Sendas Distribuidora Q1: Raising The Recommendation From Sell To Hold (NYSE:ASAI)

Investment Thesis

I recommend holding Sendas Distribuidora (NYSE:ASAI) shares after the 1Q24 results. Since my sell coverage initiation report published on March 12, shares have fallen more than 20%.

The company published good operating results in 1Q24, and its deleveraging is taking place. Furthermore, its P/E is already closer to the average of Brazilian peers, however, still without a margin of safety. Therefore, I am raising the recommendation to sell to hold Sendas Distribuidora shares.

Review Of Sendas Distribuidora’s 1Q24 Results

ASAI released its 1Q24 results with revenue in line with market expectations:

However, net income was 4.6% lower than expected. We will talk about the results in more detail below.

Revenues – Robust Annual Growth

The company’s net revenue was $3.43 billion (+15.3% y/y and -9.5% q/q). It is worth remembering that the first quarter is seasonally the worst for wholesalers. However, with the expansion of stores (28 new units), 14 of which were renovations of Extra stores, the company saw an increase of 12% y/y in sales area, and 5.2% y/y in Same Store Sale.

Additionally, one of the risks I mentioned in the coverage initiation report did not materialize. I expected food deflation at the beginning of the year, and what happened was slight food inflation, which is positive for ASAI’s results, and corroborates the change in recommendation from selling to holding.

Margins – Gain In Operational Leverage

Extra Stores that were converted to a Cash-and-Carry model tend to bring a higher gross margin than conventional stores, as they are located in privileged regions, with high population density.

With this, the company managed to increase its gross margin, which reached 16.3% (+20 bps y/y) and the EBITDA margin reached 6.1% (+70 bps y/y). The higher level of operational leverage and the maturation of the converted stores corroborate my increase in the recommendation from sell to hold.

Debt – Here Is The Point Of Attention

All attention at the moment is focused on the deleveraging of Sendas Distribuidora, and the company reported a sequential reduction in the level of leverage:

Despite this encouragement, the company has significantly higher leverage than its competitors, which do not reach 2x net debt/EBITDA, as I mentioned in my coverage initiation report. This leverage compromises the financial result, which makes the company make less profit, and this is one of the reasons why my recommendation is to hold the shares, and not buy.

Net Income – Impacted By A Worse Financial Result

Despite a good operating result, with a good increase in sales, gains in operational leverage and good prospects, the financial results still hurt the net income, which reached $12 million (-15% y/y and -80% q/q).

I believe it would be imprudent of me to give a recommendation to buy with such high leverage, and I believe it is more interesting to wait for a more robust leverage process. This is corroborated in the company’s valuation, which we will see below.

Valuation – Improving

In my last report, I mentioned that Sendas Distribuidora was trading at a P/E (20.2x) significantly higher than its peers Carrefour Brasil (15.1x) and Grupo Mateus (11.4x), and I also defined a target price based on peer average, which was $11.17 per share. As we can see, the P/L is currently more attractive.

Although the multiple is more attractive, I still don’t see a margin of safety as an indication to buy. Sendas Distribuidora currently trades at a P/E of 16.1x according to Koyfin, while the average for wholesalers in Brazil is 14.5x.

Although the P/E is more attractive, it still does not have a margin of safety in my view, so I do not recommend buying the shares; however, this is enough for me to raise my recommendation to sell to hold Sendas Distribuidora shares.

It is also important to highlight that SA’s Quant Rating tool points to buying the company’s shares. This is due to the excellent valuation score; however, this note considers Sendas’ valuation against its global peers, while I believe it is more pertinent to compare the company with its peers in Brazil.

As an analyst, my task is to bring out the pros and cons of an investment. When I recommend holding a share, consequently the investor who does not buy runs the risk of not participating in the share rise, so I will list the risks.

Risks To The Thesis

I continue to see two major risks to the thesis of not buying the shares. The first is that there may be an increase in food inflation, mainly due to the weather events occurring in Rio Grande do Sul, the main producer of rice in Brazil, a highly consumed food in the country. Heavy rains compromised plantations and meant the country had to import the grain.

The second risk is deleveraging. As we have seen, Sendas Distribuidora is on a trajectory of continuous deleveraging over the quarters. Furthermore, Brazil is going through a process of falling interest rates, which should ease the financial result and improve profits.

The Bottom Line

Since my coverage initiation report, certain things have changed in Sendas Distribuidora’s thesis. The stores converted to the Cash & Carry model are maturing well and showing a good gross margin.

Furthermore, the food deflation that I expected did not occur, on the contrary, climate events in Rio Grande do Sul could lead to an increase in food inflation, which tends to be positive for Sendas Distribuidora’s revenues.

In addition to the improvement in macroeconomic and operational factors, the company’s valuation is already trading close to the average of its Brazilian peers, and although it does not present a margin of safety, the company is now on my radar.

Based on this analysis, I am raising my recommendation from sell to hold on Sendas Distribuidora shares. Investors should pay attention to operational and financial improvements, while waiting for a better risk-return ratio to buy the shares.