ANATOMY OF A FAIL -- DMP story

 ANATOMY OF AN “F” – DMP

Probably one of the reasons I didn’t do so well in the funds management industry was my penchant for examining my errors in detail. Of course, I realise that replying that “everything is awesome” would assuage clients and consultants. I do feel that everyone makes mistakes, and the best way to avoid the repetition of systematic errors and therefore to become a better investor is to closely assess what has happened, to closely look at your errors more than your successes. With that in mind, here we go.

Growth investing is the extrapolation of past trends, and evidence indicates that the past success of a business is usually followed by future success until it isn’t. That is, once the chain is broken, a new paradigm may be at play.

When a company misses its earnings big time, there are two elements to consider being the usual quick fall in multiples as the market reassesses the ability of the company to continue on its winning ways, and secondly, the size of any earnings fall and, critically, whether it is a temporary fall or not. When analysing a fallen angel, we have to consider two outputs, one being the new trajectory of earnings and the exit PE that the market is likely to apply to the company.

The question is, once earnings break, does this assessment become much more difficult?

Although I am looking at DMP, imo, the analysis could be applied to many fallen angels.

My Trading History for DMP

DMP SP peaked in Sept 21 at $162 and began a relentless slide. My first parcel of shares was bought at $56.83 in Sept 22, almost a year since the peak and some 65% below the peak. Therefore, I assumed enough time and SP decline had taken place to enter. I then added to the shares in smaller parcels on May 23 at $51, June 23 at $42, then sold all of these smaller purchases at $54 in Oct 23, sold some more at $52 in Dec 23 and then bought a sizeable amount at $42 in Feb 24. Now I had to look up all this data. I had no idea of my trading pattern until now, and it appears all over the place, which says a lot in itself.

The conclusion is that there was inconsistent information that was making me move between being hopeful of a turnaround and then let down. However, the result was a moderate holding in the end. My earnings estimates were constantly being sliced, and turnaround projections were being projected that never came to fruition.

Just after all this trading, I wrote a piece for my journal post the interim 2024 result. It is below. (That’s a reason to journal!!). Interestingly, I grouped DMP with PXA and MIN in the same piece.

DMP FH24

One common outcome of poor results and pressure on the share price is that management is much more forthcoming with information about their businesses.

And so it was for DMP. Some interesting perspectives were delivered.

The model requires growth to succeed, DMP plans to have a network 1.9X larger by 2030. If that happens then the stock price will be higher. For that to happen franchisee stores (3x larger than the corporate store network) need to grow and that occurs when franchisees are making an adequate return that they then have confidence to invest in new stores. DMP management has intimate knowledge of this equation and what is required to spark growth. (Ed- knowing the issue and fixing it are two different things)

The QSR industry is a dogfight. The battle is fought out amongst various fast-food chain offerings, and what can be to outsiders’ small differences can impact results in a big way. One theory that I think we can discount is that Domino's pizzas are no good or that certain countries don’t eat pizza (Ed.-the SP went from $2 to $162 with the same pizzas). The point is QSR is big in almost all countries, but execution of products and pricing against strong competition can determine a broad range of outcomes. So what is happening with the various markets?

DMP markets break down into those going well and those significantly struggling. ANZ and Germany are the big markets doing well, while Japan, France and Taiwan are struggling. Japan and France are large markets for DMP, and Japan is a relatively recent entry.

During the last results call, it is apparent that management is looking closely at what works and what doesn’t in these markets. Successes in other markets such as aggregator partnerships, new products, and daytime promotions are being assessed for cross-fertilisation. World-class execution requires micro-management for each market.

Interesting points on France are that management has determined that offline pickup is weak; this is where competition is most severe. France is a big QSR market and very competitive. The competition (burger/chicken?) has a larger media budget, and DMP needs to improve in offline pickup, which is a large market in France. DMP seems to have missed the low-price point battle in this market. There seems a be a large class of people who are going to eat a burger, pizza or chicken and pick the best value on the way home. Pricing for value is critical. As I said a dog fight.

Japan is a different market with infrequent buying cycles that make it harder to assess launch successes and stock issues. DMP believe they have a very good understanding of what the market wants, are research-led and are targeting barbell menus with 1000Y as a tipping point, ie need profitable products under this level.

Overall market growth, DMP see the ANZ pizza market growing, Japan pizza taking some share and seeing some momentum, Germany pizza growing, France DMP gaining share in a flat pizza market, and Netherlands pizza growing. The markets are ok.

In terms of franchisees, there was information on the underlying profitability. Franchisees usually start buying (more stores) around 3X EBITDA. They need to see a track record and base profits, and they will commit to new stores. DMP disclosed group franchise partner weighted average EBITDA per store for the last four years. These have fallen from $138k in 2021 (C19 peak) to $95k in 2024. The cost of a store is $300k of which DMP incentivises $100k.  The economics on these numbers are still ok, but I suspect there is a long tail so the average needs to be higher to stimulate the required growth but is not an insurmountable task. It sounds as if the franchisees geared up acquiring new stores into C19 given the excess profits and need to deleverage to start buying again, a timing issue. 

A bear story is that DMP management is spread too thin, in very competitive markets and will struggle to earn returns. That, in turn, undermines the profitability that is required to generate the franchise investment to drive the outsized growth we have seen in the past with this one. That is a genuine concern. Add to that the fact that DMP raised money and then downgraded, which would not go down well with institutions. That is why the share price is where it is at.

What impressed me in this call was the level of detail, research and knowledge the company has in its markets and a proactive plan to turn this around. Not that the model is broken, but the strategy to protect margins was in hindsight wrong, it let competitors in under the targeted price levels and DMP lost share. That is now recognised and being addressed.

At $40 the share price to me assumes that the current all-time lows in margins in Japan and France (could be losses or close to it) continue, and that seems harsh given the optionality the company has.

That’s my view could be wrong

Reading this note with the benefit of hindsight reveals that I gave too much benefit of the doubt to management being able to engineer a turnaround when the operating statistics were quite poor. They haven’t turned. One large fundamental aspect I completely ignored was the use of aggregators by the competition. DMP were the delivery king with their in-house logistics. In C19, that gave them an enormous advantage. With the advent of Uber Eats et al, everyone was able to deliver at a nominal cost, and DMP lost their competitive advantage. There has been no real recovery from that.

LESSONS LEARNT

What would have been useful was a series of assumptions which backed my initial investment and showed how they changed over time. What we don’t want to see is the usual value trap where the SP falls validates ever lower valuations. Those scenarios usually dont work out well.  

The lesson, imo is if you see a strong break in fundamentals and still buy due to a lower SP you have to nail the underlying cause otherwise it’s a world of pain. If you wrongly identify the real reason for the business model being under threat, or underestimate the causes, that is, overplay something that exists but is not significant and miss the significant issue that is again pain.

How well do you know the business model, and can you identify exactly what is going on and assume a relatively quick recovery? Much harder than it seems. There are easier ways to make money. As outlined in my yearly review, buying a share where there is no question over its business model but the whole market falls is one less risky approach. The other is where a SP declines because of fears that are yet to materialise and maybe never will. If they do, that will most probably be a thesis breach.

In DMP case I clearly outlined the many issues but assumed a quick reversal without giving enough thought to whether there was more at play. The alternative is to wait until the business shows some signs of stability or recovery. That risks the SP running ahead as word leaks out or speculators have a punt. That can happen, but the alternative is potentially large losses.

So that’s it. Buying into fractured numbers is more risky than we may think, and running the risk of a late re-entry is probably, in most cases, worth the risk as opposed to riding the deterioration lower without a clear path to fundamental recovery. At the very least, do not automatically double down; that’s a disaster, and in these cases, thankfully, I avoided that outcome.

 

 

 

 

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