GrandVision: Are You Seeing This Opportunity? (OTCMKTS:GRRDF-DEFUNCT-581463) (2024)

The investment case in a nutshell

We believe that GrandVision’s (GRRDF) goal to grow its top line by a 5% CAGR over the next five years is more than achievable and that it could surprise on the upside, especially once external growth is considered. Organic growth is supported by structural drivers such as an ageing population, an underpenetrated market as well as an increasing use of electronic devices as well as specific company initiatives. Furthermore, the high level of industry fragmentation offers plenty of opportunities for external growth.

We think that the business model is bullet-proof because if a recession happens, the company should still be able to grow its business given its medical products offerings (Non-discretionary items by nature) and its mass market positioning. Moreover, the business model is also protected from e-commerce disruption.

On top of top-line growth, the company has an opportunity to improve margins and grow its cash flow. Indeed, amongst the three segments operated, two of them should have meaningful margin expansion opportunities by leveraging existing infrastructures, optimizing supply chain and improving the product mix.

Finally, the company trades at a discount to its peers. More important, we believe that the growth profile is underappreciated by most investors. Indeed, we believe the company will be able to grow its business over a long period of time, given the strong industry fundamentals as well as the M&A component, which is overlooked because of the complexity for modeling it properly. However, long-term investors will benefit from longer growth and additional M&A, no matter if it happens in the next two months or in the next two years. Patience will be rewarded.

What is causing the market to misprice GrandVision?

We believe that investors misprice GrandVision for a combination of reasons. Some of them are short-term in nature: 1) FX adverse movements, 2) integration issues and related impairments in Italy and 3) in the US. Some are more long-term oriented such as the 4) investors’ inability to look at over the long term and 5) a potential industry disruption (e-commerce and regulation). We believe that all these reasons do not justify the current company valuation.

1) FX adverse movements

First of all, we believe that FX movements are unpredictable and that they are the price to pay to be exposed to the fastest growing regions such as Asia, Latin America and Turkey. We will discuss more about it in a dedicated section.

2) & 3) Integration issues and related impairments in Italy and in the US

The Italian business faced specific issues following the acquisition of the optical retail chain Randazzo in December 2014. Before this acquisition, GrandVision was already present in Italy through the brand Avanzi. These two companies were about the same size as highlighted by the number of stores. Indeed, Avanzi operated 183 in the north of Italy while Randazzo operated 190 stores in the south of the country under the brand Optissimo. From our understanding, the company strategy was to build a national brand but was not successful. At the same time, the local management team lost track of the day to day business management. As a result, the company had to recognize a goodwill impairment charge of € 19M (in Q3 2018) which reflects the lower profitability than initially expected.

A new management team is now onboard, and, at the last conference call, the CFO made it clear that despite the goodwill impairment, the ambitions of the Italian business remains the same than the initial targets (but only postponed). Amongst the ongoing progress, the company has finalized its rebranding strategy by deciding to implement a co-branding strategy: the banners are now branded as GrandVision by Avanzi and GrandVision by Optissimo. This strategy allows the company to communicate at a country level while keeping historical brands with which customers are familiar. Given the group track record in Europe and the similarities between the Italian and European markets, we have no reasons to believe that the company will not be able to restructure the Italian business.

The US business faces similar issues: Indeed, a longer than expected organizational rebuild (following the acquisition of For Eyes in December 2015 for € 129M) delays the improvement of the profitability. Moreover, it seems that the company spent more money than initially expected in order to improve the platform and the infrastructures (systems reorganization and controls implementation). As a result, the company had to recognized a goodwill impairment charge of € 38M in 2017. All these issues are now behind the company that can now focus on running its business.

We believe that the company learned a lot of these two integration issues. They have created a central management office that will help out design and plan integrations and will support local teams. As a result, integration risk should decrease going forward.

4) Investors’ inability to look at over the long term

Investing in GrandVision means that you believe in long-term trends such as ageing population, increasing use of electronic devices (with their negative impact on eyesight), underpenetrated markets (especially in emerging countries). As a result, the company growth profile should be sustainable over a long period of time. Unfortunately, most investors (or at least the largest money managers) focus on short term periods because they are assessed on a quarterly basis.

5) A potential industry disruption (e-commerce and regulation).

Finally, even if some investors have a long-term investment horizon, a large portion of them are not ready to pay for a business that could be challenged by e-commerce or regulation changes. However, we believe that these concerns are overstated. We will discuss more about these two topics in our industry analysis section.

Company description

GrandVision is one of the leading optical retailers. The company sells a large range of prescription glasses (frames and glasses), contact lenses, and sunglasses and provides optical services such as eyesight tests. The group is present with 7,000 stores and 30+ banners (see below) in more than 40 countries across 4 continents. The revenue and EBITDA are split as follows:

The company has market-leading positions in Europe and Latin America and has a top 3 position in most other markets in which it operates. In general, the group strategy consists of providing affordable glasses to the mass market through a local banner. However, in some countries, they also target the mid-high market under a different banner. Finally, the company operates also its own sunglasses retail banner called Solaris.

What are the Bulls and Bears saying?

Before delving into the analysis of the optical retail industry and GrandVision, we are going to emphasize the bulls and bears arguments. We think it will be helpful in order to have a better understanding of the investment case and to have an independent analytical mind while reading our analysis.

A very attractive industry

A growing industry…

According to Euromonitor, the eyewear market growth should accelerate over the next 5 years from 4.2% to 4.6%. This acceleration is driven by Latin America and Western Europe markets (Normalization following the reform of the French market). In terms of products, sunglasses should be the key growth driver.

These growth forecasts are supported by strong structural trends:

Positive demographics: Population growth and an ageing Population

The eye care industry is exposed to favorable demographic trends: a growing and ageing population. The growing population mechanically increases the number of people with eye problems, thus the number of people requiring treatment. The ageing population also benefits the industry because the population faces eye problems when getting old. In general, eyesight starts to deteriorate from 40 years old. For instance, 70% of people over 45 years old and 95% people over 70 years old have vision problems. The following table shows that the category of people over 65 years will grow faster (>3 %) than the overall population (~1%).

In terms of geography, Europe has already one of the oldest populations in the world and it should not change in the next decades. As a result, it is one of the continents that will benefit the most from this trend (GrandVision generates 86% of its revenue in Europe).

Lifestyle: Early age adoption and increasing use of electronic devices as well as unhealthy lifestyle

During its 2015 capital markets day, the global lenses manufacturer Essilor (OTCPK:ESLOF) has stated that 63% of the global population is affected by vision problems. This percentage could increase because people start to use electronic devices (smartphones, tablets, TV, laptops…) younger and younger and more frequently. Moreover, eyesight deterioration is also exacerbated by diabetes which is a real pandemic. Diabetes evolution is supported by obesity and unhealthy lifestyle (lack of sport, eating too much junk food).

Underpenetrated markets

According to Essilor, only 42% of people affected by vision problems have treated them (1.9B corrected/4.5B requiring vision correction). This number could improve over time with the economic development of emerging countries as well as the growing middle class in these countries. Indeed, improving economies are correlated with higher healthcare expenditures and better care.

A demand for UV protection and fashion items

Sunglasses are the fastest growing category and are expected to remain so over the next few years. Indeed, sunglasses are an unpenetrated category because most people do not consider them as an eye care product. According to Essilor, the penetration rate of sunglasses is slightly below 20% (1.4B Equipped/7.2B people worldwide). However, people are starting to become aware of the danger of UV rays (Sun). Moreover, the demand is also supported by people looking for fashion sunglasses. Finally, the penetration rate of sunglasses with prescription glasses is also very low, suggesting potential growth opportunities.

… with defensive characteristics

In addition to be a growth industry, the eye care industry is also very resilient. Indeed, glasses are a medical necessity; therefore, purchases can only be postponed, not cancelled. Indeed, vision problems impair significantly the quality of life while the cost for treating such problems is still affordable. As a result, the demand for glasses should not be significantly impacted over a long period of time.

We didn’t find data for the overall European industry, but the constant revenue growth of GrandVision and Fielmann (OTCPK:FLMNF), one of its main competitors, demonstrates the resilience of the business in Europe. The US market is also resilient as highlighted by the defensiveness of the industry during the global financial crisis (2008 and 2009).

Moreover, the industry sales are recurring because generally eyesight does not improve over time; it only deteriorates. As a result, new vision tests and new eyeglasses are required. Finally, the daily use of spectacles requires also replacements after a few years (replacement cycle is comprised between 2 and 4 years).

A focus on e-commerce threat

The brick-and-mortar retail channel is the most important distribution channel for eyewear products. Until now, the industry has not been impacted by the threat, headlines or the emergence of an e-commerce player such as Amazon. Unlike most its retail peers, the eyewear industry is more complicated to disrupt because it offers in-store services such as eyesight tests and eyeglasses adjustments (cutting and fitting) that are required for clients.

Eyeglasses are the largest component of the eyewear market and account for approximately 70% of total industry sales. In addition to in-store services, retailers offer the possibility to test dozen of spectacles before purchasing one. Testing reinforces the protection from e-commerce disruption because people need to try spectacles in order to choose the most comfortable. Furthermore, GrandVision provides its own private-label and exclusive brands; therefore, it is impossible for a customer to test them in-store and purchase them on a competitor website. As a result, this category is likely protected from the e-commerce threat.

Contact lenses account for 15% of total industry sales and are more at risk than eyeglasses. Indeed, once you know what kind of lenses you need, you can order them directly online. That’s why the omni-channel makes a lot of sense: people might be advised by opticians and test lenses in-store and refill their prescription online. It seems that a lot of people are afraid of buying them online because they do not trust the seller. Developing an omni-channel strategy (like GrandVision is doing) by strengthening a brand and a brick-and-mortar presence could overcome this challenge.

Finally, sunglasses, which account for the remaining 15% of total industry sales, are the most at risk because they do not require additional services and are more considered as fashion items than eye care products; therefore, people can easily buy them online and are ready to do so.

Even though a potential disruption seems unlikely, existing players have already developed e-commerce capabilities in order to increase their addressable market and to fight back any potential e-commerce threats. The omni-channel is probably the best distribution method because it targets a maximum of people and allows synergies between the different kind of customers (e.g.: contact lenses prescription can be refilled online).

A focus on regulation and potential changes

Healthcare companies face a challenging environment with increasing pricing pressure resulting from regulators and insurance companies trying to carve out healthcare spending. Eyeglasses are generally not reimbursed in most countries of the world, except in France and in the US. As a result, most of the costs are out-of-pocket, suggesting a low risk of regulation disruption

The French market has already faced significant regulation change in 2015 and 2016. The government passed a new law limiting the maximum benefits that insurance plans can provide (in order to remain tax deductible). Amongst these measures, glasses reimbursem*nts are now limited to once every two years (previously once a year). Furthermore, price caps reimbursem*nts have been introduced and vary from €470 for basic lenses to €850 for more complex lenses (inclusive of €150 reimbursem*nt limit on frames). As a result, people renewed less their eyeglasses and, when they did, they spent less in order to remain below the reimbursem*nt rate. Going forward, these reforms are here to stay, and we could see even more reforms in the near future. Indeed, Mr. Macron has the desire that insurance companies provide at least 17 fully reimbursed models (including different quality of glasses and frame of different colors) from 2020.

The US is the only market where the company could still be impacted by regulation changes. However, we are not aware that US regulators or insurance companies have specific plans targeting the eye care industry.

Finally, we want to point out that regulation changes strengthened the position of GrandVision. Indeed, the company has been able to gain market share because of its affordable eyewear positioning. Future regulation changes could act as a tailwind by increasing the demand for eyeglasses.

The company

Revenue trajectory, margin evolution, non-cash working capital and capex are very important because they are the key components of free cash flow, thus the key metrics of valuation. We will discuss about each of them in details.

Revenue trajectory

The combination of favorable secular trends and specific company initiatives should allow the company to reach its target of 5% revenue growth per year until 2023. This target is expected to be reached by:

• Boosting LFL growth (+3%) which is the less risky method to boost revenue growth and offers the strongest operating leverage (because it requires almost no capital investments).
• Opening new stores and optimizing the store network (+1%) by closing underperforming stores and opening new one in attractive locations.

• Pursuing bolt-on acquisitions (+1%) in order to strengthen its positioning or/and entering in new markets.

The company could also pursue mid-to-large M&A deals (transaction higher than € 35M) if opportunities arise. This element is not factored in the company guidance but given the strong cash generation and the company history (7 mid-to-large M&A deals since 2014), it is an element that could provide upside to the company guidance and consensus estimates.

Are revenue growth targets reasonable?

The 3% LFL growth target seems challenging to reach when looking at historical data. However, we believe that this target is realistic. First of all, Euromonitor expects that the Western European and Eastern Europe markets will grow over the next five years by 3.60% and 6.30%, respectively. Given that GrandVision generates 86% of its total revenue in Europe (with a larger exposure to the most developed European economies); the 3% LFL growth target is not out of reach. Moreover, the company is also implementing different initiatives for boosting LFL growth such as growing the contact lenses business which has a shorter repurchase cycle than traditional eyeglasses (especially daily-use contact lenses). This shorter repurchase cycle leads to higher annual spending. Furthermore, the contact lenses are complementary to spectacles because people wearing contact lenses will also purchase prescription glasses as well as consumables (cleaning solutions, boxes).

GrandVision will also benefit from the recovery of the French market (16% of total revenue) which faced declining volume since 2015 due to regulation changes. Moreover, the company should still be able to gain further market share over independents (that are not able to be competitive in terms of pricing).

Finally, the US business should also grow nicely once the integration process is completed. Indeed, the group targets the value part of the market, which is the segment gaining market share. As a result, the organic growth of the US business should outperform the US market.

Given the high degree of market fragmentation in most countries in which the group operates and its strong cash flow generation, it will not be challenging for GrandVision to find attractive retail assets to acquire. Historical data shows that external growth (including mid-to-large deals) has increased revenue by 3.6% per year on average since 2012. As a result, we think that bolt-on acquisition growth targets should be easily reached.

Finally, the company targets 1% revenue growth coming from store openings. The group will probably target the US market in which the group is underpenetrated. Moreover, the company has also plenty of opportunities for managing its store portfolio in its more mature markets. Historically, new stores openings have increased revenue by more than 1% every year but one (in which it was 0.8%).

To sum up, we think that the 5% top-line growth guidance is reasonable and we believe that the group will further boost its revenue by pursuing external growth. We also believe that most investors under-appreciate the growth profile of the company as well as its duration.

FX could impact revenue growth going forward: what is the company exposure?

GrandVision generates 86% of its revenue in Europe. Amongst these 86%, roughly 60% is realized in euros, thus the remaining 26% is mainly split between GBP, CHF, SEK, DKK and NOK. We acknowledge that the group is also exposed to other European currencies such as the Polish Zloty, the Bulgarian Lev or the Czech Krona, but the exposure to these currencies is not significant at the group level.

In Europe, the G4 business negative FX impact is 100% the result from the British pound depreciation (following the Brexit vote). The impact on the Other Europe business is the result of the depreciation of the NOK (fall in oil price), SEK and DKK, which has been partially offset by the appreciation of the CHF. The negative impact for European operations was close to 1% per year in average in the last 3 years. Although not helpful, the impact remains manageable. Moreover, we are not worried about these particular economies so we believe that over the long-term, these currencies could be subject to the mean-reversion theory.

The bulk of negative FX impact come from the smallest business unit, Asia & Americas. Indeed, in 2014, this business unit accounted for only 9% of total revenue but for 50% of the total FX impact between 2014 and 2017. Most of emerging currencies have collapsed, so diversification did not help. It is difficult to predict their moves in the short term, but we think it is the price to pay to be exposed to the fastest growing economies. We also want to point out that the organic growth adjusted for the negative FX impact of the Asia & Americas business unit is far higher than the rest of the group.

The company does not disclose information about its cost base. However, we know that employee costs and occupancy costs are the largest costs and are paid in local currencies. We also know that GrandVision sources its frames in Asia and purchase them in US dollars.

As a result, we believe that the group is "long" all currencies (ex-USD), meaning that a depreciation of the currency impacts more its revenue than benefits its cost base (negative impact on earnings).

The picture for the USD is less clear. The US accounts for 17% of the Asia & Americas segment. The Asia & Americas segment accounts for 14% of total 2017 revenue. As a result, US represents 2.4% of total revenue, € 82M of revenue or 9% of COGS. We think that the revenue generated in USD is very close to the dollar-denominated COGS, meaning that an appreciation or depreciation of the US dollar does not impact the group profitability. However, the US business will grow quickly in the future, suggesting that the group will reach a "long" USD position in the near future.

To sum up, FX has been a headwind since 2011 (at least), and we have no clue on future FX movements. However, we know that the growth potential of these geographies is worthwhile; that's why we strongly encourage the company to still invest (carefully of course) in these countries.

Margin improvement

According to the company, EBITDA is expected to grow high-single digit because of the operating leverage as well as the benefits from higher economies of scale. The company has also mentioned that M&A deals will remove any positive margin improvement due to integration costs. However, even though these expenses affect margins and cash flow in the short term, they disappear over the long term, once the company has been properly integrated at the group-level, only postponing the margin improvement story.

The company has a real opportunity to improve margins (ex-M&A transactions) because its operating expenses (marketing, wages, rents) and its infrastructures (digital platforms, TechCenters) are fixed expenses and will be spread across a larger revenue base. Moreover, the group wants to increase the penetration of its own exclusive brands as well as higher-value products such as contact lenses which have higher margins.

However, it is important to note that the group strategy is long-term oriented as highlighted by its commitment to reinvest part of the savings into the business. Indeed, the company will maintain price pressure in order to weaken its competitors and strengthen its positioning. Furthermore, the company will also reinvest in digital initiatives and marketing in order to boost its sales, strengthen its brands and develop its omni-channel capabilities.

Excluding M&A, the EBITDA margins of the G4 business is probably close to its maximum, that’s why we do not forecast an improvement. It will remain close to 21% which is in line with its historical average and similar to Fielmann's margins (Fielmann business profile is similar to the G4 business). However, the model assumes slightly below margins in the short term due to the integration costs related to Tesco Opticians.

The other Europe business EBITDA margin should improve over time because the company has already a strong footprint in the region. We consider that it will recover its previous peak of 19% over time which is still below the G4 business margin even though there are not structural differences between these two geographies. Keep in mind that this business unit is composed of several developed countries similar to G4 countries (The Netherlands, France, Germany, UK) such as Sweden, Denmark, Finland, Norway, Italy, Portugal, Spain and Switzerland. A large part of margin improvement will come from the Italian business which is currently operated at a lower level of profitability than the group due to the poor integration of Randazzo.

The Americas & Asia business offer the most opportunities for margin improvement because it is a sub-scale business. The group priority is to grow the US business in order to build scale.

Indeed, the company operates only 1777 stores in this region which is similar to the number of locations in other Europe despite a larger geographic area (meaning a lower density of stores). We consider that the group will be able to reach 12% EBITDA margin in a 10 year time which is below the 18% margin generated by Luxottica retail business (LensCrafters, Pearle Vision and Sunglass Hut).

The following table shows the evolution of revenue and EBITDA margin based on our assumptions of revenue growth and EBITDA margin.

Negative non-cash working capital resulting from the business model and a dynamic supply chain

As almost all retailers, GrandVision has a negative non-cash working capital resulting from the immediate cash inflows from customers while suppliers are paid at credit.

For clarification purposes: We define non-cash working capital as the difference between current assets excluding cash and current liabilities excluding short-term financial debt. The current ratio is the ratio of total current assets over total current liabilities. As a result, a company may have (at the same time) a negative non-cash working capital and a positive current ratio.

The negative non-cash working capital is good for GrandVision because it results from an immediate payment from its customers (so no risk of not collecting revenue and immediate cash flow generation), a low inventory (reducing the risk of obsolescence and the invested capital) and high payables (a source of free funding). As a result, this feature is really attractive for high-growth companies because part of their operation growth is self-funded.

N.B.: Even though we like the company's negative non-cash working capital, we have to admit that its liquidity profile is poor (2017 current ratio is 0.64x) because of its dependence to short-term borrowings (commercial papers and bank overdrafts).

The company has optimized its supply chain in the last few years by reducing significantly the number of SKUs and suppliers. As a result, the company is more reactive to consumer changes and has increased its bargaining power over its suppliers. The group has also developed regional hubs (including its TechCenters in which they cut, edge and fit the glasses and warehouses); which increases the group reactiveness and improve inventory management. Finally, the company wants to keep reducing the inventory in stores. As a result, the non-cash working capital has improved every year since 2012 but 2017. 2017 seems to be an exception and, according to the management, this deterioration is only temporary.

“The lower cash flow from operating activities resulted from a lower movement in working capital than in 2016, linked to the strong network expansion and temporary effects of the transition to a more global supply chain, as well as a one-off payables improvement in 2016.”

(Source: Company 2017 annual report)

Given the business model, the company statement and the optimization of the supply chain, we have no reasons to believe that the non-cash working capital will not normalize towards -1.5% of revenues in the coming years.

A peer analysis suggests that these expectations are not overly optimistic given that Fielmann and National Vision have respectively a ratio of roughly -1% and -3.5%. Amplifon, a hearing aids retailer, has a ratio close to -6%.

Capital investment is required to pursue growth opportunities

The company spent roughly 5% of sales on average for capex and intangible asset acquisitions. These investments are required to support the company growth. Like GrandVision, National Vision and Amplifon are pursuing growth, thus investing heavily in their business. Fielmann invests a bit less because the group has a lower growth profile due to its focus on mature markets.

Our model assumes that the capital expenditures will remain elevated going forward. Indeed, it will increase to 6% before slightly normalizing towards 5% in order to reflect the lower growth profile. These estimates are in the high-range of the [4%/6%] company guidance. These investments should be sufficient to support the growth ambitions of the company.

Relative valuations

Most of valuation metrics highlight that GrandVision is cheaper than its peers.

Our forecasts and valuations

The following table highlights the different valuation models that we used in order to derive the business valuation.

For the sake of simplicity, we provide only our base case valuation DCF model which does not include any contribution from mid-to-large M&A deals.

We want to highlight several points:

- Top-line growth is 4.8% over the next 10 years, which means that we did not include the benefit from mid-to-large M&A transactions. Keep in mind that the company has executed 7 mid-to-large deals since 2014.

- We believe that margin improvement might be even more pronounced (in the absence of M&A) because we did not incorporate a margin improvement in the G4 business and we are not aggressive in the margin improvement for the Americas & Asia business given the lack of visibility.

- The non-cash working capital will improve slowly over time (towards -1.5% of total revenue).

- Capex will remain elevated, decreasing from 6% to 5%.

- Even though we believe about the long-term growth prospects, we are conservative and use a long-term growth of 2.5%

- Finally, we are using a WACC of 8% which is higher than the WACC based on our CAPM model.

We also provide our relative valuation model. The peer list encompasses five companies active in the eye care industry (Fielmann, National Vision, EssilorLuxottica, Hoya and Cooper) and one retailer of medical products (Amplifon).

Conclusion

GrandVision operates in a resilient industry that benefits from structural growth trends such as population growth, ageing population, increasing access to care and higher prevalence of vision problems. As a result, the company is in good position to grow profitably its business. Given the high cash generation of the business, the management can (and will) consolidate the market by pursuing M&A transactions in these fragmented markets. Finally, the company has also an opportunity to improve its margins by leveraging its infrastructures. We consider that the risk/reward is attractive and notice that our valuation suggests 32% upside (based on a share price of €18.70).

Risks

Leasing: GrandVision rents almost all its retail locations. Their profitability could be negatively impacted by increasing rents during renegotiations.

Refractive surgery: It is an alternative treatment to wearing sunglasses or contact lenses. However, this treatment is still costly and do not resolve all vision problems.

M&A Integration risk: The group has been very active on the M&A front and the external growth strategy should not change going forward. As a result, they could overpay or/and struggle to integrate an asset.

Liquidity: The stock liquidity is reduced because the main shareholder, HAL Trust, is a long-term investor and owns 76.7% of the company.

Capital increase: A capital increase might be required if the company pursues a large M&A transaction. However, even though current shareholders will be diluted, M&A transactions are generally value accretive (in this sector) and help the company to build its global platform. Moreover, we believe that HAL Trust will not accept to be diluted if the risk reward of such deal is not skewed to the upside.

Suppliers’ concentration: The group has significantly reduced its number of suppliers in order to strengthen its bargaining power. As a result, they face a potential risk of supply disruption.

FX risk: GrandVision runs its business globally, thus it is exposed to foreign exchange fluctuations (including the most volatile emerging currencies).

Stanislas Capital