DCC plc is an Irish sales, marketing and business support services group operating across three divisions: Energy (69% of operating profits), Healthcare (19%) and Technology (12%). It’s a “miscellaneous” distributor not too dissimilar from Logista, where its “specialty” is not tobacco but rather oil.
Founded in 1976 as Development Capital Corporation and first listed in Dublin in 1994, it was originally focused on providing needed capital for young companies in Ireland. Over time it transformed into a decentralised industrial holding with various business areas: similar to other many successful companies, it had to look outside of its home country for growth and has acquired over 300 companies. While 25 years ago revenues were almost equally split between Ireland and the UK, today DCC is present in 21 countries, including the US.
[After few years of double listing, DCC delisted from the Dublin Stock Exchange in 2013 and today is only traded on the London Stock Exchange in GBp: the annual accounts are also in GBp.]
Since its IPO in 1994, DCC has been a consistent compounder: operating profits have grown at a 14% CAGR with only one dent in 2012 during the Euro/PIIGS crisis. Part of this growth was organic and due to the performance of the business; but a significant portion (~2/3) was generated by acquiring other distributors, mostly financed with internal cash flows.
Business segments
DCC Energy
The biggest division is split into two lines (LPG and Retail & Oil) and is mainly active in the UK and continental Europe with a distribution network of almost 3,000 tanker trucks that serve more than nine million consumers across 13 countries. As a typical distributor, the company earns a small (but stable) amount per ton of liquefied gas or litre of oil delivered.
LPG (liquefied petroleum gas: 38% of group operating profits): supply of propane and butane in cylinder and bulk format for domestic heating, cooking, commercial, industrial and agricultural purposes across ten countries in Europe, the US and Hong Kong. Suppliers are the oil majors like BP, Total and Shell. In addition, DCC offers natural gas, power and renewable energy products, and a range of specialty gases such as refrigerants and medical gases.
DCC is either #1 or #2 in almost all countries in which it operates: in the US propane market (it’s present in 21 states), DCC is still “only” the 6th largest player, but it has significantly improved from the 13th place a couple of years ago thanks to several small acquisitions.
France: Butagaz #2 (21%)
Britain: Flogas #2 (33%)
Ireland: Flogas #2 (44%)
Germany: Tega #3 (n.a.)
Netherlands/Belgium: Benegas #1 (44%)
Sweden: Flogas #1 (48%)
Norway: Flogas #1 (55%)
US: seven brands #6 (2%)
Hong Kong/Macau: DSG Energy #1 (n.a.)
Similar to Logista, turnover and volumes are not necessarily the best metrics to track for a distribution company that charges through commodity price increases / decreases: profits and margins/unit are more helpful KPIs.
Retail & Oil (32% of group operating profits): provides transport and heating energy, lower emission fuels and biofuels to consumers and SMEs businesses across Europe. It also owns and operates 1,173 retails petrol stations (manned and unmanned) and an extensive fuel cards business for retail and commercial customers in 9 European countries. For example: the French retail business comprises an extensive network of 276 Esso-branded, unmanned retail petrol stations (64 of which include car washes), 43 Esso motorway stations and a further 126 Esso-branded dealer-owned stations.
DCC Retail & Oil has been a consolidator of many fragmented businesses since 2001: with the exception of the Nordics, it generally has again the #1 or #2 position in the countries in which it operates. And even as #5 player, the Nordics are still highly attractive as the market is less fragmented.
Oil
Britain: several brands #1 (15%)
Ireland: Emo #1 (14%)
Sweden: Qstar #1 (18%)
Austria/Germany: Energi Direct #2 (16%)
Denmark: Energi #2 (16%)
Retail
France: unmanned petrol stations #1 (n.a.)
Sweden: Qstar #5 (12%)
Denmark: Shell brand #5 (11%)
Norway: Esso brand #4 (18%)
Overall, retail volumes have been slightly declining on more efficient consumption, electric vehicle (EV) penetration and more recently (2020/2021) as travel was negatively impacted by the pandemic. However, DCC is increasingly penetrating lower emission and premium fuels, lubricants, services and convenience retail. Similar to LPG, the energy mix is evolving to lower-carbon sources and DCC is actively driving it. Despite the pressure on traditional oil volumes (flat over the last 5 years), operating profit increased 12% p.a. with stable ROCE.
DCC Healthcare
DCC partners with leading consumer brands to create and manufacture high quality health and beauty products, and to supply primary and secondary care providers with essential products and services.
Business is also organised into two segments: DCC Vital (53% of revenues) is a classical distributor of medical products (including its own brands) to hospitals, primary care and retailers in the British, Irish, German and Swiss markets, while DCC Health & Beauty Solutions (47% of revenues) provides outsourced product development, manufacturing, packing and related services to brand owners (like Nestle Health, P&G Health or The Body Shop), specialist retailers and direct sales organisations, principally in the areas of nutrition (health supplements) and beauty products. While Healthcare remains very much exposed to UK & Ireland (55% and 16%, respectively, of segment revenues), DCC gained a meaningful presence in the US by acquiring three distributors since 2018 (19% of revenues).
Contrary to Energy, revenue is a meaningful indicator to follow: sales have been growing 8% p.a. while adj. operating profits have increased 15% p.a. over the last 7 years, with margins expanding 500bps to 13%.
DCC Technology
DCC Technology is a specialist distribution partner providing a broad range of consumer, business and enterprise technology products and services to (online) retailers, resellers and integrators (over 63.000 global customers). Suppliers are the large hardware and software companies, like HP, Microsoft and Netgear. The product portfolio is well balanced containing lower margin consumer products and higher margin enterprise products (like professional audio visuals for conferencing). It operates in 19 countries and is the leading distributor of appliances, Pro Audio products and musical instruments in North America, and the fourth largest distributor of technology products in Europe.
Despite representing over a quarter of group revenues, technology is the lowest contributor to operating profits given the very low margins experienced by the business (less than 2%). While growth in both revenues and operating profits has remained robust over the last 5 years (11% and 15%, respectively), ROCE has been steadily and dramatically declining: 1) the product mix shift was unfavourable with lower margin consumer products outperforming and higher margin enterprise products lagging (Covid-related); 2) Brexit uncertainty and UK’s dealing with the pandemic caused weak UK trading; and 3) the roll-out of a large SAP program, now completed, has had a negative impact on earnings while increasing the capital employed.
Those reasons point to temporary problems, but nevertheless this is an issue to monitor closely: growth in the underlying product markets is also limited to GDP dynamics (2%-5%).
Strategy: serial acquirer and capital allocation
Distribution companies add value by bringing together suppliers and customers in an efficient way that otherwise would not transact or only at higher prices. In cases of bulk goods (oil, gas, chemicals), DCC also provides lot size transformation, which means buying large quantities and supplying in smaller lots.
The distribution markets are by nature local and benefits disproportionally from a large network and scale:
It makes no sense to ship products for kilometers on a daily or weekly basis to end customers: gases/oil/petrol are very complex (and regulated) to transport from a different region at competitive costs
A larger network sources larger quantities from its suppliers and therefore can extract better terms.
Those are two reasons why distribution networks have a tendency to consolidate locally, which is also the strategy DCC pursues actively. Furthermore, consolidation allows to extract overhead costs and densifying the network in terms of optimising the physical infrastructure (trucks and warehouses) and the routes.
DCC specialises on the delivery of essential products that are demanded regularly and therefore offer a recurring stream of revenue: and this is not a business that can be disintermediated by Amazon or eBay. Once the local production capacity and distribution system are installed, it is difficult for competitors to enter that market: a new entrant has not only to build the infrastructure (the easiest part) but also to establish (or “steal”) a large customer base as well as the supplier relationships. A “partial” network is of limited value to customers and suppliers and most likely uneconomical to run. As such, the pricing power of existing companies is not unlimited (if prices rise too much in a region and profit margins become sufficient, there is an incentive to build new networks), but competition is not uniquely focused on prices.
DCC’s operating framework is based on 6 key priorities that are also directly linked to remuneration:
In particular:
Strive to be #1 or #2 in the local markets it operates in: scale is critically important to provide a better service to suppliers as well as customers and to be able to generate high returns. Strictly correlated, operational efficiency and innovation provide a sustainable competitive advantage over competitors
Reinvest cashflows to grow and scale businesses, and extend existing capabilities to new markets, especially those that are still fragmented. For example: the acquisition of TEGA in Germany in 2018 allowed DCC to enter the refrigerant (non-heating) gases market, a product that was later offered by other subsidiaries in France and the Netherlands
Continue to build a cash generative business which consistently provide returns on capital employed well in excess of its cost of capital: financial discipline is demonstrated both by not overpaying for acquisitions to secure attractive incremental returns and by using debt sparingly to decrease financial risk and to allow to act quickly when opportunities present themselves
A strong focus on return on capital is a key part of the strategy and goes back to the founder Jim Falvin: page 2 of the annual report states:
“We are an ambitious and entrepreneurial business operating in 21 countries, supplying products and services used by millions of people, every day. Building strong routes to market, driving for results, focusing on cash conversion and generating superior, sustainable returns on capital employed enable us to reinvest in our business, creating value for all our stakeholders.”
Over the past 3 decades DCC has made several hundred (mostly small) acquisitions and has continuously expanded and consolidated its network which also enabled the company to enter new product categories and new geographies. Since 2000 it has indeed spent roughly £4bn on acquisitions: it also divested some subsidiaries for around £325 million (the biggest was the Environmental division sold in 2017 for £160 million).
According to management, there is no shortage of available investment opportunities, particularly in the energy division: several major oil companies see their own distribution networks as “outside of the core business” and so are willing to dispose of these assets at reasonable prices to free up capital for dividends, for example. The bottom line is that a certain distribution company can be materially more valuable for a suitable acquirer than standalone: DCC can buy other distributors on average for 7x-8x EV/EBIT (around 6x after accounting for cost synergies: overheads, optimisation of trucks, routes, warehouse footprint), a very attractive level that partly explains why DCC has maintained a high ROCE.
But despite the importance of company purchases, reinvesting in the existing businesses and innovation remain top priorities in the capita allocation decisions.
What could the future of the energy division look like?
The global response to climate change has resulted in a fast-growing demand for new technologies and solutions that enable a transition towards a lower carbon future. But energy demand is expected to continue to rise: oil, gas, biofuels and renewables will all play significant roles during the transition.
DCC is supporting customers in the delivery of affordable, secure and increasingly clean energy solutions:
Commercial and industrial: efficiencies and less carbon intensive solutions such as LPG are driving most emissions reduction. For early adopters such as light manufacturing or hospitality, solutions such as solar, renewable electricity and biofuels are key part of the energy mix.
Domestic: greater mass adoption of new heating solutions includes advanced biofuels, heat pump systems and domestic EV charging.
“Oil2LPG conversion” (the promotion of cleaner fuels like BioLPG or other renewable energy products) has been a material driver of volume growth: DCC actively assists customers to switch from oil to LPG as it has lower running costs and cuts CO2 emissions by up to 20% compared to heating oil (and 50% less than coal). With the fuel sources becoming more diverse, customer needs are more complex, which provides DCC with opportunities to add value beyond just volume growth: smaller competitors are less like to offer similar diversity which should enable market share gains.
Today DCC already offers a range of cleaner alternatives in several countries, particularly in the Nordics:
20% of distributed fuel in Sweden is bio-based reducing emissions by 30% (15% in Norway, 11% for total DCC)
Currently 100+ EV fast chargers installed in the Nordics, with the continued expansion in France (partnership with Engie) and UK
Pilot project with Shell to introduce sustainable aviation fuel in Denmark
Hydrogenated vegetable oil (HVO) produced from food and industrial waste is produced in 37 locations in Sweden and offered to retail customers (use reduces emissions by 80%)
Some financial numbers and valuations
[At this point, an important clarification is required. What the company calls Adjusted Operating Profit is actually EBITA, as it’s defined as net operating profits pre-amortisation of intangibles and pre-exceptional items. The denominator of ROCE (Total Capital Employed) is also adjusted to exclude some items, for example right-of-use assets / liabilities (it does report ROCE including leases, but usually refers to the first metric). The company’s reported ROCE is therefore pre-tax and pre-several items that should rather be included. From now on I will use my own calculated ratios, not those used by the company; as such, ROIC and margins will be lower than what was reported above.]
Over the last 10 years ROIC has averaged around 11% (still above the cost of capital), but steadily decreasing: incremental ROIC over the period has been around 6%-7% (at least according to my calculations: the company would probably have a different, higher number). The main reason is the pace of acquisitions and the related goodwill (invested capital is dominated by intangible assets - £2.6bn out of £4bn invested, of which £1.7bn is goodwill): Return on Net Operating Assets is indeed slightly better (15%-20% over the more recent years, but again steadily declining).
Acquisitions over the last few years were also less synergetic than in the past as DCC entered new markets (US, Hong Kong) where it had little or no presence. For example, last December it acquired Almo (it’s biggest deal ever) to expand the technology business in North America. While it is difficult to forecast where acquisitions might take place, it is likely that in the future they will be more weighted towards existing geographies with higher cost synergies and therefore higher returns.
Cash flow generation is very high with relatively low reinvestment needs (before acquisitions).
Management has always shown an aversion to permanent debt and clearly prefers a conservative balance sheet: debt levels can fluctuate depending on the acquisition cycle, but they are typically reduced quickly soon after. For example, as at FY2022 it had gross financial debt (including leases) of £2.3bn, but also £1.4 bn of cash (given the nature of the business it has very low inventories and a cash conversion cycle of just 10-12 days), for a net debt position of around £900 million. Long-term debt was increased by £400 million in bank borrowing as a consequence of the acquisition by DCC Technology of Almo in the US. Over the cycle, net debt/EBITDA averages 1.2x.
Following the 2011 crisis, DCC’s share price developed splendidly and far better than the operating results until 2018 (it also coincided with the move to a UK-listing only): P/E ratio expanded from 13x to 30x, EV/EBIT from 10x to 24x and FCF yield halved from over 7% to around 3.5%.
After reaching a high of £77 in January 2018, the stock trades today at around £50 (during the early pandemic period it crashed down to £42): P/E today is 14x, EV/EBIT is 12x and normalised FCF yield is again around 7%. Despite the reinvestment for growth, DCC still pays out 50% of earnings as dividends (there are no share repurchases), for a current 3.5% dividend yield.
The stock trades today more or less at the same price as in 2015, despite operating profits being up 160% and core EPS up 120% (but FCF/share are only up around 50%). But is it really cheap?
Risks
Energy transition: at some point the ~70% energy profit exposure will be severely impaired and DCC will be left with a “dead product” that does not need the existing infrastructure. The risk is real but probably overblown (see section above): DCC is not blindsided by the energy transition, it is in fact driving it and the transition is an opportunity to become more important to clients regarding their energy provision and mobility. The current experience particularly in the Nordic countries also demonstrate there is no significant compromise on financial returns in pushing for alternative energy sources.
Rising inflation: as a distributor, DCC makes a margin on the products it distributes: if input prices rise, products and services can be repriced relatively quickly. (Volumes might however be negatively impacted). DCC has operated in the energy industry for 45 years and in that time has seen many periods of significant price volatility. The second, necessary condition is that tangible reinvestment needs are relatively minor in relation to operating cash flows, or the inflating capex will offset rising profits. DCC does not have particularly high reinvestment needs: capex is less than 10% of gross profits and 30% of operating cash flows.
Technological obsolescence: well-run distributors are very difficult to replace due to the value they bring to the involved parties. However, there is the risk that the category that is subject to the distribution vanishes without the company reacting.
Conclusions
Over its corporate life and also as a public company, DCC has demonstrated to be a consistent compounder.
Distributors are essential as they provide a network to transact on. With the exception of contract manufacturing within the Healthcare division, DCC does not produce anything: rather, it is the “route to market” for its suppliers distributing essential and frequently used products to customers.
The company seems to have a very strong internal culture: over its 45 years history it only had 3 CEOs. Current CEO Donal Murphy has a long tenure, having joined in 1998 and becoming Head of the Energy division in 2006 before moving to the CEO position in 2017. Previous CEO Tommy Breen had been with DCC for 33 years, and the former CFO Fergal O’Dwyer, who retired in 2020, has an even longer history by joining in 1989 and having been CFO since the IPO in 1994.
The market is currently mostly concerned about the durability of energy distribution, even though oil prices have little influence on the actual business, and the business model itself is very stable and extremely resistant to the economic cycle.
The business is unlikely to be disrupted in the short-term, but growth will continue to come mostly from acquisitions: compared to Logista, for example, there is a much higher reinvestment risk (Logista also has a better cashflow/dividend profile and the huge advantage of the tobacco tax float).
The company definition of ROCE (used to gauge the attractiveness of a potential target) is technically not “wrong”, but in my opinion it overstates the real underlying returns: adjusted profits are on average 125% of NOPAT, so the risk is to end up accepting lower quality acquisitions and thus diluting ROIC.
Long-term incentives for management are also based on ROCE (40%), adjusted EPS growth (40%) and total shareholders’ return over 3-year periods (20%), thus adding to the risk of growing the business at any cost to meet these goals.
I’ve seen several analyses exposing the merits of DCC and how this disciplined serial acquirer creates long-term value, but for the moment I’m not yet convinced of its merits: I’ll keep checking the company and will revisit my thesis from time to time.
Great analysis. Thanks for sharing. I looked at them a while ago and the overstated ROCE was what put me off. I have to look at Logista.