Europris: 7% Yield On Groceries Only Found In Norway

Summary

• Europris is a Norwegian discount chain with sales in a variety of segments, including groceries, home improvement goods, specialty retail and general merchandise.
• Due to the national character of Norway, the company cannot really be compared to its international competitors or peers.
• When seen in such a way, Europris is appealing despite certain indebtedness and very little cash reserves, and warrants at the very least some attention.

Those of you who know my articles know that I'm a big fan of investing in the national grocery infrastructure of a nation, including ICA Gruppen AB (OTC:ICCGF) and Axfood (OTCPK:AXFOF) in Sweden, as well as Kesko (OTCPK:KKOYF) in Finland. You may also have noticed that I steer away from home improvement/electronic retailers found in the same space, such as Clas Ohlson and other names European/Scandinavians may invest in.

Norwegian company Europris (OTCPK:ERPSY) has a number of things speaking against investing in it. It certainly isn't a pure grocery play. Not only does it sell tools and home improvement goods, but it also sells clothes and other more risky ventures. The company's debt is high, and the payout ratio is alarming when seen next to the debt and forward investment requirements.

However, a combination of national specifics to Norway as well as positive growth catalysts makes this company an interesting play in the long term - and one I may be happy to invest in.

Let me explain the reasons.

Europris - Merely a ~5-year history

The development of Europris during its time on the Oslo stock market has not necessarily been one of positive share price growth.

(Source: Avanza)

Initial expectations for the company were high. I remember the IPO at the time, and I distinctly remember my thought process as well - that a mixed bag of groceries, clothes and general merch would have to do a lot of structuring prior to becoming a truly profitable operation on a national scale. I did not invest in the IPO, and it seems I was right in not doing so. The company wasn't ready at the time and required lots of capital and care.

So, just what is Europris?

(Source: Company Investor Presentation, 2019)

To use the company's own, somewhat (in my opinion) hilariously outdated market speech/material to make my point, it's that it is a discount variety retailer relying on the sale of three main product categories to generate cash flow.

(Source: Company Investor Presentation, 2019)

The company is in the same segment as Scandinavian peers Öob - Överskottsbolaget - and Tokmanni out of Finland. In fact, Europris recently bought a large 20% stake in the company owning ÖoB in Sweden in order to generate synergies in the supply chain, as they essentially sell the same sorts of products and collaborate on store brands.

To equate these stores with traditional grocery stores would be wrong. These are not Walmarts (WMT), but are typically more heavily focused toward the general merchandise/specialty retail side of things than groceries. ÖoB initially sold military surplus supplies and only later transitioned into becoming a "normal sort of store.

The company's operations on Norwegian soil have no peers.

(Source: Company Investor Presentation, 2019)

While other companies exist, Europris has over 260 stores across all of Norway, including remote areas, and nearly all of them are profitable operations as of the time of publishing this article.

The company also has an impressive record of growth in terms of revenue, even though it hasn't managed to keep margins up during the revenue expansion, down from 14% 2015 to 12% in 2018. However, on a peer comparison, it outperforms competitors by far.

Europris' focus and goals should come as no surprise to anyone.

(Source: Company Investor Presentation, 2019)

The company actively makes sure to have the lowest prices in target segments - much like its Scandinavian counterparts. Because of its now-active sourcing/supply chain involving companies in all of Scandinavia, it also enjoys the advantages of scaling despite being a relatively new operator.

(Source: Company Investor Presentation, 2019)

The company is also active in launching its own brands, including the first Nordic private brand set to launch during 2019, which will include Europris as well as ÖoB. The logic involved is simply economies of scale. Similar things are being done to Norwegian sourcing, where the company is launching a large warehouse to replace the current five ones. The result is an increase in capacity of 34% on a smaller rental area, as well as sector-leading automation and efficiency starting 2020-2022.

Europris has already done a bit of a transformation in terms of its stores, from a corner store to something more akin to a national chain.

(Source: Company Investor Presentation, 2019)

On the positive side, the sales mix has begun leaning more heavily towards groceries, which is something I welcome. While margins in other areas are higher, groceries represent, to me, a more defensive offering.

Going forward, the company is also looking to open more concept-type stores in city centers to offer a more upscale sort of appeal. Geographically, the chain is diversified into the entirety of Norway with representation even in the most remote areas.

So, what we have is a discount variety retailer active in three product areas with representation all over the wealthiest nation in the world. Europris is improving sourcing and SCM, as well as automation and warehousing. Its plans simply look rather promising.

Finances and Risks

While its overall plans look promising, the market's view on the company doesn't really share the overall positive light at this point.

Europris has been through a number of M&As over the past few years. It was acquired first by IK Investment Partners, to later be sold to Nordic Capital Fund VII. While the overall stock market over the past few years has gone up, the valuation metrics for Europris, since that time and 2016, has gone only one way overall - down.

This doesn't make all that much sense when we look at financials since the year 2013. Revenue, profit, and growth during this time have stayed consistent - and the numbers support it.

However, some issues exist - and here they are.

(Source: Börsdata, EPS NOK/share)

Part of the reason for the issues Europris stock has been seeing is margin pressures, as seen in the EPS development. Despite an impressively growing revenue expansion, EPS has not followed suit in the same proportions and does not follow the trend of either revenue/share or other metrics measuring how much money the company uses/invests.

At the same time, its dividend payout has gone up.

(Source: Börsdata, Company dividend NOK/share)

Despite Europris targeting a "50-60%" payout ratio, the company is currently paying out almost 72% of EPS, which is clearly unsustainable even in relation to its own targets. Not only that, put into peer context on an international level, this is extremely excessive. It represents a margin that the company is currently not able to achieve.

More importantly, Europris has also increased debt as a result of the many M&As and investments it's been doing. It currently stands at around 2.5X net debt/EBITDA ratio, but been increasing YoY for a number of years at this point.

At the same time, company cash on the balance sheet has reached nearly zero due to investments.

(Source: 1Q19 Presentation)

At the end of 2Q19, this number had not recovered materially in any way.

Further quarterly reports will shed more light on this development, but in this contributor's opinion, the market is viewing Europris as a bit of a risk due to the following financial factors:

• High debt, which has increased YoY for some time.
• Very little cash/cash-like reserves left as of 1Q19, with more investments yet to come during the rest of the year.
• Excessive dividend ratio with a nearly 7.5% yield, above the company's own P/O target which is well above where a retailer/discount store should be.
• Many lofty targets, including twelve new stores 2019 alone, franchise takeovers and transformation into an omnichannel retailer through e-commerce investments.
• Short-term expenditure impacts from SCM constraints related to current warehousing capacities, expecting additional costs.
• The potential need, as a result of this, to tap more capital.

Having said this, I want to point out that the overall growth-related metrics when looking at Europris, for the most part, are looking excellent.

(Source: Company Presentation, 2019)

It's hard to argue with a history like that, even if foreign capital injections have been part of it for a long time now, including the IPO.

Europris presents itself as, and supports the picture of itself as a growth company in terms of revenue expansion, even if the current organization and SCM isn't where it "needs" to be. The company's transitional period in terms of logistics is well-planned and currently stands as follows.

(Source: 1Q19 Presentation)

So, in terms of finances, while the company delivers on growth metrics, it faces some headwinds in the financing portion. Cash flow/FCF is in decline since late 2018, and even if 2Q19 improved this, it's still well below where it was last year. SCM constraints are causing bottlenecks in logistics, which the company is addressing through centralization, but which will continue to impact results for years as of now. Add to this a too-high dividend, the debt situation and plans to become an omni-channel retailer, and it doesn't take a doctorate to understand just why the market is assigning a rather low valuation to Europris.

Valuation

So, by low valuation, I'm talking about a part-grocery company that's trading at roughly 11.5 times 2018 earnings. In terms of national peer comparison, even comparing it to retailers not active in the grocery trade, this is comparatively low.

This contributor doesn't consider the company's future demands a problem as such. Let's run through the list.

With regard to company debt, Europris is not in violation of any debt covenants, and has, since the last year, re-financed loans and terms once again. The company has further access to capital and funding, should it require that. Not only does this address the funding/investment concern, but it also means that the company debt isn't an immediate concern - even if the company, at current levels of debt, should focus on repaying this debt. The interest exposure for the company at this point is, after all, not inconsiderable, especially given the high dividend.

When it comes to the dividend, this contributor considers the current company dividend unmaintainable long term unless it seriously improves its current profits and margins. The current exaggeration is likely to appeal to some investors, but a retailer/grocer in growth stage can't maintain this sort of payout ratio and expect to invest in its planned growth projects by debt and remaining cash alone, while at the same time paying excessive returns to shareholders. It's simply irresponsible.

The current SCM/Logistic issues Europris is facing isn't something that can be solved overnight and will be taken care of in the long run through the company's investment plans and a new organization, aided by new and more competitive sourcing.

This leaves Europris as a grocer/discount retailer at a relatively low valuation in relation to its peers, albeit with an excessive dividend ratio. I don't see any way the company could magically or overnight improve its margins to any significant degree. Due to the high investment activity during a transitional period, I expect that profitability and margins will actually take further hits - at the very best, we should expect flat development here. Even if the current profitability is above where it was during years such as 2013-2014, the uncertainty lies going forward.

However, the point is this: nowhere in either quarterly reports, forecasts or considerations is there a realistic prospect of a fundamental collapse of the core business.

(Source: Börsdata)

Yet, the market is treating the stock as though this is the case - and has for 3 years. Sales aren't slowing, they're up. Revenue isn't slowing either. While we can point to certain risks - interest exposure, high debt, unmaintainable dividend in a more problematic environment, margin pressure - it only goes so far before we must ask ourselves the following question: "What am I willing to pay for a semi-recession resistant retailer in a strong nation?"

Sure, there are risks. However, Norway is a small nation with a history of highly preferring national operators. Many chains have tried expanding in Norway - even Lidl tried it once. They failed and withdrew.

Norwegians like Norwegian stores - similar to Swedes. That, along with other factors, makes Europris a valuable company where risks should be considered just that - risks. Not the thesis itself.

With other grocery companies like Axfood and ICA trading at ridiculous multiples, Europris seems like somewhat of an undervalued haven in these times. While the company isn't pure grocery, it nonetheless shares some of the tendencies here.

Even with the debt and currently unmaintainable dividend, I argue the following: Europris should be traded at a fair value of 15 times earnings given its geographical position in Norway across the nation and its track record. Were it not for the debt, an argument could be made that it should trade at a significant premium, but the fair value of 15 times earnings takes into consideration the likely occurrence of a dividend cut.

However, even considering the most conservative scenario, which is a cut down to the 50% EPS mark (I consider a lower payout unlikely), the stock trades at over 5% yield today. The upside, given the target of 15 times earnings, is over 45% - and the company has traded at this level not that long ago (1-2 years).

I consider it likely enough that the company will trade here again.

Thesis

My thesis for Europris and those interested in investing in the company is simple: this is a mixed-bag Norwegian discount retailer that is opening SCM pipes to the Scandinavian market and working to improve its profitability. The company has an established, market-leading position and a proven record of growth.

While the potential risks are there in the form of a (likely) dividend cut as well as a comparatively high net debt position with investments on the horizon, none of these risks are unmanageable in the light of a continued, viable core business.

Consequently, if you're aware of the risks and are able to accept a potential dividend cut (which, let's be honest, would be justified from a healthy finance perspective), this may be a very good investment with future growth potential. Add to this the very rare fact of a grocer/retailer being even slightly undervalued in today's market, and an argument can be made for why you should consider jumping this opportunity.

I've been careful about Europris for a very long time because I didn't feel that the valuation reflected the risks. However, with the company now working towards improving its SCM, centralizing warehousing and having opened relations with ÖoB, I consider the current structure appealing enough to represent an appealing investment at this valuation.

I'm in no hurry. The company reports 3Q19 on Friday - at that point, I will probably initiate a position in the stock, as I do expect some further constraints from the SCM will contribute to higher costs. Even if the stock price doesn't fall here, I'm happy to invest at that valuation, however. Take a look and see if you are as well.

Thank you for reading

Recommendation

At 11.5 times earnings, I believe the market overestimates the "risk value" of Europris debt, investment requirements and high-payout dividend. I consider the fair value to be 15 times earnings. That makes the stock a "Buy" with a strong potential upside.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ERPSY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.