The New DAVIDsTEA: The Worst Is Behind Us And A New Era Begins
Summary
- DTEA recently settled the lease liabilities, so the new DTEA emerged with a significant amount of remaining cash to develop its growth strategy.
- A few days ago, DTEA announced a significant deal with the Rexall pharmacies in Canada.
- I believe that Rexall’s “store-within-a-store” concept opens up a whole new world of opportunities and more Rexall-like deals will come in the next months.
- The secular tailwinds are unquestionable thanks to health-conscious wellness-oriented consumers (including Millennials & Generation Z) who increase their tea consumption, so the outlook for the tea industry is bright.
- The new DTEA at $2.70 per share is dirt cheap while generating profits and having a fortress balance sheet.
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In my previous article in September 2020, I pointed out that DAVIDsTEA (DTEA) was dirt cheap at $1 per share, so investors should see the big picture and buy it with both hands.
Since then, DTEA has outperformed exceeding $7 per share in early 2021, which translates into a 600% return for those who listened to my advice and held it in their portfolios for a few months.
Given that the CCAA proceedings were completed and DTEA settled its lease liabilities for C$18 million a few weeks ago, I will present the new DTEA in this article while explaining why it's grossly undervalued at $2.70 per share.
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Key Points About The New DTEA
A few days ago, DTEA reported that revenue in Q2 2021 was C$18.7 million, down 18.6% from C$23.0 million in the prior-year quarter. And many investors didn't like it, so they sold the stock which has landed at about $2.70 per share over the last days. This was an overreaction.
And it was an overreaction because revenue in Q2 2020 is not the right comparable, because all the company's stores were closed in Q2 2020 due to Coronavirus. As a result, consumers overloaded their digital carts and revenue in the prior year's quarters was boosted by pantry stocking.
That said, let's dig deeper into the quarterly reports for the new DTEA pro forma the restructuring and the closure of 200+ unprofitable stores in North America:
1) Revenue: I will start with revenue in Q4 2020 because the company re-opened its 18 profitable stores in late August 2020, which is about the middle of the third quarter, so we want to assess the full contribution from the 18 profitable stores, among other things.
In Q4 2020, the company's strongest quarter, revenue from the e-commerce & wholesale segment was C$35 million while brick & mortar sales were C$5.2 million. For comparison, in Q1 2021, revenue from the e-commerce & wholesale segment was C$19.9 million while brick & mortar sales were C$3.3 million. Also, in Q2 2021, the company's weakest quarter, revenue from the e-commerce & wholesale segment was C$15.6 million while brick & mortar sales were C$3.1 million.
Therefore, it seems that quarterly revenue from the brick & mortar segment range between C$3.1 million and C$5.2 million depending on the quarter. And I project that this will not change substantially in the foreseeable future, so the key moving part will be the revenue from the e-commerce & wholesale segment.
2) Gross profit margin: Gross profit margin was 42.7% in Q2 2020, compared with 46.3% in Q1 2021 and 38.9% in Q4 2020. Therefore, the gross profit margin has stabilized above 40% and, I project that it will remain above 40% in the foreseeable future.
3) SG&A expenses: As a result of the new business model (e-commerce and wholesale) and the closure of the majority of the brick & mortar stores, SG&A expenses dropped 76.5% on a YoY basis being C$10.6 million in Q4 2020.
And more importantly, they kept falling in 2021 given that they were C$9.2 million and C$9.1 million in Q1 2021 and Q2 2021, respectively. Therefore, I project that annual SG&A expenses will be approximately C$36 million in 2021.
4) Stockholder equity: I will intentionally pass net income and adj. EBITDA in Q1 and Q2 2021, because there is a lot of noise in the financials (i.e. non-recurring expenses) due to the restructuring that distorts the clarity of the business. And I will focus on stockholder equity that has passed from deeply negative in Q1 2021 into positive territory at C$48 million in Q2 2021, thanks to the completion of the restructuring and the settlement of the lease liabilities.
On top of this, I forecast that stockholder equity will keep rising in the second half of 2021 and 2022, because I project that the new DTEA will generate profits, positive operating cash flow and positive free cash flow in the next quarters.
Annual Revenue From The Rexall Pharmacies
DTEA announced a significant deal with the Rexall pharmacies in Canada a few days ago. These 115 locations will be added to the company's distribution network this September, so their full contribution to the quarterly revenue will take place effective Q4 2021, the company's strongest quarter. And the key question here is: How much revenue will they contribute to the top line annually?
Before answering this question, I will point out that quarterly revenue from the 18 brick & mortar stores range from approximately C$3.1 million to C$5.2 million, depending on the quarter, as explained in the previous paragraph. Therefore, quarterly revenue per brick & mortar store range from approximately C$170K to C$290K and daily revenue per brick & mortar store range from approximately C$1.9K to C$3.2K, depending on the quarter.
Given that the Rexall pharmacies have fewer SKUs and less traffic than the brick & mortar stores, we project that daily revenue per Rexall pharmacy will range from C$190 to C$320, depending on the quarter. In other words, I project that the daily sales from the Rexall pharmacy will be 1/10 of the daily sales from the brick & mortar store.
Therefore, quarterly revenue from the 115 Rexall pharmacies is estimated to range from about C$2 million to about C$3.3 million, depending on the quarter.
As a result, annual revenue from the 115 Rexall pharmacies is estimated to be about C$10 million (C$2.3m in Q1 + C$2m in Q2 + C$2.4m in Q3 + C$3.3m in Q4).
However, there is a parameter here that can't be accurately estimated. It's the extent of market cannibalization due to the other locations of DTEA's wholesale network. However, I believe that market cannibalization will be very small, because all the Rexall pharmacies in Canada are over 400 and DTEA chose only 115 locations, which implies that DTEA chose those Rexall pharmacies where there is limited, if any, overlap with the other locations of its wholesale network in Canada. That said, I forecast that annual revenue from the 115 Rexall pharmacies will be about C$9 million.
Estimates For The New DTEA Pro Forma The Rexall Deal
Revenue in the first half of 2021 for the new DTEA was C$42 million. Given that Q3 traditionally is stronger than Q2 (the weakest quarter) and Q4 traditionally is the strongest quarter, I project that revenue in the second half of 2021 will be about C$70 million, including the revenue from the 115 Rexall pharmacies that started contributing to the top line effective late Q3 2021.
As a result, annual revenue in 2021 for the new DTEA is estimated to be about C$112 million (C$42m + C$70m), including the revenue from the 115 Rexall pharmacies in late Q3 and Q4 2021.
However, including the revenue from the 115 Rexall pharmacies on an annual basis, annual revenue for the new DTEA is estimated to be about C$116 million (C$42m + C$70m + C$2.3m in Q1 2022 from Rexall + C$2m in Q2 2022 from Rexall).
As also noted above, gross profit margin for the new DTEA has stabilized above 40% while being almost 45% in the first half of 2021.
Meanwhile, quarterly SG&A expenses have been about C$9 million over the last couple of quarters (Q1 and Q2 2021), including some one-time expenses such as online marketing expense and software costs, as the company pursues its digital-first strategy. Therefore, we forecast that annual SG&A for the new DTEA is about C$36 million.
After all, these are my forecasts about the company's annual net income:
1) Based on C$112 million in annual revenue in 2021, 42% gross profit margin and C$36 million in annual SG&A expenses, I project that annual operating income is about C$11 million. Given also that finance costs are trivial pro forma the restructuring, annual net income (before income taxes) in 2021 is estimated to be about C$11 million, based on a less than half year revenue contribution from the 115 Rexall pharmacies.
2) Based on C$116 million in annual revenue, 42% gross profit margin and C$36 million in annual SG&A expenses, I project that annual operating income is about C$13 million. Given also that finance costs are trivial pro forma the restructuring, annual net income (before income taxes) is estimated to be about C$13 million, based on a full year revenue contribution from the 115 Rexall pharmacies.
Valuation
Market cap at $2.70 per share is about $71 million. When it comes to the company's leverage, DTEA had zero bank debt before Coronavirus and kept having zero bank debt after the settlement of the lease liabilities last June. Therefore, the company's capital structure has remained unchanged.
To make things even better, the new DTEA maintained a significant amount of cash after settling the lease liabilities and ended up having C$12 million (about $10 million) in cash in Q2 2021. Therefore, its Enterprise Value at $2.70 per share is about $61 million.
I also project that the new DTEA will generate about C$8 million in free cash flow in the second half of 2021, bringing its cash to approximately C$20 million (about $16 million) in Q4 2021. As a result, I project that its Enterprise Value at $2.70 per share will be about $55 million in Q4 2021.
That said, let's calculate now its key metrics:
1) Based on a less than half year contribution from the 115 Rexall pharmacies, we estimated that annual revenue and net income in 2021 will be about C$112 million (about $90 million) and C$11 million (about $9 million), respectively. As a result, I project that including a less than half year contribution from the 115 Rexall pharmacies, annual adj. EBITDA in 2021 is estimated to be about C$15 million (about $12 million).
2) Based on a full year contribution from the 115 Rexall pharmacies, we estimated that annual revenue and net income will be about C$116 million (about $93 million) and C$13 million (about $10 million), respectively. As a result, I project that annual adj. EBITDA is estimated to be about C$17 million (about $13 million).
After all, the new DTEA at $2.70 per share trades less than 1x its revenue and 5 times its adj. EBITDA. In other words, the new DTEA at $2.70 per share is dirt cheap, profitable with a fortress balance sheet, based on absolute and relative valuation analysis.
Unilever And Implications For The New DTEA's Valuation
According to the latest news here and here, Unilever (UL) may sell its tea arm to Advent and Singapore wealth fund for £4 billion, which converts into about approximately $5.6 billion. According to the previous links, the bid is about Unilever's PG Tips and Lipton Ice Tea brands, while the potential sale does not include Unilever's tea operations in India or Indonesia, or its assets in the ready-to-drink tea segment.
This deal is interesting for two reasons. First, we will check the key metrics of the deal such as EV-to-adj. EBITDA and EV-to-Revenue, once the deal is completed. Second, the potential suitors are not one or two. There are more than a handful of potential suitors who are willing to invest in the tea industry such as the Advent-GIC consortium, the Cinven-Abu Dhabi Investment Authority consortium, Carlyle, Clayton Dubilier & Rice and KKR.
The Secular Tailwinds Including The Zen Philosophy
As linked above, there are more than a handful of funds who want to invest in the tea industry, which is a strong indication that they realize the sector's growth prospects. Specifically, the global tea market size was valued at $55.1 billion in 2019 and could reach $69 billion by 2027, a compound annual growth rate (CAGR) from 6.6% to 6.9%, according to reports from Allied Market Research and Research & Markets. And this CAGR should not surprise you because:
1) Health benefits: Tea is a calorie-free beverage and a rich source of antioxidants coupled with minerals whose regular consumption helps reduce cell damage and slows down ageing, reduces stress, lowers cholesterol levels, lowers blood pressure and facilitates healthy weight loss, among other positives.
2) Caffeine: A cup of tea has much less caffeine than a cup of coffee.
3) Zen: The Zen philosophy is becoming more and more part of people's lifestyle globally over the last years, because Zen is a way to peace of mind that contributes to happiness, according to some ancient Greek philosophers such as Epicurus, as shown here and here. And drinking tea is a Zen experience. Tea is closely connected with the Zen philosophy. Coffee isn't.
Specifically, it's not only the fact that Zen is a school of Buddhism and the Zen temples have tea ceremony rooms where the Buddhists drink tea, as shown here. It's also the fact that tea and Zen share a handful of common characteristics, as shown here.
In brief, tea is much more "Zen" than coffee, because tea has relaxing properties while coffee is a stimulant. That said, how much tea do you drink daily? Or how "Zen" are you?
Personally speaking, I was a frequent coffee drinker until ten years ago, but I have become a fervent tea drinker over the last years. And it's not only due to the health benefits. Thanks to my morning specialty teas, I do feel that I have much better body energy and energy flow during my daily activities, which is very important for me.
After all, thanks to the aforementioned secular tailwinds, tea consumption by health-conscious wellness-oriented consumers including Millennials and Gen X, has been rising over the last years and is expected to keep rising in the next years, as shown here, here, here, here and here.
More Deals To Come For The New DTEA
The house is clean now, so I believe that the growth has just begun. And we don't really need to read between the lines to realize that the new DTEA will announce more deals in the next months.
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Both the CEO and the COO have stated it more than once lately, as quoted below (emphasis added):
As a leading tea merchant with a strong brand, we seek to share our passion and love for tea, and our unique and innovative blends, with new audiences. We have now laid the foundation to scale and expand our business in a borderless environment both in North America and around the world, and we are excited about the future.
and (emphasis added):
I am pleased by our results for the second quarter. From a seasonality point of view, the second quarter is generally our weakest quarter. We see significant and exciting opportunities to expand this type of concept within Rexel and other North American retailers. We want to continue to be convenient to as many consumers as possible, and this new concept provides another opportunity for DAVIDsTEA to reach our community of tea lovers in new, local and accessible ways while expanding the reach of our products to new retail shelves.
and (emphasis added):
We are laying the foundation to scale and expand to become a truly global tea company. This is supported by steady demand for tea around the world as more people understand the benefits, traditions and wellness associated with tea and the traditions of community and sharing that place DAVIDsTEA's unique approach, sense of offering of the most unique blends in the marketplace at the core of the growing health and wellness space.
and (emphasis added):
Jane brings her leadership, knowledge of DAVIDsTEA and deep experience in the retail industry to the Board and will help guide DAVIDsTEA as we fulfill our ambition of becoming a global tea company. Our transformational journey continues and it's truly been a team effort.
and (emphasis added):
In conclusion, our vision is to become the world's most innovative tea company, inspiring greater wellness and sustainability. Our past success was supported by the pillars of an exceptional brand and innovative blends of high-quality teas, combined with a unique and exceptional in-store experience. Our goal is to replicate that success in the digital world and through the right partnerships with other retailers, supported by best-in-class technology and customer engagement.
and (emphasis added):
DAVIDsTEA's expansion to 115 Rexall locations is just the beginning. We see this as phase 1 of our expanded wholesale distribution footprint in a post-COVID consumer environment. As we look for new and innovative ways to accelerate revenue beyond our growing e-commerce business supported by our 18 flagship stores, we are confident we will secure and reinforce our position as leading tea merchants.
That said, here are some potential deals in the next months:
1) The Rexall pharmacies in Canada are owned by McKesson (MCK), which covers the U.S., Canada and 12 countries in Europe. And in Europe, MCK serves more than two million people across more than 7,000 owned and banner retail pharmacies. On top of this, through its 97 pharmaceutical distribution centers, MCK delivers over 100,000 different essential medicines and supplies to more than 55,000 pharmacies and hospitals throughout Europe. Therefore, given that the relationship is already there, DTEA could make another deal with MCK expanding its wholesale segment internationally.
2) Based on the "store-within-a-store" concept, the new DTEA could make Rexall-like deals with:
A) Pharmacy chains in the U.S. such as Walgreens (WBA), CVS Health (CVS), Rite Aid (RAD), etc., or pharmacy chains in Europe and Asia.
B) Companies with significant brick & mortar retail footprint from other sectors such as hospital chains, bookstore chains, schools & colleges & universities. For instance, the new DTEA could make deals with bookstore chains such as Barnes & Noble (BKS) with 627 stores in the U.S. or privately-held Books-A-Million with 260 stores in the U.S. Also, when it comes to hospitals, HCA Healthcare (HCA) is the biggest chain in the U.S., followed by privately-held CommonSpirit Health and Universal Health Services (UHS).
3) Deals with grocery chains in North America, Europe or Asia.
4) Deals with marijuana producers for the production of THC-infused and/or CBD-infused teas, given that the consumption of cannabis-infused beverages has been on the rise and the outlook is promising, as shown here and here. On that front, it must be noted that back in 2018, Herschel Segal (DTEA's biggest shareholder) acknowledged that 6 marijuana producers, some of the biggest names in the sector, approached DTEA to team up and launch cannabis-infused tea. According to the previous link, he told them that it was too early because DTEA had to improve its situation and clean its house first, before thinking about teaming up with the marijuana producers. He also said that DTEA can only dream about this collaboration. Given that the house is clean now, this marijuana-related dream could come true.
Risks
I believe that the key risks associated with this investment are:
1) The Rexall deal: As noted above, I forecast that annual revenue from the Rexall pharmacies will be about C$9 million. However, this isn't a slam dunk and the revenue from Rexall could fall short of my forecast.
2) Future deals: As noted above, it seems that DTEA will announce new deals in the next months. However, this isn't guaranteed and the company might fail to do this. And also, if it announces new expansion deals, they might not work, as originally anticipated.
3) Microcap stock with high volatility: DTEA is a microcap stock with high volatility, which largely results from the fact that insider ownership is high at almost 50%. In other words, DTEA is a low float microcap stock. Therefore, this is not for day traders, momentum traders or short-term traders. Instead, I believe that the potential buyers need to have a 12-month investment horizon (at least).
Takeaway
DTEA recently settled the lease liabilities and can now focus on its growth strategy while having a rock-solid balance sheet. The Rexall deal is the beginning and I believe that more deals will come in the next months, based on the company's statements.
From a valuation standpoint, the new DTEA at $2.70 per share is dirt cheap, because it trades less than 1x its revenue and 5 times its adj. EBITDA.
On top of this, the secular tailwinds are there. After all, don't miss it.
Value Digger is a former fund manager with more than 30 years of investment experience. Since 2015, he has consistently beaten the market thanks to select long ideas (high-yield dividend stocks & value stocks) and short ideas from different sectors. Since 2015, he has locked in profits from more than 130 picks making about 60% per pick (average return). As a result, Value Investor's Stock Club (VISC) is one of the most-subscribed services for value investors on Seeking Alpha. See the 5-star ratings and outstanding reviews here and sign up for a 2-week Free Trial here!
This article was written by
Value Digger is a former fund manager with more than 30 years of investing experience and a full-time deep value investor with a track record of market outperformance. He shares both long and short ideas from different sectors. His investment philosophy is firmly grounded in Ben Graham-style value-oriented opportunities that often have an asymmetric risk/reward profile.
He runs the investing group Learn more .Analyst’s Disclosure: I/we have a beneficial long position in the shares of DTEA either through stock ownership, options, or other derivatives. 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.
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Comments (122)
btw: they have outsourced most (if not all) of their logistics since November last year
