Welcome to Trade Ideas.
I am Brian Price, joined by Ben Axler, CEO and founder of Spruce Point Capital.
Great to have you with us, Ben.
First time on Real Vision.
Pleasure to have you.
Thank you for having me.
So when it comes to short selling, for quite some time you've been talking about the golden
age.
How do you feel about that thesis right now?
I feel very good.
We've been patient and consistent in our view that the market is overvalued, being fueled
by low interest rates, being fueled by accommodative tax policies, being fueled by excess liquidity,
chasing returns.
And I think what we're starting to see now is a little bit of the unwind of the easy
stimulus.
Rates are finally rising.
This is a condition that is necessary.
We have signs of speculative excess in the market, cryptocurrencies, marijuana stocks,
people chasing businesses with no profits at excessive valuations.
So what we saw coming to fruition is here.
And we don't think that the full brunt of the unwind in the market has happened.
And now we face potentially recessionary risks from tariffs being imposed or threatened to
be imposed by President Trump and still excessive valuations.
So we still feel good that now is a great time to be in the golden era for short selling.
And with that in mind, what's the name that's on your radar right now?
So we've been very vocal and public about a company called Dollarama.
Dollarama is a Canadian dollar store.
At Spruce Point, we take a forensic look at companies to find evidence of financial overstatement,
misvaluation, excessive stock promotion.
We've had a lot of success in Canada, our friends to the north.
We've done over six public campaigns in Canada.
And I've seen an average drawdown about 50% in the names that we've targeted.
And Dollarama fits the mold.
We're attracted to it because of its excessive gross margin.
So Dollarama is the only dollar store we can find in the world posting 40% gross margins
and 25% EBITDA margins.
And as we started to do our work-- look at the governance, look at the management, look
at the business strategy, the goals set out by the company to the investor base.
So we felt very strongly that Dollarama presents a very favorable risk reward.
Why?
Because the valuation is high.
The expectations for the company to hit aggressive growth targets we felt could not be achieved.
Plus we feel that the margins, which the company projects at 40%, are bound to come down for
a variety of fundamental reasons.
So from that point of view, we feel Dollarama presents a good risk reward for being short.
And when you're talking growth targets, we're talking about new stores being open.
Walk me through the numbers, what they've presented
to the market, and what you anticipate as actually being realistic.
So we've seen this playbook a number of times by companies that come public.
They put out modest growth targets and then over time extend the growth targets higher
and higher.
And with Dollarama, it was IPOed a number of years ago and set a target of 900 stores.
And then slowly, they increased it to 1,200 to 1,500.
Now they're up to 1,700 stores.
They're at about 1,100 stores right now.
And we already see signs that the story is a broken growth story.
What do I mean by that?
If you look at last quarter's results, you'll see that the company fell significantly short
of its first half store growth opening count.
So they're looking to do 60 to 70 stores a year.
They're well behind plan through the middle of the year.
We've also noticed that the cash flow in the first half of the year is starting to contract.
We think perhaps they bought too much inventory.
The inventory is not selling.
They're not able to stock the new stores that were planned to be open.
And then lastly is the same-store sales numbers.
So the company has been able to maintain a pace of 67% same-store sale comps.
For the first time, they ratcheted that back to 3% to 4%, which we think is probably more
normalized, more fair, more achievable.
So we're seeing the signs of the crack in the story.
And I always get asked, when's the best time to short a stock?
Personally, from a lot of painful experience shorting stocks, the best time is when the
story is cracking, when the numbers are coming down.
That's exactly where we are in the cycle here for Dollarama.
Is part of your thesis having to do with the fact that this isn't a proprietary business?
It's not like they're a Chanel or a Christian Dior.
It's a dollar store.
This is not a very hard wheel to reinvent.
Is that part of what we're talking about here as well?
Absolutely.
When I'm looking at short ideas and where I want to put my capital at risk, I always
ask myself, does the world need this business?
Does the world need another dollar store?
Does Canada need another dollar store?
How easy is it to replicate this business model?
And the point of Dollarama-- it's very easy to replicate it.
The management team and the brokers that support the company would love investors to think
that they're the best retailers.
They have a proprietary way of doing things.
They're better at sourcing products from China.
They're better at distributing.
They're better at pricing and promotion.
You know what?
I don't believe that story.
I might believe it if they were selling a technical medical product that maybe there's
two or three in the world.
But they're selling low-priced dollar items.
And so we do think that competition is coming.
That's also part of the reason why we think the numbers are starting to contract.
Dollar Tree we believe is going to make a greater push into the market there.
And Miniso, a Chinese, low-cost model with a fresher look, is coming into the market.
Amazon delivers low- priced goods everywhere.
So it's the fundamental story that's finally catching up with Dollarama.
For a period of years, they did have less competition.
Now it's creeping in.
And the easy levers managements pulled to accelerate the earnings we think are no longer
available to them.
Ben, you mentioned levers that this company has used in the past.
Drill down on that a little bit more for me.
What does that mean?
It's a fantastic question.
So some of the levers are on the pricing side, and some are on the cost side.
On the pricing side, they started as a dollar store, right?
And as we saw their transaction growth declining, management has slowly pushed up the average
ticket of an item they sell.
So no longer do you go in there and you find items for a dollar.
You now find items for $2, $3, $4.
This is not a sustainable strategy.
We think based upon our research and our channel checks and certainly customer complaints online
that their customers are figuring out they're no longer a dollar store.
And when you go there looking for dollar-priced items, and now you're finding higher-priced
items, well, why not go to Walmart?
Why not go to other stores where you can get those higher- priced items and not have to
go to the dollar store?
So we think management can no longer push up prices higher without potentially alienating
more of their customer base.
On the cost side, we've seen management do some things that we wouldn't recommend nor
do we think are sustainable.
For example, to preserve margins, we've noticed that they pulled product out of bundles they've
sold.
So for example, rather than paying a dollar for 20 pencils, you might pay a dollar for
15 pencils.
This is not a sustainable strategy.
Again, the customers will figure this out.
They don't want to be cheated so that the company can maintain their margin.
Management has also used currencies, we think, as a profit center.
So they price products in Canadian dollars.
And they source products from China that's linked to the dollar.
So they've hedged.
And they've said they haven't needed to adjust prices.
But they are adjusting prices higher.
So we think they've used currencies as a way to profit.
And now the currencies are reversing.
We think that tailwind is going to become a headwind.
Another lever and a criticism we have of the company is related-party dealing.
So it's worth looking at the history of Dollarama.
It was founded by the Rossy family.
The Rossy family comes from a long line of retailers in Canada.
Over time, the Rossies have been selling their stock.
But what have they been doing to extract other value out of the company?
Related-party purchasing.
So what we've noticed is that the company has been buying real estate and warehouse
assets directly from the family.
What does this do?
This actually removes rent expense, which draws down margins and replaces it with an
asset that they depreciate.
Well, that's kind of convenient.
Management compensates itself on EBITDA.
With EBITDA, any depreciation you take out, you add it back.
So we've seen related-party purchasing, which flatters the numbers, which has also created
what we think is an inefficient distribution model whereby all the warehouses are in Quebec.
But yet they need to serve all of Canada, which is quite an expansive country.
Dollar Tree, for example, has a distribution center in Vancouver.
Dollarama has no distribution on the West Coast.
So it's tactics like this that we see and continuing breakage of a link between how
insiders are behaving relative to the benefit of shareholders.
So Ben, a lot to unpack there.
Talk to me a little bit about capital allocation and how it relates to management's tactics.
We're pretty critical of how management's allocating capital.
One thing they've been doing pretty aggressively is buying back stock.
And there's nothing inherently wrong with buying back stock.
It's generally viewed as a way to return capital to shareholders.
But Dollarama is a growth company, right?
And it's a growth company that trades at the highest valuation for any dollar store in
the world and even relative to other premium retailers.
It's in growth mode.
It should be buying back its stock when its stock is cheap, not when it's expensive.
So how and why is it doing this?
It's buying back stock while management's selling.
That's a classic red flag.
I mean, we've looked at a lot of companies where we've noticed capital being deployed
for buybacks while the management's selling right into that bid.
What's important to look at also is the CFO who's overseeing this decision making.
If you look at the proxy statement where his ownership is disclosed, every year he is granted
stock and options.
But he holds zero stock.
So what does that tell you?
Every stock he's getting, he's selling right into the company's bid.
And so we have a big problem with that.
He should have to hold some stock for the longer term.
On top of that, how is the company funding this buyback?
They're using short-term debt as a means to buy back stock.
Why is this a problem?
We're, again, in a rate-rising cycle.
And to not have long-term debt fixed in is a big problem.
We estimate over a billion and a half dollars of Dollarama is going to come due in the next
15 quarters.
And they're going to have to consistently refinance at a higher rate.
Why not lock the rate in for the long term?
If you're viewing your stock as a long-term investment, why not fund it with long-term
debt and not short-term debt?
So we have a big problem there with the way the capital is being deployed.
They also pay a dividend, a really de minimis dividend.
If they were really considerate, I think they would deploy more money to the dividend rather
than to buying back their stock at an inflated value.
So we're seeing a pickup in competition.
We're hearing about a dollar store that's selling products for a lot more than a dollar.
So the customer feels like they've been misled a little bit.
And then you have management that perhaps isn't putting its money where its mouth is.
So with all this in mind, if you were to describe management's tactics in one word, what would
you pick?
Again, getting back to what we look at as incentives, I would see a breakage of an incentive
link between shareholders and the company.
And management could be buying back stock.
The stock, by the way, is down 30% since last quarter.
If they were serious about the business, why not commit capital?
Why not buy back stock right here and right now to send a signal?
They've not done that.
Management hasn't done other things that could reassure investors.
They could have held an investor day.
They could do a roadshow.
They could get out there and try to assure investors that their business model isn't
broken and that they have a way to address this extreme underperformance of the share
price.
But they've not done that.
And so it's that breakage of incentive structure whereby the Rossy family only owns 5% now
of the stock.
What incentive do they really have left?
And that's why, as we've seen and we pointed out, they're doing things like more related-party
family purchases of real estate.
They're maintaining and/or increasing their base salaries, things that you might expect
they do to extract more value out of the company, when the share price value is declining.
That's what I think this all comes down to.
That sounds to me to be perhaps a tad fraudulent, irresponsible, something in between those
two.
Where would you put it?
I'd say irresponsible.
Fraud is a very strong word.
It is a strong word.
That's one end of the spectrum, perhaps irresponsible on the other end.
And I just wanted to see where we are in terms of how management is approaching their business
right now.
I think irresponsible in terms of, again, how they're allocating money.
One of the other criticisms we have is if you go into some of their stores-- and bear
in mind, Dollarama stores-- some of them have been around for 20 years.
You walk in there.
And it's a very tired look.
It's a very old look, whereas some of the newer competitors we've pointed out, like
Chinese Miniso-- they have a very fresh, contemporary look to the business.
On the point of capital allocation, one thing we're very critical of is that management
is not spending any money marketing.
We've already demonstrated that foot traffic is declining.
What are they doing to try to bring customers, both existing and new, into the store?
Well, they could be spending money on marketing.
If you look at the dollar stores in the US, for example, they spend consistently 2% of
revenues on sales and advertising.
Dollarama spends zero.
How is this a sustainable business strategy?
Moreover, if you look at the customer segment, they have no social media presence.
As I'm sure you're well aware, millennials want to connect through Twitter, through Instagram,
through Facebook.
Go on all these platforms, and Dollarama is absent.
So what does that mean?
We think they could lose a whole segment of the market of people they're just not connecting
with.
So this would be a better use of capital-- to invest in marketing, refresh the store
base, rather than buying back stock at an all-time high valuation.
That we think is responsible.
From a valuation standpoint, where is this name trading relative to its peers?
The valuation is insane.
And I emphasize that it's insane.
We bifurcate the market in two ways.
We look at the other dollar stores.
And that could be Dollar Tree, Dollar General.
We can look at the valuation for dollar stores that were acquired, like Family Dollar.
And then we look at the names of premium retailers, companies that have cachet, companies that
have pricing power-- a Ferragamo, a Tiffany, a Prada.
Dollarama trades closer to a higher-end retailer like a Tiffany or a Ferragamo.
Why should that be the case?
Dollarama sells products of limited value with no pricing power, with no cachet that
are available anywhere and everywhere.
And so the valuation is on the higher end closer to the premium retailers.
And it trades at a significant premium to the dollar store peers.
And you might ask yourself, well, is it growing faster?
Quite clearly, an investor might be willing to pay a higher multiple if there were sustainable
growth.
But the answer is no.
So Dollarama is projected to grow revenues about 6%.
Well, that's not all that exciting.
Why would I pay a premium multiple for something that's just not growing?
And that's assuming that it hits the analyst price targets and analyst projections.
We've already shown that this year the story is starting to crack.
And they're starting to miss those numbers.
And we think that's going to continue.
So right now it's trading at about 13 times EBITDA for 2019.
It's trading close to 18 to 19 times PE with shrink 3 and 1/2 times revenues.
We don't see that as sustainable.
Dollar stores here in the US with comparable growth trade at 1 times revenues, maybe 10
times EBITDA.
And when we try to think about what is this business worth, we say to ourselves, it's
a mature concept, maturing.
I think we can agree on that.
Even if we haircut management's long-term store count target, they're looking at 1,700
stores.
Let's give them the benefit of the doubt that they're going to do 1,500.
Let's pull back the margins a little bit.
We've already demonstrated that currencies are changing.
Logistics and transportation costs are going to have to increase as they broaden out the
business.
They're going to have to market labor, which we didn't touch on.
Minimum wages are going up 9%, 10%, 12% in the various provinces.
In Canada, you start layering all these things in.
Incremental interest expense with interest rate is rising.
We're getting $2 or less of earnings power.
And at a 15 times multiple, we think this thing's in mid-$20 price target range.
And with the shares in the low 30s, we still see more downside risk.
And that's assuming almost everything goes according to plan-- they can even get to that
loftier target over time, which we don't think they will.
So with all of this in mind, walk me through how an investor would go about shorting this
name.
So the stock trades up in Canada and Toronto.
The ticker is DOL.
It also has an over-the- counter symbol I believe of DLMAF, which you can enter through
any US brokerage to short the stock.
There is an abundance of shares available-- last time I checked, 15, 20 million shares
outstanding-- so almost no cost of borrowing other than the de minimis dividend that they
pay, which is maybe a half a percent.
It's extremely liquid, which is what we like.
We try to find situations that we're not going to put our capital at risk when there's a
big control shareholder or an illiquid security that there could be a short squeeze.
We see very little short-squeeze risk in the name this big and liquid.
So it's very actionable.
It's very timely.
The company is going to report earnings in the next week.
We still think the numbers are quite aggressive absent management accelerating buybacks to
reduce the share count to increase earnings per share.
We think there's, again, very few additional levers they can pull to continue to prop up
the numbers here in the short term and long term.
Well, Ben Axler, we really appreciate you coming on and giving us this thesis.
If management at Dollarama is listening, we welcome a response from them.
But until then, we will have our eyes on this stock and keeping an eye towards the end of
the year.
Thank you very much for having me.
So Ben likes betting against Dollarama.
Specifically, he suggests shorting ticker symbol DOL at current levels.
His target price is $25 over the next six months.
That's Ben Alxer, founder and CIO of Spruce Point.
And I am Brian Price for Real Vision's Trade Ideas.
Thanks for watching.
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