On Dec 19, we reaffirmed our Neutral recommendation on Companhia Brasileira de Distribuicao (CBD - Free Report) . While we are optimistic on the company’s long-term growth outlook, we remain on the sidelines due to the tough retail environment and consistent margin pressure.
Why the Reiteration?
This Brazilian retailer is witnessing compression in margins over the past few quarters. It is struggling hard to keep prices down in the face of inflation in Brazil. In fact, economists in Brazil forecast sluggish growth and higher inflation rate in 2014. The company is also focusing on store openings in new states, which will pressurize margins. In addition, rapidly rising food costs will more than offset the improving earnings of cash and carry business.
A tough retail environment also poses a challenge for the company. A slowdown in consumer spending has been affecting the company’s home appliances sector as it depends largely on the disposable income of consumers. In the home appliances sector, large multinational chains and other specialized Brazilian companies pose significant competitive threat to the company’s secured market share.
However, Companhia Brasileira remains positive on its growth outlook for the next three years. Despite currency headwinds and inflation, the company expects its sales to grow faster than the inflation rate. Moreover, the company plans to expand its stores and market share by reducing costs in the face of a tough retail environment.
Companhia Brasileira expects to open 400 new food stores by 2016, which includes 360 new convenience stores in its Mini Mercado format. The company also has expansion plans for its wholesaler, Assai, which has been posting solid results for the last few quarters. The company is expected to open 12 to 15 stores per year through 2016 under the Assai banner, particularly in the fast-growing Northeast region.
In addition, Companhia Brasileira plans to open 210 stores during the next three years in the ViaVarejo unit, which includes household appliances and e-commerce operations.
In order to maintain its market share and deliver robust growth, the company expects to follow an aggressive price strategy by running stores efficiently and maintaining its operating profit margin by cutting expenses. The company also expects to reduce selling, general & administrative costs to 17% of net revenue by 2016 from 19.2% in the third quarter of 2013.
During the third quarter of 2013, Companhia Brasileira focused on reducing administrative costs in its supermarket unit and streamline distribution of its home furnishing business, which contributed to quarterly earnings growth.
Management intends to convert its savings into lower prices for consumers to increase store traffic. With such a strategy, the company’s market share is expected to increase over the next quarters. CBD holds a Zacks Rank #3 (Hold).
Better-ranked retail companies include Kirkland’s Inc (KIRK - Free Report) , Harris Teeter Supermarkets Inc and Best Buy Inc (BBY - Free Report) . While Kirkland’s sports a Zacks Rank #1 (Strong Buy), Harris Teeter and Best Buy carry a Zacks Rank #2 (Buy).