Companhia Brasileira de Distribuicao: Righting The Ship (NYSE:CBD)

Companhia Brasileira de Distribuição (NYSE:CBD) hosted a promising investor day presentation earlier this month, highlighting the mid-term turnaround strategy at the core business. Key targets include a return back to positive FCF generation and sustaining above-inflation revenue growth on an aggressive store expansion plan. Given the complexity of the plan, this won’t be an easy task, and management rightly guided any recovery to double-digit EBITDA margins being a gradual process. In the near term, the key balance sheet driver remains non-core asset divestments in Brazil, which presents an incremental >R$1bn opportunity through FY23. With Éxito’s spin-off also on track for a Q2 2023 close (more on this in my prior CBD coverage here), the path to value unlocking remains intact. At ~3x fwd EBITDA for a company positioned to grow through the near-term headwinds and drive margin expansion over the mid to long-term, the stock screens favorably.

Transition Complete; Expansion is Now the Key Focus

FY22 was a transition year featuring a range of operational adjustments to build out the ‘new’ Brazil unit and dispose of most of its hypermarkets. Going forward, CBD is now focused on reigniting volumes across the business, with the key target being to drive revenue growth ahead of inflation through the cycles. For starters, the fresh assortment will be a key focus area as the company looks to become a specialized fruits and vegetables player with a presence across all channels. This means getting the share of perishables up to 53% (+5%pts), better personalization for customers, and supply chain resilience to ensure on-shelf availability. These seem very achievable, given the progress CBD has made thus far. For instance, CBD has already completed most of the supply chain optimization work post-sale of its hypermarkets and now maintains an impressive ~96% shelf availability.

Beyond the internal operations, management also aims to balance cash generation while also accelerating store expansion. Of note, CBD targets the opening of ~230 stores, comprising ~90% proximity formats and the remaining ~10% under the ‘Pao de Acucar’ banner. For context, the company has only opened 49 stores YTD, including hypermarket conversions; even accounting for the additional 24 stores in December (mainly proximity format), this only adds up to ~73 openings for the year. So the plan to accelerate new openings to the targeted 300 stores by FY24 could be a challenge, in my view.

The focus on proximity is likely a positive for growth, though, given it matches key socioeconomic and consumption trends (e.g., higher demand for convenience and outgrowth across the snacks, healthy products, and ready-to-eat categories). Assuming good execution and that the competitive landscape also stays benign, CBD’s ambitious proximity format expansion should translate into profitable growth over time.

On the Path to Double-Digit EBITDA Margins

CBD had already guided to double-digit EBITDA margins when new CEO Pimentel took over earlier this year, but the company remains nowhere near this target. Cost inflation and supply chain headwinds have been the key drivers of the miss. Increased investment needs related to premium client acquisition, as well as operational adjustments, have also contributed. Thus, management’s decision to adjust its adj EBITDA margin guidance range to a more conservative 8%-9% by FY24 (slightly above the >7% YTD) seems prudent. Getting there will depend on execution, with management citing initiatives to boost the gross margin, such as supplier negotiations and product mix shifts; on the opex side, CBD will lean on improving efficiencies from structure resizing and self-checkouts, among others.

In addition to the core initiatives, online penetration will also be key. Relative to the ~10% for FY22, CBD is targeting 5%pts increase per year through FY24, implying ~15% revenue contribution by FY23 and ~20% by FY24. Growth here should be accretive to the overall profitability, given that online carries higher EBITDA margins than the physical stores due to CBD’s logistics costs advantage (most orders are shipped from stores). So while the core business no longer enjoys double-digit EBITDA margins, there is a clear runway to restoring profitability back to this level in the mid to long-term. With many of these initiatives already being implemented as well, the margin target seems well within reach.

Cleaning Up the Balance Sheet

Management is also accelerating the deleveraging process, now targeting for CBD to become a zero net debt company over the next two years. Near-term inflows should help – these include the final payment from Sendas Distribuidora (ASAI) of ~R$1bn for the hypermarket sale, as well as ~R$400m in dividends from Exito ahead of the upcoming spin-off. In addition, CBD has a plan to realize funds from non-core asset divestments (mainly Extra fuel stations and real estate) potentially worth >R$1bn in FY23. For now, all eyes will be on the Exito divestment, which CBD expects to monetize by the end of FY2023. Thus far, the spin-off is running according to schedule, and the company is currently in the process of gaining the necessary approvals ahead of a Q2 2023 close.

Righting the Ship

CBD management made all the right noises at this year’s investor day, but given the complexity of the operational bottlenecks ahead, getting back to a sustainable earnings growth algorithm will be a gradual process. In the near term, the planned divestments of its non-core assets in Brazil present upside for FY23. Plus, the Éxito spin-off is also going according to plan, and pending approvals on the transaction, a Q2 2023 close seems well within reach. At the current ~3x fwd EBITDA valuation, the stock is cheap and pays out a solid dividend yield to investors willing to wait for the thesis to play out.