible operating leverage which is evident in revenue CAGR (2014–2020) of 30.0% vs. operating income CAGR (2014–2020) of 41.0%.
Dino has been able to grow mostly from funds generated internally and some debt. Debt/EBITDA is currently at 1.1x (debt/EBITDA is a metric used to measure the level of debt relative to cash being generated; EBITDA is a rough measure of cash flow). Also, Dino enjoys the benefits of negative working capital[1], with an average cash conversion cycle since 2014 of -25.0 days.
The former operations director at Stokrotka, one of the competitors from Lithuania that is slowly expanding into Poland, told me that Dino, with its focus on villages and small towns of Poland, hardly ever spends anything on advertisement, while all its competitors (Biedronka, Lidl, and Stokrotka), with their focus on bigger towns and cities, flood the radio and other media with advertising.
How about the future? Can Dino grow and perform at a similar level? The strength and durability of Dino’s competitive advantages—its focus on villages and small towns, small-sized stores, owning the land on which the stores operate, fresh meat delivery, and no advertising spend—make Dino unique and a tough competitor. I expect Dino to grow at a rapid pace over the next few years.
Dino has a terrific opportunity to reinvest in the stores and grow its footprint. The chart on the right (above) shows the 16 provinces and the number of Dino stores per 100,000 people in each province. The two west central provinces are the densest at ~12.0 stores/100k, while Dino has only 4.2 stores/100k in Poland. Management has an internal target of increasing its store base by 20% every year (average over the last 10 years was ~28%). Currently, Dino is opening up almost one store every workday, but it is rapidly moving towards two stores every workday.
Since 2014, Dino has generated PLN 3.2 bill in FCF and reinvested PLN 4.3 bill, almost all of it in growing its store base. With urbanization expected to remain flat at the current level, and most competitors focused on bigger cities and/or ill-equipped to provide fresh products, I expect Dino to continue to reinvest and grow its store base at a fast pace.
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Is it run by a competent management team? I prefer businesses run by owner-operators who, in general, tend to be good long-term decision-makers. Dino was founded by Tomasz Biernacki, a reclusive 47-year-old who is just that. Tomasz now owns 51% of the outstanding shares of Dino. As chairman of the supervisory board, he takes an active role in capital management and operating decisions. For example, the former director of Stokrotka told me that Tomasz, a multibillionaire, is very cost conscious, has a reputation of being a penny pincher when it comes to managing operating costs, and was famously involved in picking the lowest-cost basket maker for garbage collection at the stores.
The decision to focus on growing the store base in small towns of Poland, supplemented by growth in distribution centers, has created enormous value for all constituents.
Another important decision by the management team has been to NOT pay any dividend. It has said that, taking into account the quick store growth strategy, the board of the company has not paid any dividend and does not intend to for the foreseeable future. It is reinvesting all its earnings back into the business which is generating more than 20% return on capital.
Warren Buffett wrote in his 1984 letter to shareholders:
Unrestricted earnings should be retained only when there is a reasonable prospect—backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future—that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.
On that measure, every PLN retained by Dino has created PLN 12.51 since 2017 when the company went public.
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Is it available at a reasonable valuation? Dino is highly profitable and trades at a healthy premium (P/E – 30.3x; P/FCF – 34.0x) due to its high growth rate and market opportunity. Multiples have gone up over time, as well.
As a long-term investor, I am interested in tracking the primary drivers of business found below.
· Store Growth: Over the next five years, I expect Dino to meet its internal growth of increasing its store base by 20% per year, which will take its store count to ~3,700 by 2025; if the company improves its store base to 10.0/100k residents, the expected store base will be close to 4,000 by 2025.
· Like-for-like Growth: The average over the last 10 years has been 11.0% and, in recent periods, has been more than 12.0%.
· EBITDA Margin: The average since 2014 has been 8.7% and, in recent periods, has been more than 9.0%.
The cumulative FCF generated over the next five years is more than PLN 80.0/share which, at our average cost, translates into a 5.0% FCF yield.
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Key Risks / Ways This Can Fail:
· Competition: An important issue that could derail the thesis is competition. While Dino seems to have a great opportunity to expand its store base, will Biedronka or somebody else expand in small-town Poland? While it is a possible threat, it is not clear that any of them are capable of delivering “proximity” and “fresh meat” in a cost-efficient manner.
· Execution: Opening one to two new stores a business day is wrought with execution risk. However, based on more than two decades of growth, Dino’s management team appears to be well equipped to handle the challenge.
· Tomasz Biernacki: While the founder is now the chairman of the supervisory board, he has been instrumental in the company’s growth. Fortunately, he is only 47 years old.
[1] Negative working capital happens when a business turns over its inventory and collects on its receivables much faster than it has to pay its suppliers (i.e., loan from suppliers without interest cost).