5. Financial Results
Growth, more Growth, and Inflation
Pepco’s focus is rapid expansion, and its financial metrics reflect that. Revenues are up 19% for the first half of 2022, and so are operating costs. With H1 revenues at €2.4B already, 2022 seems set for new record-breaking revenues.
| FY19 | FY20 | FY21 | YOY Change | |
|---|---|---|---|---|
| Stores | 2,694 | 3,021 | 3,504 | 14.8% |
| Revenue (€m) | 3,415 | 3,518 | 4,122 | 15.8% |
| Underlying EBITDA (€m) | 333 | 442 | 647 | 37.6% |
| Underlying PBT (€m) | 202 | 49 | 244 | 133.1% |
| Net Debt (€m) | 461 | 1,239 | 1,202 | -3% |
| Cash Generated from Operations (€m) | 236 | 628 | 752 | 18% |
Source: PEPCO
Overall, the company has managed to keep its margins mostly intact, even if inflation put them under pressure. Some costs are up, like freight and energy, but they are offset by higher efficiency in general operations and supply.
This has allowed Pepco to keep prices mostly unchanged. This should reinforce its brand and position with customers beset with rising prices. Price leadership will also be highly beneficial to its entry strategy into the western European markets.
Since 2019, net debt has risen rapidly, in parallel to store growth. It is not putting the company at risk, but access to capital is still a constraint on the growth rate. I would still expect that ability to “digest” growth is also a constraint, so growth could probably not accelerate much more even if the Company takes in more debt.
Store Performances
The new shops in Western Europe are more expensive to set up, with almost double the CAPEX requirement per store. Earnings per shop are also 15% higher.
This brings the payback period for each shop to 25 months, compared to the very short 18-month payback period of the Eastern European shops.
Any money manager or entrepreneur would be jealous of that rate of return. As long as there is more space in Europe for new shops, Pepco is likely to stay a quickly growing compounding machine.
| Typical Store Annual Performance | PEPCO CEE | PEPCO WE |
|---|---|---|
| PROFIT & LOSS | ||
| Revenue (€m) | 1,000 | 1,600 |
| Underlying EBITDA (€m) | 225 | 260 |
| INVESTMENTS | ||
| CAPEX | 175 | 325 |
| Pre Opening Costs | 35 | 50 |
| Working Capital (€m) | 70 | 75 |
| Return Metrics | ||
| Payback Months (post tax) | 18 | 25 |
| IRR | 72.7% | 61.2% |
Source: Pepco Presentation
Stock price
Since its 2021 IPO, Pepco’s stock performance has been far from stellar. The price chart below is even worse if you would convert it into dollars, as the Polish zloty, along with all European currencies, has crashed brutally against the dollar in the last few months.
This is despite the company managing to achieve all its objectives and more. This has happened for several reasons.
- Brick-and-mortar retailers were out of favor during the pandemic.
- A listing on the Warsaw stock exchange makes Pepco stock virtually invisible for most investors in Western Europe and the USA.
- The war in Ukraine has scared investors out of all “Eastern Europe” stocks.
- While the USA might be in a recession, Europe might be headed for an energy crisis-induced depression.
- The crashing currency has removed any foreign interest in Polish stocks.
Interestingly, almost none of those reasons should really affect Pepco. The Company did well enough during the pandemic, the war did not affect it, and it should benefit from mothers hunting for bargains after struggling to pay their energy bills.
But with only 8 analysts covering the stock, it is not so surprising to see Pepco trading as “some Polish retail stock” rather than “an aggressively growing profitable European company”. In that respect, increasing its footprint on the ground in Western Europe will most likely put it on the radar of more investors and analysts at the same time it gains new Western customers.
This seems to me to be a stock for patient investors, ready to wait for the compounding effect to kick in over a period of 5 or more years.
From a purely trading point of view, the current negativity and Europe’s woes are probably not yet at their peak (this could be happening during the very energy-poor winter ahead, with “surprising” higher inflation), so we might see some time before a bottom. Alternatively, a “discounters are a refuge” narrative could appear rapidly.
Valuation
By most metrics, Pepco seems rather cheap. Its P/E ratio is 24, pretty low for a company growing 10-20% a year. We need also to remember that earnings are pushed lower by all the massive investment in new shops that will pay for themselves in 2 years.
Free cash flow has been positive since 2019 and growing rapidly. At the current level of the Trailing Twelve Months (TTM), the price to free cash flow is 19.
In addition, most of the quickly growing CAPEX and investing cash flow spending is to fund accelerating growth (new shops), and not maintenance CAPEX. So the free cash flow would probably be even higher if Pepco was not investing massively in growth.
Using 2021 free cash flow numbers, the price to free cash flow ratio would be 8.7.
PEPCO Cash Flow
| Breakdown | TTM | 9/29/2021 | 9/29/2020 | 9/29/2019 | 9/29/2018 |
|---|---|---|---|---|---|
| Operating Cash Flow | 464,154 | 702,416 | 579,571 | 182,127 | 76,162 |
| Investing Cash Flow | -219,223 | -183,613 | -165,358 | -130,870 | -177,190 |
| Financing Cash Flow | -444,109 | -414,995 | -243,194 | 12,868 | 173,168 |
| End Cash Position | 282,828 | 507,702 | 400,167 | 246,974 | 184,485 |
| Capital Expenditure | -224,310 | -180,893 | -163,944 | -135,811 | -112,627 |
| Insurance of Capital Stock | 58 | 58 | – | – | – |
| Insurance of Debt | 626,897 | 606,897 | 53,000 | 457,116 | 282,369 |
| Repayment of Debt | -753,659 | -735,439 | -53,000 | -302,534 | -825 |
| Free Cash Flow | 239,844 | 521,523 | 415,627 | 46,316 | -36,465 |
Source: Yahoo Finance
How To Invest in Pepco
The Pepco Group is listed on the Warsaw stock exchange in Poland. It should NOT be mistaken for Pepco Holding, a US electric utility.
It is possible to buy Warsaw-listed stock of the Pepco Group (PCO.WA) through a broker offering access to European stock exchanges, for example, Interactive Brokers. For a full explanation of how to invest directly in foreign stocks, you can read our recent article on the topic.
Another option can be the German stock exchange Börse München (based in Munich). Pepco stock is listed on it in euros, in something that seems similar to a GDR. Unfortunately, the page and interface seem exclusively in German, so direct purchase might prove more than a bit tricky. An international broker giving access to the Warsaw stock exchange will be a better option for most investors.
Pepco Shareholders
Before being listed separately, Pepco was owned by Steinhoff International Holding. The company owns several retailers, including declining brands like France’s Conforama. Steinhoff is massively indebted and in the process of renegotiating its debts.
Pepco was spun off in an IPO, essentially to provide fresh cash to Steinhoff to help them manage their debt load. Steinhoff still owns 79% of the Pepco Group. In the long run, I expect Steinhoff to progressively sell its other holdings to pay off debt.
On one hand, this might put pressure on Pepco’s share prices. On the other hand, this will not affect fundamentals like the explosive growth of Pepco, nor its entry into lucrative Western European markets.
I am not really impressed by the quality of management and of investing decisions at Steinhoff Holdings (short of Pepco). Luckily, they seem to have a rather hands-off approach to the handling of their brands, letting each brand’s managers work without interference.
Overall, the Steinhoff ownership is a negative in my view. Especially as they hold a controlling interest, placing minority shareholders’ rights a risk.
Still, the quick growth of Pepco, supporting a rise in share price, is in Steinhoff’s interest. So I would consider their interests mostly aligned with minority shareholders.
The largest risk would be Steinhoff being forced to sell its Pepco holdings too soon, and the buyer then taking the company private. This is a low risk, but it exists. Considering how many extremely successful other discounters like Lidl are kept private, this could well happen.
