DCC. Focusing on DCC Energy. Scope for organic growth across geographies. Acquisitions to further strengthen the business

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1 DCC Focusing on DCC Energy Institutional outlook Industrial support services We believe DCC Energy is a strong business, uniquely placed, given its extensive European footprint and leading market shares in both oil and liquefied petroleum gas (LPG), supported by the group s robust balance sheet. The division has multiple levers that can help drive solid organic growth, which we expect to be complemented by strategic acquisitions that could provide significant upside to our numbers. Year end Revenue ( m) PBT* ( m) EPS* (p) Net debt ( m) 03/12 9, /13 10, /14e 11, /15e 12, Note: *PBT and EPS are normalised and fully diluted, excluding intangible amortisation, exceptional items and share-based payments. Scope for organic growth across geographies We believe DCC Energy is well positioned to achieve further organic growth in oil and LPG, both in Britain and internationally. In Oil Britain, we believe the division can benefit from its increasing retail presence, improving market shares in underrepresented product segments and cross-selling additional products and services. In Oil Scandinavia, the group can penetrate new segments (such as the bunker site market), diversify its customer base and take advantage of its flexible logistics, while in Germany the group now has a strong local platform to address a large and fragmented market. In LPG Britain, DCC can leverage synergies from its MacGas acquisition and drive oil to LPG conversions, while internationally the group can improve the performance of previously underinvested assets acquired from oil majors, increase cross-border sales and expand into new segments. Acquisitions to further strengthen the business P/E (x) Yield (%) While the Energy division has significant organic growth potential, acquisitions remain a key element in driving earnings growth. On the oils side, markets remain highly fragmented, both in Britain and in Europe, enabling DCC Energy to further consolidate its markets and drive efficiency gains in a business where economies of scale are considerable. In addition, oil majors continue to divest non-core assets and we believe DCC remains well positioned to take advantage of this trend due to its strong balance sheet and reputation. Our numbers incorporate no contribution from further acquisitions, but we estimate that a 150m acquisition spend, coupled with a16% pre-tax ROI, would imply an additional 24m of PBT pa. While uncertainty about targets and timing remains, the Energy division s historic share of acquisition expenditure at 59% would imply a more than 14m profit uplift pa from inorganic growth in the Energy division alone. 18 November 2013 Price 2,809p Valuation 3,217p Difference 13% Market cap 2,354m Net debt ( m) as at end March Shares in issue 83.8m Free float 96% Code Primary exchange Secondary exchange Share price performance DCC LSE N/A % 1m 3m 12m Abs Rel (local) week high/low 2,861.0p 1,764.0p Business description DCC is a sales, marketing, distribution and business support services group. Currently it operates via five separate divisions: Energy, SerCom, Healthcare, Environmental and Food & Beverage. Analysts Zsolt Mester +44 (0) Gareth Jones +44 (0) institutional@edisongroup.com Valuation: Remains compelling Despite a rise of over 11% in the last month, DCC still trades at an 8% discount to the support services sector on an FY14e P/E basis and at a 6% discount on an EV/EBITDA basis, even with no further acquisitions in our numbers. H1 results gave further reassurance about the strength of the underlying business and we remain buyers of the stock. We maintain our valuation of 3,217p, leaving 13% upside to the current share price.

2 DCC Energy: Strong track record and market position DCC Energy is engaged in the sales, marketing and distribution of oil and LPG, with leading market shares across Western Europe. Energy represented 77% of total group revenues and 57% of adjusted EBITA as of FY13. The division s activities can be split into three segments: Oil, LPG and fuel cards. Exhibit 1: Volume by segment Exhibit 2: Profit by segment LPG 9% Fuel card 6% Fuel card 11% LPG 34% Oil 55% Oil 85% Source: Company data, Edison Investment Research Source: Company data, Edison Investment Research The oils side of the business supplies transport fuels, heating oils and fuel oils to commercial, retail, domestic, agricultural, industrial, aviation and marine customers in Britain, Ireland, Austria, Denmark, Germany and Sweden, while also engaging in fuel card services as the largest independent player in Britain. Oil represents 85% of the division s volumes, but only accounts for 55% of the division s profits due to its lower pence-per-litre margin compared to LPG. While margins are significantly higher in the LPG business, ROCE levels (at c 20% on average) are similar across the two business lines, as LPG is considerably more asset intensive (due to higher storage costs and the ownership costs of cylinders and tanks). The oils business follows different operational models across geographies: in the UK, the group owns most of its infrastructure, while in the Nordic regions it uses outsourced infrastructure (with pay-for-use agreements). The outsourced infrastructure has the advantage of reducing the detrimental impact of warm winters (or any other demand-side shock), but it does not offer the same leverage benefits as the owned infrastructure. The group s fuel card business in the UK, representing 6% of volumes and 11% of profits in FY13, has a strong c 75% nationwide coverage of total sites and remains a key part of the division s strategy due to its attractive characteristics of negative working capital impact and lack of seasonality. DCC s LPG business supplies propane and butane (in bulk form or in cylinders) to domestic, commercial, agricultural and industrial customers mainly for heating, transport and industrial use in Britain, Ireland, Sweden, Norway, Belgium and the Netherlands. LPG is predominantly used in locations with no natural gas grid, but oil to LPG conversions are also becoming more common as the use of LPG becomes more economic (due to savings on fuel costs, carbon usage reduction and lower maintenance costs). Providing strong returns and cash generation While DCC as a whole has a strong focus on return on capital employed, the Energy division in particular offers high and resilient returns: it had an average ROCE of over 22% in the last 10 years and return on capital employed was at c 14% even in FY12, when the division was hit by both the mildest winter on record for the last 10 years (resulting in a c 20m negative impact on operating profit) and the economic recession, showing its resilience. The division s cash generation is also strong, as shown in Exhibit 3. DCC 18 November

3 Exhibit 3: 10-year cumulative cash flow generation m Oil LPG Energy total Operating profit Change in working capital (18.2) 85.2 Depreciation CFO Net capex (97.5) (125.5) (223.0) FCF FCF/CFO 84% 64% 77% Acquisiton spending (426.5) (104.5) (531.0) Net cash generation Source: Company data, Edison Investment Research DCC Energy has generated c 744m of FCF in the last 10 years on a total operating profit of c 675m, representing a c 15% CAGR over the period. This strong cash flow performance has enabled the group to finance the division s significant inorganic growth initiative from internal cash generation. The division has spent a total of c 531m on acquisitions over the last 10 years, which represents 59% of the group s total net acquisition spending of c 900m over the same period. Inorganic growth allowed the group to build strong market positions in Britain and Western Europe, which is especially valuable given the substantial economies of scale in the business. Better network utilisation and leveraging the scale of the business (via better terms from suppliers) further improves margins, return on capital employed and cash generation, creating a virtuous circle for DCC Energy. Leading market shares in a business of scale, yet plenty still to go for The total addressable market for DCC Energy remains large and fairly stable. The Western European fuel market is estimated at c 420m tonnes pa and is expected to decline by c 1% pa through to However, growth trajectories differ significantly across product categories: Driven by the move away from petrol towards diesel, volumes in the former category are expected to decline, while the demand for diesel is forecast to increase steadily. Similarly, LPG is also expected to gain further share as more supply comes on stream, making it an increasingly economic alternative to other fuel types (with the added benefit of lower carbon emission). Meanwhile, overall heating oil volumes are expected to continue to decline modestly in the coming years, with the impact differing across geographies. Volumes in the UK are expected to remain robust, while volume declines in Scandinavia are forecast to be more significant due to stricter government regulation. Exhibit 4: Markets remaining broadly stable tonnes (000s) e LPG Diesel Petrol Jet fuel Other kerosese Gasoil HFO Lubricants Source: PFC, Edison Investment Research DCC Energy s markets differ substantially on the LPG and the oils side. While the oil distribution market remains highly fragmented in the UK and in most of Western Europe, LPG markets are significantly more consolidated (with the top four to five players usually taking at least 70-80% of DCC 18 November

4 the total market). This is a result of LPG being a more niche product, while also being considerably more capital intensive (distributors need to own their tanks and cylinders), presenting higher barriers to entry for smaller local players. DCC Energy s strategy is focused on taking leading market shares in geographies where it is present. This enables the group to take advantage of the significant scale benefits the business offers. Driving operational efficiencies has a significant impact on the division s bottom-line performance as every 0.1p increment in the per litre margin results in a c 11m uplift in operating profit at current yearly volumes. The division has been making significant inroads to establish a strong European presence by entering seven countries in the last four years. Moreover, as shown in Exhibit 5, the division now has strong market shares in all those markets except Germany, where the group is currently only present in Bavaria via a greenfield start-up in Straubing and via the Bronberger & Kessler acquisition in Munich. Exhibit 5: DCC Energy leading market shares across geographies Geography Volume Market share Market position Britain oil 6,500m litres 18% 1 Britain LPG 270k tonnes 27% 2 Ireland oil 900m litres 10% 5 Ireland LPG 70k tonnes 39% 2 Austria oil 850m litres 13% 2 Germany oil 300m litres 4% in Bavaria Local presence Sweden oil 350m litres 17% 1 Sweden LPG 190k tonnes 47% 1 Norway LPG 95k tonnes 43% 1 Denmark oil 250m litres 13% 2 Netherlands LPG/aerosol propellant 60k tonnes 24% 1 Source: Company data, Edison Investment Research While the market is large and DCC Energy has leading market share across several geographies, it only supplies 2.5% of the overall Western European addressable fuel market. This means there remains a significant opportunity for continued expansion. We believe, as explained in more detail later, that DCC can further consolidate the fragmented oils markets where is it already present via acquiring small local players and by capitalising on oil majors continuing to dispose of non-core assets, where it is often the preferred buyer as a result of its reputation and strong balance sheet. In addition, scope remains for organic market share gains via cross-selling products and services (such as fuel cards), further expanding the group s retail presence (independent and unmanned petrol stations) and addressing the group s variations in market share across product segments. Meanwhile, in LPG the group can drive efficiencies from the recently acquired and previously underinvested assets, increase cross-border sales in Scandinavia and the Netherlands, capitalise on new product opportunities (such as LNG and aerosol propellants) and target oil to LPG conversions. Finally, both in oil and LPG, the group can penetrate new geographies to increase its pan-european footprint. Also representing an adverse weather hedge While the division has been diversifying its product mix away from heating oil in recent years, it still represents a significant part of the business (24% on the oils side and 27.5% in total, including LPG). This means there is significant weather-related volatility in the business and temperatures during the division s key trading period of December to February can have a considerable impact on the group s performance. Moreover, it is not only average temperatures that affect divisional performance, but also the volatility of weather conditions. An extremely cold month coupled with two mild ones affects profitability in a different way to three equally cold months, even if average temperatures are identical across the two scenarios. This makes it very difficult to accurately forecast or quantify the impact of weather on operating profits. Management budgets on a 10-year average temperature basis for the division and if weather conditions in the key three-month trading period differ significantly from the historical average, actual divisional performance might materially DCC 18 November

5 diverge from the underlying performance. Exhibit 6 shows the estimated impact of weather and the underlying profitability over the last six financial years. Both FY09 and FY10 saw a c 9-10m positive impact on operating profits due to colder than average weather, while extremely low average temperatures in FY11 boosted divisional profitability by an estimated 20m. In FY12, the group experienced its biggest weather-related swing to date of c 40m, when the coldest winter of the last seven years was followed by the warmest winter on record. The group s resilience is well displayed by the fact that the division posted a 14% ROCE despite highly unfavorable weather conditions, coupled with a recessionary macroeconomic environment. Conditions normalised in FY13 with a c 5m benefit from temperatures 1.4 degrees below the 10-year average. Overall, while the group s weather sensitivity poses some challenges to the business (the requirement to carry excess capacity in the winter months, etc) and increases the volatility of the division s earnings, we believe it also offers a bad weather hedge that can be highly valuable from a portfolio perspective. Exhibit 6: Impact of weather on operating profits m (50.0) FY08 FY09 FY10 FY11 FY12 FY13 Underlying profits Weather impact Source: Company data, Edison Investment Research LPG: Leveraging synergies and targeting conversions Britain The group first entered the British LPG market in the 1980s and had a reasonably small market share at c 2%. The business grew organically until 2001, when DCC acquired the LPG assets of British Gas, effectively doubling the size of its operation. After another period of organic growth, the group significantly increased its market share again to c 27% in 2012 by acquiring BP s LPG business (for a total consideration of 40.5m) trading as MacGas (cleared by the OFT in early 2013), as displayed by Exhibit 7. The group now runs its LPG operations branded as Flogas in England and Wales and under the name MacGas in Scotland. We believe leveraging the synergies from this acquisition represents a significant opportunity for DCC Energy. Currently, c 51% of the volume in DCC s British LPG business comes from commercial bulk customers, 16% from domestic bulk, 21% from cylinders and 12% from autogas. In our opinion, one of the key opportunities for DCC s LPG business in Britain comes from leveraging the significant synergies and scale efficiencies from its latest acquisition. The group has now merged its latest acquisition with the existing business on its systems, hence the division can trade as a fully integrated unit in the crucial winter trading period. We believe the group can drive significant efficiency gains via optimising the depot network, improving routing and scheduling and by negotiating better terms with suppliers, which will have a positive impact on the division s margins. DCC 18 November

6 Exhibit 7: Estimated market shares by category Estimated market share Bulk market Domestic bulk Commercial bulk Flogas 15%-25% 10%-20% MacGas 0%-10% 5%-15% Merged entity 20%-30% 20%-30% Calor 45%-55% 45%-55% Avanti 5%-15% 5%-15% Others 10%-20% 10%-20% Autogas market Including sales to BP/Moto Excluding sales to BP/Moto Flogas 20%-30% 25%-35% MacGas 15%-25% 0%-10% Merged entity 40%-50% 30%-40% Autogas (JV between Shell and Calor) 25%-35% 30%-40% Others 25%-35% 30%-40% Cylinder Flogas 20%-30% MacGas 0%-10% Merged entity 25%-35% Calor 45% Energas 0%-10% BOC 0%-10% Others 5%-15% Source: Office of Fair Trading, DCC estimates based of DECC data, Edison Investment Research The group s LPG business can also benefit from targeted oil to LPG conversions and we have seen promising signs of this initiative in the H1 results. We believe there are three main drivers of increasing conversion levels. Firstly, as shown in Exhibit 8, the cost of LPG has been decreasing compared to oil due the recent de-coupling. This is the result of an increase in supply from shale gas in the US with more production coming on stream also in Russia (a new 1.5m tonne export facility was recently completed close to St. Petersburg) and the Middle East, driving down prices. Secondly, companies continue to look for ways to reduce their carbon footprints to comply with stricter regulations and increase corporate responsibility. Given that LPG brings a significant reduction in carbon usage (gasoil and heavy fuel oil, for example, are associated with 29% and 31% higher carbon emissions respectively compared to LPG), it remains an important factor in driving further conversions. Finally, LPG is associated with lower maintenance costs as it is a much cleaner burning fuel. Exhibit 8: LPG s relative cost decreasing Source: US Energy Information Administration While conversions might cannibalise some of the revenues in oil, we believe the overall impact is beneficial for the division given that LPG is higher margin than oil (while offering similar rates of DCC 18 November

7 return due to higher tangible capital requirements) and churn is significantly lower (as customers tend to be stickier given longer contracts and company owned tanks). International We believe DCC Energy is well positioned to grow in its existing international LPG markets. The group acquired its Netherlands-based assets from BP in 2012, which trade under the Benegas name. Its main focus is on the bulk segment of the market (representing 47% of volumes) and is the Netherlands leading supplier of aerosol propellants, with a 53% market share (representing 48% of total volumes). We believe Benegas has four main growth avenues to explore: Increasing cross-border sales: While the group already has a tiny market share in Northern Belgium as a bulk supplier, the business can capitalise on further cross-border opportunities not only in Belgium, but also in France and Germany. Due to the group s regional management structure, Benegas was not allowed to engage in significant cross-border selling under BP, while under the new ownership management will be incentivised to expand beyond the Netherlands. Making a play on the autogas market: Given that BP has retained its Dutch autogas operations, Benegas does not currently address this segment of the market. We believe this market represents a significant opportunity for the business, especially given that the Dutch management team has considerable sector experience. Increasing the capacity of the aerosol business: While already a strong force in the local aerosol propellant market, the business remains capacity constrained to supply more into the European market. While this is a more niche market, we believe it represents an important growth channel if the group manages to establish its presence as a pan-european supplier. Stronger focus on organic growth: Given its non-core status in BP, the business was underinvested, which limited its potential to achieve robust organic growth. Improving the performance of such assets is a key area of focus for DCC s management, and by establishing and further investing in the sales team, the group has built a strong platform to help secure new customer wins and drive organic growth. The group s Scandinavian business, acquired from SFR in 2012, is the number one player in both Sweden and Norway and mainly a bulk supplier to industrial and commercial customers, which represents 80% of total volumes. The remaining 20% consists of bulk heating and wholesale distribution. We believe the growth paths of this business are very similar to that of Benegas. Firstly, the cross-border sales potential in the business is considerable with the possibility of supplying to Denmark and Finland. Secondly, these assets were also underinvested as, for example, the Norwegian business was not allowed to invest in new customer installations, severely limiting the potential to gain further market share. In addition to gaining market share organically in current geographies, the group has the capabilities and the opportunity to extend its European footprint by penetrating new geographies or by buying additional assets in existing markets. As previously mentioned, despite its strong presence DCC Energy only serves c 2.5% of its addressable Western European fuel market, leaving scope for further expansion. As oil majors continue to sell their non-core businesses, we believe DCC will be able find suitable opportunities to obtain assets that can serve as platforms for growth in new regions. Over the last 10 years, the Energy division spent c 531m on acquisitions (representing 59% of the group s total net acquisition spending) and we expect management to continue to focus on its selective acquisition strategy (with a target pre-tax ROI of 15-20%), providing significant upside to our numbers. While pinpointing the impact of acquisitions for FY14 and FY15 is hard due to uncertainty about targets and timing, an annual spend of c 90m (based on FY12-13 average group-level acquisition spending of c 153m pa and taking the division s historic share of acquisition expenditure at 59%) and a conservative 16% pre-tax ROI would imply a DCC 18 November

8 c 14.4m uplift (equivalent to over 8%) to our FY14 group PBT estimates on an annualised basis from inorganic growth in the Energy division alone. Oil: Several growth levers remaining Britain While the group has a very strong position in the British oil market, we believe there is plenty of scope for further expansion. The group currently has a market share of 18% in oil and management targets 20% in the medium term, which suggests it could potentially go as high as 25% in the longer term. We believe DCC Energy has several characteristics that distinguish it from smaller players and enable the group to achieve sustainable growth. DCC Energy has a strong national footprint with a robust company owned infrastructure across the country, which means the division is capable of efficiently supplying national accounts (such as Royal Mail) at multiple locations. The group also offers a high degree of flexibility for customers (delivering smaller loads to retail petrol stations, unlike many of the oil majors) and benefits from the strong brand loyalty of commercial customers. Finally, the group s additional services (measuring utilisation levels for clients, arranging planned delivery, etc) also create stickiness in the customer base. We believe the growth in Britain will come from four main sources: Further market consolidation: The oil market in Britain remains highly fragmented, giving DCC the opportunity to further improve its market share position. The high level of market fragmentation is well displayed by the fact that in Britain the group has an 18% market share in oil, while the second biggest player, Watsons, currently serves c 3% of the market. Opportunities are also likely to occur given the group s varied market share across regions. DCC Energy, due to historical acquisition patterns, has a 30% market share in Scotland and 20% in the North, while only 11% in the South. This relatively lower market share in the South provides the group with significant growth potential, both organically and via acquisitions. Increasing retail presence: While the group has grown its retail exposure significantly over the last years (with retail now accounting for 20% of UK oil volumes), we believe there is a lot more to go for. The opportunity is twofold: Firstly, given that oil majors are pulling back from the retail segment, DCC Energy can service more independent retail petrol stations as the division s flexibility and value-add services make it an appealing partner for independents. Secondly, unmanned forecourts also represent an interesting growth segment for the group. In Northern Europe, c 50%of the market is made up of unmanned stations and the UK has seen a decrease in the proportion of people using the shops attached to stations, introducing the possibility of increasing the number of unmanned sites. This, coupled with the fact that many independent petrol stations suffer from succession problems, presents DCC Energy with the opportunity to acquire these sites and convert them into unmanned forecourts (with no shop on site). The diversification into oil retail exposure will enable the group to own the end-customer and earn the full retail margin on its products (c three times as high as the wholesale margin), leading to top-line growth and margin improvement. Improving market shares in products where the division is underrepresented: The group s market share across different product segments is varied, giving scope for market share gains in underrepresented categories. For example, the group has a c 30% market share in gas oil and kerosene, but only c 7% in road transport fuels. While this diversification will result in a negative mix effect (as margins for gas oil are at c 3-4p per litre versus transport fuels at c 1-2p), ROCE remains high and the significant volume increase and scale efficiencies can offset some of this impact. Cross-selling products and services: The group can increase its share of wallet in its existing customer base via cross-selling additional products and services. Cross-selling not DCC 18 November

9 only provides the group with additional revenues (and, in many cases, higher margins), but also increases customer stickiness, which is crucial for the business, especially in times when customers come under pressure. The division has been increasingly successful at cross-selling fuel cards to bulk diesel customers and has also grown its lubricants business over the past few years. This initiative also helps DCC further expand the sales of its differentiated products (such as fuel-efficient diesel, premium kerosene, etc). International We believe DCC Energy can achieve further growth in its current existing geographies. In Scandinavia, while the company already has strong market share positions (with 17% in Sweden and 13% in Denmark), there is scope for further gains. Both the Danish and the Swedish businesses can make further progress with diversifying the customer base (mainly consisting of commercial customers) and taking advantage of flexible logistics, which, unlike the owned infrastructure in the UK, is fully outsourced with DCC utilising pay-for-use arrangements. Additionally, the Danish business, which was bought from Shell, can increase is presence in marine fuels and lubricants, while the Swedish business has the potential to penetrate the bunker site market and further consolidate what remains a fragmented market. The division also has the potential to extend its fuel card operations to Europe on a larger scale (currently only a tiny fraction of revenues in Denmark), as oil majors outsource these non-core functions and only retain them for the largest customers. Germany probably represents the biggest opportunity for DCC Energy given that it is a large market with similar characteristics to the UK. This presents a significant roll-up opportunity for DCC, and the group has been trying to establish its presence in Germany over the recent years to build a platform for future growth, both organically and via acquisitions. The group initially used its strong Austrian position as the first step towards a German entry and in 2012 set up a greenfield operation in Bavaria to establish local presence. The group acquired Bronberger & Kessler (Eni-branded business) in May 2013 to strengthen its Bavarian position. While it currently only supplies less than 4% of the Bavarian market, the group now has a local presence and a strong portfolio of suppliers, and we believe the business can scale up quickly if the right opportunities arise. As explained above, as well as growing in existing regions, the group can enter new geographies to enlarge its Western European footprint and further capitalise on economies of scale. Upside risks to earnings In addition to the division s long-term attractive growth prospects, we believe our numbers for FY14 remain conservative, providing scope for potential upgrades. Our divisional EBITA of 124.7m is based on zero organic volume growth (resulting in total volumes of c 11bn litres) reflecting a challenging macroeconomic environment and a 2.8% improvement in pence-per-litre profit (to 1.13). We believe these numbers might prove conservative in light of the 2.3% organic volume growth and the19.4% profit-per-litre improvement in FY13, as well as in light of the strong margin expansion in H114. While clearly a significant proportion of the rapid profitability growth in FY13 was a rebound from the historic lows of FY12 (affected by an unusually mild winter, high oil prices and a weak macroeconomic environment, resulting in a c 15% decline in heating-related volumes and a 2% decline elsewhere), we believe the group has also grown underlying profitability. Higher overall volumes, better utilisation of the existing network and the increasing proportion of LPG assets (which command higher margins) present an opportunity for the Energy division to increase pence-per-litre margins despite the negative impact from mix in oil (given that heating oil is associated with substantially higher per litre margins than transport and commercial fuels). While visibility on full-year numbers at this stage is limited due to the weather dependence and the heavily H2-weighted nature of the business, an organic volume growth of merely 1% and a profit per litre DCC 18 November

10 improvement of 10% (significantly below that in H1) would give a divisional EBITA of 134.8m, representing an 8.1% upgrade on divisional EBITA level and a more than 5.5% upgrade to group PBT compared to our base case scenario. Exhibit 9: Energy EBITA sensitivity Organic volume growth m (5%) (1%) 0% 1% 5% (5%) % Profit growth 3% per litre 5% % % Organic volume growth % (5%) (1%) 0% 1% 5% (5%) (11.6%) (8.2%) (7.4%) (6.5%) (3.2%) 0% (7.2%) (3.6%) (2.7%) (1.8%) 1.7% Profit growth 3% (4.5%) (0.9%) 0.0% 1.0% 4.5% per litre 5% (2.5%) 1.2% 2.1% 3.2% 6.8% 10% 2.1% 6.0% 7.0% 8.1% 11.9% 15% 6.8% 10.8% 11.9% 13.0% 16.9% Source: Edison Investment Research Sensitivities Macroeconomic environment DCC s performance would be adversely affected by a deterioration in the macroeconomic outlook. It is particularly sensitive to developments in the UK and Ireland, which together represent over 80% of the group s revenues. The group applies sensitivity analysis to its planning and budgeting models across the group to evaluate the impact of a worsening macro environment, while continuously monitoring economic indicators to identify potential signs of deteriorating market conditions and enable a rapid response to changing circumstances. The impact of weather on trading Given that a significant proportion of the Energy division s sales are generated via heatingdependent products (with heating oils representing 24% of total volumes as of FY13), the division s performance is affected by weather conditions, particularly during the winter trading period. To mitigate the impact, the group focuses on reducing the dependence on heating-related products by actively strengthening its position in the non-heating segments, with particular focus on retail petrol stations and the marine and aviation sectors. Acquisitions Inorganic growth remains a crucial element of the group s growth strategy and therefore a failure to identify, execute and integrate acquisitions would result in a significant deterioration of the group s performance. To mitigate this risk, the group and divisional management teams engage in a continuous and active review of potential acquisitions. All potential acquisitions are subject to an assessment to determine whether they are a good strategic fit for the group and whether they can deliver the required ROCE targets. A stringent internal evaluation process and due diligence is undertaken before completing any acquisition. Management has significant expertise in and experience of integrating acquisitions, with more than 200 acquisitions completed since DCC 18 November

11 Supplier and customer relationships and product quality While DCC s business is well diversified both in terms of suppliers and customers, a loss of a key supplier or customer would nevertheless have a material impact on the business line where the loss is suffered. In addition, some of the group s businesses operate manufacturing and/or productprocessing facilities. Poor product quality, especially in the Healthcare and Food & Beverage divisions, could affect customer or public safety, giving rise to significant costs and damage to the group s reputation. To minimise this risk, all manufacturing and product-processing facilities operate quality management systems, which are subject to regulatory review and licensing requirements. Valuation We value DCC via a combination of sector-based metrics and a DCF methodology. Sector-based valuation Exhibit 10 shows DCC s valuation versus the FTSE 350 Support Services Index. While the shares have outperformed the sector in recent months, due to the small upgrade in earnings forecasts, the group still trades at a c 8% discount compared to its peer group on an FY14e P/E basis and at a 6% discount on an EV/EBITDA basis. We continue to believe that DCC merits a premium compared to the sector due to the upside potential to numbers (as a result of acquisitions potentially adding 13% to PBT on an annualised basis), the group s strong market position across its divisions and its superior ROCE and cash generation/conversion versus its peers. Applying a conservative 10% premium, we get 19% upside on an FY14 P/E basis and 17% on an EV/EBITDA basis. Exhibit 10: Sector-based valuation FY14e FY15e EPS-based EV/EBITDA EPS-based EV/EBITDA DCC 14.5x 9.0x 13.9x 8.4x In line with sector 15.6x 9.6x 13.9x 8.8x Implied price (p) 3,031 2,961 2,818 2,908 Upside 9% 6% 1% 4% Premium 10% 10% 10% 10% Adjusted target multiple 17.2x 10.5x 15.3x 9.6x Implied price (p) 3,334 3, ,204 Upside 19% 17% 11% 15% Source: Bloomberg, Edison Investment Research DCF valuation Our DCF methodology (Exhibit 11) based on scoping estimates up to 2024 remains unchanged. With conservative assumptions beyond our forecast horizon (minor volume and pence-per-litre profit improvement in Energy, small margin erosion in SerCom and some expansion in Healthcare), using a 2.5% terminal growth rate and applying a 10% discount rate, we obtain a fair value of 3,044p. However, it is important to note that our DCF model does not take into account the potential benefits coming from acquisitions, which could provide a significant upgrade to numbers. DCC 18 November

12 Exhibit 11: DCF valuation m FY14e FY15e FY16e FY17e FY18e FY19e FY20e FY21e FY22e FY23e FY24e TV Total Sales 11,571 12,014 12,474 12,911 13,350 13,791 14,232 14,673 15,084 15,476 15,863 PBT Tax (32) (32) (33) (36) (38) (41) (43) (46) (48) (51) (53) NOPAT D & A Capex (70) (72) (74) (77) (79) (82) (85) (87) (90) (92) (94) Total ,860 Discounted ,386 2,740 Net cash/(debt) (186) Equity value 2,554 Average number of shares (m) 83.9 Valuation (p) 3,044 Source: Edison Investment Research Our valuation (derived by averaging the sector-based methodology and our DCF) remains 3,217p, representing a 13% upside to the current share price. Financials Income statement Exhibit 12: Income statement summary FY12 FY13 FY14e FY15e Revenues (continuing operations) Energy 6,793 8,112 8,598 8,813 Sercom 1,599 1,850 2,239 2,418 Healthcare Environmental Food & Beverages Total 8,989 10,573 11,571 12,014 Y-o-y growth 18% 9% 4% Adjusted EBITA (continuing operations) Energy Sercom Healthcare Environmental Food & Beverages Total Y-o-y growth 20% 15% 5% Operating margins 1.6% 1.6% 1.7% 1.7% Source: Company Data, Edison Investment Research It is important to note that revenue is not a highly useful metric on a group level, as the Energy division s revenues fluctuate heavily with the underlying product price, therefore key metrics for the division are volumes and pence-per-litre profit. We expect total volumes for the Energy division at 11.0bn litres for FY14 and at c 11.2bn litres for FY15. We forecast pence-per-litre profit at c 1.13p for FY14 and at c 1.16p for FY15. In SerCom, we expect 21% and 8% revenue growth in FY14 and FY15 respectively due to the rapid growth in the tablet market (where the group has leading market shares), the strong focus on handsets and accessories, as well as a favourable software release schedule and console cycle, along with a minor c 30bp reduction in margins due to the ongoing shift in the product mix. In Healthcare, we expect revenues to increase by c 30% in FY14 (driven predominantly by the Kent acquisition) and by 6% in FY15. We expect some progression on margins as a result of the mix impact, the cost synergies from Kent and the operating leverage in Health & Beauty, resulting in operating margins rising by 10bp by FY15 despite price pressure in some segments. In Environmental, we forecast sales growth of 11% for FY14 and 7% for FY15 driven by the group s non-hazardous waste management activities, along with some margin compression. For Food & Beverage, we forecast a return to positive sales growth due to soft comparatives, with margins mildly declining. DCC 18 November

13 Cash flow We expect cash flow generation to remain strong despite elevated capex levels (forecast at 70m in FY14) and increased working capital outflow. While we do not include any potential impact from future acquisitions, we include a c 12m outflow related to deferred and contingent acquisition considerations. Balance sheet DCC has a healthy balance sheet with a net debt position of c 186m (including derivative instruments) at March 2013 (resulting in a net debt/ebitda of 0.7x), leaving the company with plenty of firepower. We forecast net debt to decrease to 127.4m in FY14 and to 49.1m in FY15. DCC 18 November

14 Exhibit 13: Financial summary m e 2015e 31-March IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 9,283 10,573 11,571 12,014 EBITDA Operating Profit (before amort. and except.) Intangible Amortisation (10) (14) (18) (18) Exceptionals (19) (24) (2) 0 Other Operating Profit Net Interest (15) (15) (21) (20) Profit Before Tax (norm) Profit Before Tax (FRS 3) Tax (26) (26) (32) (32) Profit After Tax (norm) Profit After Tax (FRS 3) Average Number of Shares Outstanding (m) EPS - normalised (p) EPS - normalised and fully diluted (p) EPS - (IFRS) (p) Dividend per share (p) EBITDA Margin (%) Operating Margin (before amort. and except.) (%) Operating Margin (after amort.) (%) BALANCE SHEET Fixed Assets 1,149 1,327 1,323 1,320 Intangible Assets Tangible Assets Investments Current Assets 2,007 2,060 2,571 2,659 Stocks Debtors 1,077 1,139 1,213 1,300 Cash Other Current Liabilities (1,391) (1,681) (1,942) (1,945) Creditors (1,332) (1,526) (1,659) (1,834) Short term borrowings (59) (154) (283) (111) Long Term Liabilities (847) (814) (954) (909) Long term borrowings (707) (673) (830) (817) Other long term liabilities (140) (141) (124) (92) Net Assets ,125 CASH FLOW Operating Cash Flow Net Interest (14) (14) (22) (19) Tax (43) (31) (28) (27) Capex (61) (63) (70) (72) Acquisitions/disposals (146) (168) (12) (12) Financing (3) Dividends (55) (55) (63) (67) Net Cash Flow (84) (90) Others Opening net debt/(cash) HP finance leases initiated Others 12 (7) (0) 0 Closing net debt/(cash) Source: Company data, Edison Investment Research Note: Net debt, in line with company reporting, includes derivative instruments. DCC 18 November

15 Contact details DCC House Brewery Road Stillorgan Blackrock Co. Dublin Ireland Revenue by geography CAGR metrics Profitability metrics Balance sheet metrics Sensitivities evaluation EPS 12-15e 12.6% ROCE 14e 18.3% Gearing 13e 4.4% Litigation/regulatory EPS 14-15e 8.8% Avg ROCE 13-14e 17.0% Interest cover 13e 11.1 Pensions EBITDA 12-15e 8.0% ROE 13e 14.9% 6CA/CL 13e 1.4 Currency EBITDA 14-15e 8.6% Gross margin 14e 7.0% Stock days 13e 17.9 Stock overhang Sales 12-15e 6.7% Operating margin 14e 1.9% Debtor days 13e 39.5 Interest rates Sales 14-15e 6.7% Gr mgn / Op mgn 14e 3.6x Creditor days 13e 53.9 Oil/commodity prices Management team Group chief executive: Tommy Breen Mr Breen joined DCC in 1985, having previously worked with KPMG. He has held a number of senior management positions in the group, including MD of the Energy, SerCom and Environmental divisions. He was appointed COO of DCC in March 2006 and subsequently became group managing director in July He was appointed chief executive in May Chairman: Michael Buckley Mr Buckley joined the board in September 2005 and was appointed nonexecutive chairman in May He was group chief executive of Allied Irish Banks from 2001 to 2005, having served as managing director of AIB Capital Markets and AIB Poland. Previously, he was MD of NCB Group and a senior public servant in Ireland and the EU before that. From 2003 to 2012, he was a NED of M and T Bank Corporation, listed on the New York Stock Exchange. From 2008 to 2011, he was a NED of Enterprise Ireland. Chief financial officer: Fergal O Dwyer Mr O Dwyer joined DCC in 1989 and was appointed chief financial officer in 1994, having worked in that role leading up to DCC s flotation in that year. He has worked in DCC in senior management positions for over 23 years, during which time he has worked closely with all the group s material operating companies on a range of financial management, treasury and strategic and development matters. Principal shareholders (%) Invesco 13.6 Fidelity 12.6 Prudential 6.1 Franklin Resources 5.8 Blackrock 4.1 T Rowe Price 2.9 % 8% 76% 16% Ireland UK RoW DCC 18 November

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