Jean-Pascal Rolandez of The L.T. Funds presented his in-depth investment thesis on Distribuidora Internacional de Alimentación (Spain: DIA) at European Investing Summit 2017.

DIA is a $4 billion Spanish mid-cap with a free float of 100%. Basically, DIA is the “Aldi/Lidl” of the Iberian world. It used to be owned by Carrefour, which spun it off to shareholders after bleeding it with a EUR 1 billion dividend payout. The company, which has its own formats and corporate culture, is diligently paying down that debt and has finally reached the point where it is able to invest again in stores and develop new formats.

Carrefour dragged DIA into several countries in which the format did not work for various reasons. DIA is now refocusing on Spain (81% of sales), Portugal (4%), Brazil (10%), and Argentina (4%).

Jean-Pascal expects 6% annual organic growth in EBITDA. Meanwhile, the stock recently traded at a 20% discount to European food retail peers, which exhibit average organic growth of ~2%. DIA shares recently traded at 7x EV 2017-18E EBITDA compared to 11x for Portuguese rival Jeronimo Martins (same 6% growth rate derived from Portugal, Poland and Colombia, with no debt).

DIA is a terribly boring company (you probably would not like to shop in most of its stores) in one of the few growing retail segments (discount food retail). It is cheap and unloved (one of the most heavily shorted mid-caps in Europe). However, DIA should deliver, thanks to multiple growth drivers.

The following transcript has been edited for space and clarity.

We will discuss DIA today, a stock that is controversial in the investment community. DIA is a midcap from Spain, and it is one of the most heavily shorted stocks in the midcap universe in Europe. The reason it is controversial is probably due to how DIA has evolved over the years. To understand the investment case, it’s necessary to go back to the company’s history. I always like to understand a company’s history — it tells a lot, especially when one invests with a long-term horizon.

DIA stands for Distribuidora Internacional de Alimenticion. It’s a food retailer with an international background since the early stages. It was established in 1979 as a chain of small city stores with a focus on a single supermarket format with a maximum 600 square meters, no parking lot, but well-located in Spanish cities, Madrid in particular. DIA started in Madrid and then expanded to Barcelona and other major cities in Spain. It was then bought by Promodès, a company that later merged into Carrefour. Promodès saw that hypermarkets were developing in Spain and that small supermarkets could no longer be competitive. As a result, DIA focused on the discount end of food retailing, and from the start DIA built a strong discounter culture, becoming an Iberian Lidl or Aldi.

DIA expanded naturally into Latin America, starting with Argentina and Brazil. It also expanded into Portugal from the early days. Then Promodés was merged into Carrefour, and the latter thought it would be a good idea to broaden the scope of DIA. It was the grand times of Carrefour, which had global expansion plans. Carrefour expanded into China, Turkey, all across Latin America, Mexico, Southeast Asia, etc. Carrefour aimed for DIA to be its hard discounter across the globe, and it dragged DIA into places that were not necessarily natural for a Spanish company, such as Turkey and China. Carrefour folded its own discount format in France into DIA. The latter became a global company, but it was not natural for DIA to expand that way. Within Carrefour, DIA had to cope with and follow that plan.

Carrefour eventually realized the strategy was not working. Moreover, the Carrefour empire started to erode and even disintegrate. Carrefour had to refocus on hypermarkets and supermarkets and decided to spin out its hard discount format. It spun off all of DIA in 2011. The spinoff happened through the stock market because nobody was interested in buying DIA.

For Lidl and Aldi, it’s not natural to make acquisitions. They expand organically and, quite importantly, they are not very comfortable with Latin markets. They are German and focus on Anglo-Saxon markets. They expanded into the UK, Australia, and are now expanding into the U.S. As Carrefour was in need of cash, it took a huge dividend — about one billion euros — before spinning off DIA. DIA found itself with high gearing and a low equity valuation.

It is when DIA’s own DNA took over. The Spanish company started to refocus on its natural turf — Iberia, Brazil, and Argentina. DIA started to dispose of operations in countries into which Carrefour had dragged them, such as Turkey, China and, crucially, France. Carrefour realized it had made a mistake when it let its hard discount retail format in France go with DIA. Carrefour bought back the French operations of DIA, which helped DIA reduce gearing.

DIA had to cope with a heavy debt burden for years and therefore under-invested in stores. DIA was familiar to Spaniards, like 7-Eleven in Japan or the corner grocery store in countries with convenience store chains. People in Spain realized DIA stores were being run down and negative sentiment developed around DIA.

Fortunately, DIA was well-run despite this heavy burden. It focused on paying down debt to reach a point at which it was able to generate free cash flow and the debt level became less bothersome. The “LBO” that was DIA had gone through the most risky episode. That was about a year ago.

Gradually, DIA found some cash to give a fresh coat of paint to its stores, to refurbish stores. DIA found the energy to buy for a song three Spanish supermarket chains that had gone bust during the recession. The El Arbol chain fit nicely with DIA’s lack of presence in northwestern Spain. DIA also bought the southern Spanish stores of a troubled Basque chain, a fitting acquisition that completed nicely DIA’s network in southern Spain. Finally, DIA bought a bankrupt chain of German drugstores within Spain, Schlecker, which had a good network within cities. These acquisitions were made at low cost and fit well into DIA’s network.

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About the instructor:

Jean-Pascal Rolandez is the manager of The L.T. Funds, a Geneva-based investment firm focused on a buy and hold strategy based on a limited number of European stocks with a 5+ year investment horizon. Jean-Pascal has more than 25 years of equity investment experience and has founded the first investment club at the leading French business school ESSEC. Prior to establishing The L.T. Funds, Jean-Pascal held various executive positions at BNP Paribas for 22 years, including as Paribas’ French equity strategist.