Companhia Brasileira de Distribuicao Hurt by Lower Margins - Analyst Blog

On Nov 20, 2014, we issued an updated research report on Companhia Brasileira de Distribuicao (CBD).

On Oct 31, this Brazilian retailer reported third quarter 2014 earnings. Profit and sales grew in the third quarter of 2014. However, tough macroeconomic conditions and margin pressure continued to remain overhangs.

In the third quarter, CBD delivered profits of R$390 million (*$172 million), which increased 9.3% (in local currency) from the year-ago quarter. The year-over-year increase in profits reflects higher profitability at the Food Business (Multivarejo and Assaí) and Via Varejo. Consolidated net sales climbed 10.9% during the third quarter, driven by new store openings and positive same-store sales growth. Organic growth was mainly seen in the Assaí, Pão de Açúcar and convenience stores formats. The company opened 50 new stores in the quarter, which fueled growth.

The company's aggressive pricing strategy and tighter cost discipline also bolstered earnings.

The aggressive pricing strategy, taken up by the company since May 2013, focuses on lowering selling prices. This has helped it to win customers but at the cost of its gross margins.

In the third quarter, gross margin contracted 50 basis points from the prior-year quarter to 25.7%. The lower margins were due to the company's aggressive pricing policy and also due to greater contributions from Assaí and Cnova in the sales mix, which have lower margins.

The retailer is witnessing margin compression over the past many quarters. It is struggling hard to keep prices down in the face of inflation in Brazil, which is hurting gross margins. Also, strong growth in the Assaí business (cash and carry business), though helping sales growth, is negatively impacting margins as this business is characterized by low prices.

Moreover, the company is focusing on store openings in new states, which result in higher pre-opening costs. In addition, higher investments to increase competitiveness in the Food Retail segment and intense promotional activities, especially at Nova Pontocom are also adversely impacting operating margins.

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, the company is optimistic over the long term and expects to open 400 new food stores by 2016. The company also has expansion plans for its wholesaler, Assai, which has been posting solid results over the last few quarters. However, the company is expected to remain under margin pressure in the near term as it focuses on its pricing strategy and gears up to expand its stores and market share.

CBD has a Zacks Rank #3 (Hold).

However, better-ranked retail companies include Citi Trends, Inc. (CTRN), Safeway, Inc. (SWY) and The Kroger Co. (KR). While Citi Trends and Safeway sport a Zacks Rank #1 (Strong Buy), Kroger carries a Zacks Rank #2 (Buy).