TheChek News Flow

By Vedran Vekjardo and formerly at Agram Capital

This article first appeared on SumZero, the world's largest research community of buyside investment professionals. In some cases Barron's edits the research for brevity; professional investors can access the full version of this thesis and tens of thousands of others at SumZero.com.

Disclaimer: The author's fund had a position in this security at the time of posting and may trade in and out of this position without informing the SumZero community.

Target price: $24

Recent price: $15.37

Timeframe: 1-2 years

Thesis:

At a time of high valuations, one of the rare pockets of value comes from turnaround stories. This is one of them.

Carrefour is one of the world's largest retailers, with EUR80 billion in net sales. Yet the company is trading at a fraction of the price of other large global retailers or, for that matter, its former self. I believe that is poised for change. With a new and proven management in charge, the company is going through serious and thorough restructuring that will lead to the stock appreciation.

Once upon a time, Carrefour was the second largest retailer in the world in terms of sales, but years of underperformance and strong competitive pressures in the domestic market are the cause of decades-long stagnation.

After a series of disappointments, dismal results and many, many CEOs, the Carrefour board decided it was time for a new management team led by Alexandre Bompard. Bompard joined Carrefour coming from Fnac-Darty and brought Mathieu Malige with him, as CFO. This time the board has chosen wisely, since Bompard is a big corporate star in France with a brilliant track record. His past performance tells us he is perfectly suited for the CEO position at Carrefour.

He became CEO of Fnac, a French books, music and electronics retailer, in 2010. At the time Fnac was under immense pressure from competitors, most notably Amazon. He managed to stop the bleeding with the cost-cutting plan that included layoffs and reduction of logistics and stores'costs, as well as putting in charge a new and talented management team, formed between new external hires and internal appointment. Sales stopped falling, competitiveness was restored, margins increased and after a 2013 IPO, its stock price tripled. On top of that, he was the brains behind the successful Fnac-Darty merger. Surely, his appointment was a clear winner for Fnac shareholders.

Carrefour is a global food retailer with a network of 11,947 stores in 30 countries. It has close to 380,000 employees and serves more than 100 million customers. With 46% of total sales, France is Carrefour's largest and most important market. About 27% of sales comes from other European countries, of which Spanish is the largest, followed by Italy, Belgium, Poland and Romania. Latin America is the fastest growing market for Carrefour and it represented close to 19% of sales in the first half of 2018. It consists of two countries: Brazil and Argentina. The rest of the sales come from Asia -- China and Taiwan. Alongside its directly operated stores in those 10 countries, Carrefour operates a network of franchised stores in many other countries: Indonesia, Saudi Arabia, and Algeria to name a few.

Despite being the largest, France is not the most profitable market for Carrefour due to fierce competition going on there. The most profitable market with the largest margins is actually Latin America, more precisely Brazil, where Carrefour owns 71.8% shares of local retailer Atacadao, after its 2017 IPO.

For years, Carrefour has been losing share in very competitive French retail market. It was so competitive that even German discounters Aldi and Lidl had a hard time gaining share. After years of presence in the French market, German discounters hold a much smaller share than in comparable European markets. The price leader in France is Leclerc. It has been gaining share for years and is now the market leader in groceries. Its business model is simple -- everyday cheap prices. Hypermarkets, which represent half of the sales in France for Carrefour, have a price gap of approx. 400 bps to Leclerc.

On January 27 this year, after six months at the helm of the company, the new management presented a comprehensive transformation plan, "Carrefour 2022." At the core of the plan is a massive cost reduction of EUR2 billion on a full-year basis as of 2020.

Over the years, Carrefour has created layers and layers of bureaucrats, consultants and managers (unlike Leclerc, where its members occupy top management positions) who besides adding to the costs slow the decision making process. To reduce Leclerc's competitive advantage, Bompard and his management team have decided to cut 2,400 jobs of 10,500 at its HQ in France. And they didn't leave it there. Similar layoffs were planned for Belgium and Argentina, as well as divesting (selling or closing) 273 ex-DIA stores. But actually the vast majority of the EUR2-bn cost reduction comes from the a) optimization of direct purchasing like reducing assortments by more than 10% and using global scale at negotiation table with international suppliers; b) rationalization of indirect purchasing (strict management of expenditures and renegotiation of historical contracts) and c) reduction of logistics costs.

A big part of that savings would be used to gain price competitiveness vs. Leclerc. In addition, the focus of the plan is on massive investments in digital -- EUR2.8 billion over the next five years, or six times more than current investments, and to take at least 20% of French food e-commerce market or EUR5bn in sales by 2022. On top of that, they have planned to reduce the sales area of hypermarkets in France by at least 100,000 m2 to match their catchment areas, to form purchasing and selling alliances, to dispose of 500 million of non-strategic assets, to selectively choose investment projects and cap them to EUR2bn per year and to increase the share of Carrefour branded products to a third by 2022.

It is an ambitious plan, no doubt. As far as I was concerned, already the experience and success with Fnac implied that the management was able to carry out such plan. H1 results published a few weeks ago made me almost certain of that.

In the first half of 2018, they achieved EUR520 million or a quarter of annual savings planned for 2020. The workforce reductions in France, Argentina and Belgium have been made, and Carrefour made an exit of 273 ex-DIA stores. Also, Carrefour signed important strategic partnerships with Systeme U, Google, Tencent and Tesco. With Systeme U and Tesco it was a purchasing partnership with a goal to negotiate lower prices with suppliers. In December of 2017, Carrefour signed a similar agreement with Fnac Darty regarding purchasing partnership for household domestic appliances and consumer electronics in France. The goal of the strategic partnership with Tencent was to boost Carrefour's loss-making Chinese business, especially by improving Carrefour's online visibility there, but also using Tencent digital and tech expertise in offline retail like, for example, in newly opened La Marche "smart store" that uses facial recognition technology. The partnershi