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DDR

DDR  

  By: rick-mooney on Nov. 27, 2018, 9:41 a.m.

Hey Claude, just a couple of thoughts on your DDR piece, firstly the risk of a move to BYOD is somewhat mitigated by the fact that the retailers have to buy from a distributer, so if there is an overall significant move to BYOD a company like DDR will lose some direct corporate clients and then pick up some new sales through the retailers.

Second point that is worth noting with DDR is the quarterly divvies, that can be a plus for those investors in the retirement phase.

Finally my two big concerns with DDR (despite it being one of my largest holdings), as you mention the debt incurred by the recievables facility, but as I have talked with you on twitter, DDR management are adamant this strategy is best for the business and given the track record its hard to argue! The second one is that as someone who runs an IT business and has accounts with a number of distributers, I simply dont understand why anyone uses DDR! They are more expensive and dont give free freight to retailers. As a shareholder I would prefer to push my business their way, but I have never ordered through them because the cost to my business would be unsustainable.

I have never really found a way to get comfortable with this personal insight into the business, other than to accept the hard numbers which show revenue of over $1b so someone is buying from them!

Re: DDR  

  By: Claude on Nov. 27, 2018, 1:19 p.m.

Interesting insights, thanks Rick.

It may be that the postage isn't such a big issue for many people, but if they are charging more than some others, it would be worth investigating why sales do keep growing -- is it the wider range, personal relationships, or faster and better service?

If you have any examples of where they are more expensive you could send it through to me at claude@ethicalequities.com.au and I could investigate further.

Thanks again for posting!

 

Claude

Re: DDR  

  By: rick-mooney on March 1, 2019, 11:48 a.m.

Thanks to @MattBrazier2 detailed writeup on DDR's latest Annual Report. He was articulated far better than I, the points that i picked up when having a first scan of the AR, good news on revenue & earnings, less so on cash flow. I am also chuffed that as a beginner I managed to identify the source of the drop in cash flow - noting on twitter this morning the combination of changes in inventories and payables. Matt also echoes my long term concern about financing the receivables facility with debt. The facility ballooned by 15% last year, debt is now larger than equity. As I have said previously I would much prefer dividends were reduced and over time the facility become funded by retained profits, but given that its largely a private family business, this arrangement has suited the majority of shareholders (family), by providing a very strong quarterly income stream that is fully franked. 

Happy to continue to hold despite my reservations!

Re: DDR  

  By: mark-fergusson on March 1, 2019, 12:34 p.m.

I have held DDR for long time, always participated in DRP and it has become 12% of portfolio. They pay out virtually all profit as dividend and now have to fund $55m warehouse build. Are you aware how they are going to fund capital cost of the warehouse ? My fear is a capital raise now that share price has risen. They did issue shares back in Aug 2015 to raise capital am thinking they could do it again as they need the cash and have high debt. Maybe sale of some of my holding is a good strategy.

Re: DDR  

  By: Matt on March 2, 2019, 8:39 a.m.

Hey Rick,

Great insights on DDR. Like you I was concerned with debt and this stopped me from buying shares when the stock was trading on multiples that implied little or no growth (a big mistake). However, I increasingly feel that not only is the debt not a problem, but it is actually a benefit as it improves the capital strucutre of the company. This is because debt is cheaper than equity. For example, average debt was $102 million in 2018 and finance and borrowing costs totalled $6.8 million. As the cost of debt is paid before tax (unlike equity), there is also a tax benefit from using debt. So the effective cost of debt in 2018 was 0.7*6.8 = $4.8 million or 4.7%. On the other hand, the stock trades on an earnings yield of about 5.9% (2018 NPAT of $32.5m/$548m market cap) and this is probably the lowest earnings yield the stock has ever traded on. So even when trading on a record low earning yield, the cost of debt is still lower. 

Of course, there is also the risk of default when using debt (unlike equity) but this risk is low given debt is only 1.9x EBITDA. In other words, the company could pay off all its debt in about 2 years if it stopped investing in capex or interest rates would have to rise to ~50% before the company was unable to pay the interest on the debt.

Then when I got over the question of debt, I was put off by the higher prices that DDR charges. I assumed that it would lose market share because of this but in fact the reverse has happened! I don't understand what is going on here but perhaps Claude is right that they offer a superior service somehow. I have heard that there is a well aligned incentive structure for staff so perhaps this is part of the reason.

Hey Mark,

You make a good question about how they will fund the warehouse construction and it was remiss of me to leave this out of my article. It would make sense to me that they raise equity capital at these levels given the stock is trading at historically high multiples of earnings. Even though debt is still a little cheaper, we may be at a cyclical low in interest rates and the company also already has a sizeable amount of borrowings so my preference would be for an equity injection. You are right that this will probably lead to a subdued share price in the short term (shouldn't be anything too severe though) but in the longterm it will probably lead to a higher share price (all else equal). This is because they are expanding warehouse facilities to grow the business and the company has historically achieved high returns on capital (27.6% in 2018). Assuming they can achieve a 20% return on the capital raised for the warehouse build (less than historical performance) then there will be significant value creation for shareholders given they can raise equity on an earnings yield of about 6% right now (see above).

Matt

Re: DDR  

  By: rick-mooney on March 2, 2019, 2:29 p.m.

Thanks for the detailed response Matt, I think what you say makes sense, and as I said we also have to see it from the point of view of the majority shareholders, and they clearly prefer the income stream! I can live with it just fine, its one of my biggest holdings and my average is $1.60 odd, if only a few more were such good custodians of my capital.

I have finished my analysis and updated my spreadsheets for the year, obviously there is a hit to the implied IV with the drop in FCF, but I still have a range of IV across my metrics that is $2.50-$3.60. I would still regard it as at least fair value at current prices.

I have given up trying to understand why anyone uses DD as a distributer! Sometimes insider knowledge is completely useless.

To Mark's point, I think Matt is likely right and the warehouse construction would likely be funded with equity, I would certainly struggle with that much extra debt added to the balance sheet! If they do raise it may well create a chance to top up at a discount on market.

Re: DDR  

  By: Claude on April 1, 2019, 9:55 p.m.

What a cracker it has been - hope you've held!