Keep a close eye on cash flow for this company. Although profits are increasing, cash flow isn't. In this situation there is always a risk that they could be reporting cash outflows as capital expenditure and increasing their assets rather than as expenses and reducing their profit.
Management explanations on capex are very vague and don't seem to match the actual situation, mixed in with some creative 'spin'. Extract from interim report presentation in February 2015:
'Net capex increasing to $40.9m, to leverage current momentum and accelerate growth of stores across all markets'
This seems very inconsistent with their business model as a franchisor. Interesting that although store numbers did increase by approximately 90 in this 6 months, most of the growth is in franchised stores. Corporate stores only grew by 19. Franchisees are required to fund all the capital costs to establish their store so expanding franchised store numbers should not materially increase the company's capex/assets. This has always been one of the attractions of franchisors e.g. they are capital 'light' businesses and can generate good cash flow without the need for major re-investment in capex.
Its therefore a very vague statement that doesn't really match the reality of the business model, and therefore should always be a major red-flag.
To report capex spend of $40.9m for six months but to only grow corporate stores by 19 raises serious questions as to whether these cash outflows are genuinely capital expenditure (assets) or should be expense items and reduce profit. Based on the information on their website, franchisees need approx. $400k to fund the fit-out of a store, so applying the same figure to the 19 corporate stores would mean capex of approx. $8m. They have done some store relocations in Japan but that still would not amount to anywhere near the capex reported in the interim financial statements.
If some of the amounts capitalised as assets on the balance sheet are actually expenses it would have a potentially large impact on profit given profit for the half was slightly less than $30m (i.e. capex exceeds profit - $40.9m vs $30m).
Even if the classification of these cashflows are correct it should negatively impact the appropriate multiple you would place on the business given the amount of cashflow that is needed to be reinvested in the business. Its fine to justify the large capex spend on the sizeable new store rollout and expansion of the business but that would only make sense if they are increasing the number of corporately owned stores.
The shares sell on a multiple of 50-60 times 2015 profit, the multiple to free cash flow is even more crazy i.e. well over 100 times free cash flow. If some capex items are actually expenses that crazy price-earnings multiple of 50-60 could be even crazier - perhaps closer to 100 times (i.e. like the free cash flow multiple)!
This lofty share price is also making management very rich. There CEO, Don Meij, is about to pocket $15m profit on the exercise of options granted to him. If the share price remains near $40 he will pocket another $15m next August - see article:
Its not a stretch to say that management of companies that trade on extreme multiples have a greater incentive to manage reported earnings as the even the slightest disappointment could have a huge impact on the share price given such a lofty valuation, especially given how much personal wealth is tied to the share price in terms of their options.
The other issue with this company is the lack of liquidity. On some days only a total of 100,000 shares change hands and often in tiny parcels of 50 shares. This is a very small amount of volume for a company that now has a market value of approx. $3.5 billion. Luckily there is enough volume for small shareholders to exit their position if they wish. You couldn't say the same for fund managers like Hyperion that holds close to 7 millions shares or 8.5% of the company (based on the last annual report). I would hate to see what would happen if they had to liquidate their position e.g. caused by fund outflows etc. If I held units in their fund's I would seriously have to consider exiting given they have built up such a large position in a very illiquid company. They might be basing the unit price of their funds on DMPs share price of $40 but I don't think this is a price at which you could dispose of this sizable parcel of shares.
Overall, I think this company needs to improve their disclosure. The lack of adequate explanation of capital expenditure is one example but there are many more. For example, 13% of their expenses (the 3rd largest expense line item) on the profit and loss statement is classified as 'Other expenses' with no further explanation in the notes. Companies with poor disclosure should always raise serious red flags, but when you combine this with management explanations that don't match the business model, a hefty market valuation and management making millions on their options, boutique fund managers building large illiquid positions and little volume......you have the makings of a potential disaster.
DMP Price at posting:
$39.54 Sentiment: Sell Disclosure: Not Held
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