Dino Polska: Disrupting Growth In Poland (OTCMKTS:DNOPF)

Opener

I like to invest in high-quality businesses – ones that can generate high returns on capital above the cost of capital and grow significantly over time. I believe the combination of a high return on capital, along with double-digit top-line growth at a reasonable price, is the winning formula. Moreover, I prefer simple businesses; I’d rather not delve into a tech company whose competitive products I don’t fully understand. On the contrary, Dino is a retailer, and retail is quite straightforward to comprehend (though very challenging to succeed in). I understand the growth paths and risks involved, which is valuable information for me.

I believe Dino (OTCPK:DNOPY) presents us with an opportunity to acquire a simple, growing business with a low beta and a relatively predictable future.

Here Are The Things I Like

First of all, I want to hold my positions for the long term, and one thing I know will happen in the future is a recession. I don’t know when, but it will occur. That’s why I like to buy businesses that are less cyclical, ‘all-weather’ businesses. Dino primarily sells groceries, and people need to eat regardless of their economic conditions. No, it’s not recession-proof, and I’m sure that in a severe recession, there will be impacts on Dino’s sales. But these impacts will be less severe than on other businesses that are more ‘nice to have.’ As we have seen with sales since the IPO, Dino’s growth is linear, and I expect it to continue in the future.

A major tailwind for Dino is the power of Polska (Poland). Poland is on the rise economically, with its economic growth being one of the strongest in the world over the last 30 years. This is because of the post-communist era. The transition to capitalism paved the path to prosperity, and Tomasz Biernacki built a great business out of it. According to McKinsey, demographic factors picked, and productivity growth could further drive GDP growth moving forward. In a bullish case, Poland could double its GDP in the forthcoming decades.

Although technological progress has been one of the drivers of Poland’s economic growth, Poland has not yet reached the point of technological saturation. In addition, investment in innovation and the materialization thereof, as measured by the number of patents per capita, is much lower than in the rest of Europe.

The growth in Poland’s economy will be a significant factor in the like-for-like growth of Dino.

Another factor I like is the business model. Today, there’s an increasing need for people to shop close to their homes. Dino operates relatively small stores that can fit in cities and towns, especially in Poland, where 80% of the population lives in rural areas. Nowadays, especially in the EU, people prefer a more convenient experience than the huge supermarkets with vast selections.

Dino strives to be a low-cost provider. It matches the lowest-cost providers in the area every week. Much of the growth will come from mom-and-pop shops that can’t compete with the prices and convenience that Dino offers. Dino has its own meat provider, so it can deliver fresh meat like the big chains outside of town, but it can provide this service while being nimble and within walking distance.

Dino owns its stores, giving it the flexibility to build the stores in the same format, providing customers with the same good experience. This can also lead to impairment in the value of real estate on the balance sheet in case of a real estate slowdown.

Another positive point, and also a negative one, is that Dino is growing higher than inflation, indicating significant pricing power. However, inflation has been high in recent years, contributing to the higher like-for-like growth. If the inflation rate decreases, so will Dino’s organic growth.

Based on the last five years, Dino’s beta is relatively low at 0.5, meaning that investors have made 3.5X their money, with low volatility.

Finally, a very important point here is that the company is majority-owned by Tomasz Biernacki, who is the founder and chairman. He holds 51% of the company shares, as well as voting rights. Based on his history with Dino, I’m happy that he is leading the company.

Risks

Dino, in itself, looks pretty stable and predictable to me; however, being based in Poland poses challenges for foreign investors.

Firstly, if you invest in the Warsaw Stock Exchange, you are exposed to currency risk. You will invest in PLN, which has been relatively stable in recent years against the dollar but could result in losses at the time of sale.

If you decide to invest through the OTC, in DNOPY, you will likely have a hard time buying and selling due to low volume. This could impact gains when you try to sell.

A major risk, in my view, is the Ukraine war. Poland shares a border with Ukraine, and any aggression towards Poland from the Russian side will affect the stock. I do see this as a low risk because Poland is a NATO ally.

While Dino owning its stores provides advantages, in the case of a real estate market downturn, this could lead to a write-down in value and consequently hurt EPS.

Additionally, if inflation in Poland were to decrease, this could result in lower growth for Dino.

Looking forward, as store density grows, we could see an impact on like-for-like (LFL) growth; it could be akin to internal competition.

Numbers

I appreciate Dino’s linearity, having grown above 30% CAGR in topline revenue over the last decade. However, we should anticipate lower growth in the future as the business matures and inflation moderates.

Dino managed to grow its gross margins, indicating increased bargaining power with suppliers, but since COVID-19, it has reverted to the more familiar 23%.

EBIT margins have also remained stable at around 7%.

In my view, besides revenue growth, the most important figure for a company’s success is high returns on capital, as well as stability and even improvement in growth. Dino has a high ROC and is growing, which is a major factor to consider moving forward, indicating increasing efficiency in the business.

A useful way to identify a critical flaw in the business, not easily found in the financial statements, is through ratios like DSO, DPO, and DIO. At Dino, DSO and DIO are pretty stable, and DPO is on a downtrend, meaning less power for Dino against its suppliers. However, the decrease isn’t significant enough to be considered a warning sign.

In terms of solvency, I don’t see any risks here. Net debt is at ~$208 million, and cash from operations is significantly higher, meaning that if necessary, Dino can easily halt capital expenditures and pay off the debt.

Dino isn’t paying dividends or buying back shares, but on the other hand, it is investing in the business and not diluting shareholders.

Looking forward, management expects low teens growth in store count, and with low teens LFL sales growth added based on historical growth rates, we can anticipate 20%+ topline growth in a base case. This is outstanding for 24 times forward earnings. Looking ahead, as store density grows, we could see an impact on LFL growth, similar to internal competition.

Q3

Earnings were great in Q3; revenue grew by 28%, and net income by 24%. The decrease in margins was driven by higher prices to purchase merchandise. Like-for-like (LFL) sales grew strongly at 16%, driven also by inflation but exceeding food inflation, indicating more foot traffic in the stores.

Valuation

In my view, Dino is reasonably valued, trading at NTM 24 earnings. It would be misleading to look at FCF multiples for Dino simply because of the high capex needed to support the business. If we assume around 20% earnings growth, which is not out of reach, we are looking at a forward PEG ratio of 1.2, which to me looks perfectly reasonable considering the high returns on capital. You won’t find many companies at this level of growth with a PEG ratio of less than 2. Moreover, the TTM P/E is lower than past averages.

Let’s perform a simple DCF. If we assume top-line growth for 2023-2025 as per analysts’ estimates, and thereafter a 100 basis point decrease in growth each year, along with stable margins and capex spending, and a 6.1% terminal growth rate, we arrive at the current price. Assuming a terminal growth of 2-3% seems too low to me for the TAM of the business. Yes, it’s not the type of situation that screams ‘cheap,’ but I’m willing to pay a reasonable price for high-quality businesses.

Conclusions

In my view, Dino Polska is a high-quality compounder, which is likely to continue as such. I like the fact that it is founder-led and that it is a simple business. I believe the risks are relatively low, and the business is quite predictable. Earnings are estimated for late March, and I will be watching.

I think that Dino can manage to sustain its double-digit growth rate, at least. This is because one of the company’s goals is to increase store count as well as like-for-like (LFL) growth, which could be driven by Poland’s economic growth, as well as the closure of more and more mom-and-pop stores. Dino has the cash flows to expand its store count, and its superb service and prices will naturally attract more consumers, as we have seen in the last decade. We might also see margin expansion due to increasing bargaining power. If the growth rate remains in the high double-digit area, the price is reasonable to me.

Looking forward to your comments.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.