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Why are we taking a fresh approach to food retail?

Food retail has been a core focus area for L1 Retail from the outset, given our experience as operators and investors in the sector over the past 25 years.

Within food retail, our belief is that proximity is a critical element of serving customer needs – centred around the location and convenience of the store, but now also increasingly digital proximity through e-commerce and, in particular, express delivery. The second key element is having a clear and differentiated assortment, with a focus on fresh categories and on high quality private label products with a strong value-for-money reputation.

Finally, we see the importance of the role of food retail in the community, never more clearly seen as through the COVID-19 pandemic, and having a clear sense of purpose in serving society and the community is fundamental to our thinking.

Why DIA?

In our review of potential investment opportunities five years ago, Spain emerged as an attractive market opportunity, a vibrant and increasingly dynamic economy and one of the few large markets in Western Europe that has yet to see significant consolidation. In addition, Latin America, and specifically Brazil, has parallels to the consumer environment and market structure in Russia, where X5 has been very successful in growing and innovating over the past decade.

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In 2017, we identified DIA as an attractive investment opportunity: a proximity retail concept that was well positioned in attractive markets, but one which had lost its customer offer, was seeing declining footfall and sales densities, and needed a fundamental reset. It was clear that the business was overly focused on driving short-term profitability and needed a reference shareholder to support much-needed business model change and investment.

We believed the business had strong potential to grow in Spain and Portugal through improved sales densities and from selective consolidation, and could see very significant growth in Brazil over the long term as the largest player in proximity retail in a market where all the large operators are focused on large stock-up baskets. In taking a significant minority stake, and in becoming DIA’s reference shareholder, our intention was to influence the company in a positive way and improve the way it was run.

Accounting irregularities

Unfortunately, in October 2018, the company disclosed historic irregularities in how profitability was accounted for, leading to a crisis in confidence around the company and its board of directors. This led to a significant reduction in liquidity and the requirement for a more active role by L1 Retail to rescue the company. In May 2019, L1 Retail acquired control of the company, and in July 2019 a rescue restructuring was agreed with. lenders, with L1 Retail committing a large capital injection.

L1 acquires control

Since then, DIA has experienced a significant improvement in its performance under L1 Retail control, and in August 2020 L1 Retail committed further capital to support the DIA capital structure by acquiring over 90% of the company’s bond issues. This removed short-term capital structure uncertainty and has reinforced and supported management in driving the turnaround. In total, L1 Retail has invested €2.4bn in DIA over the last three years.

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Since taking control of DIA in May 2019, there have been four key areas of focus:

1. Strengthening the team

We strongly believe that long-term sustainable success can only happen with a strong team. To this end, we have invested in renewing the leadership team, both at group and country levels, by bringing in new talent to change the way we operate, together with some of the existing team that was committed to seeing a new DIA created. In addition, there’s an important task of creating a new culture between those coming in and those remaining, across four countries. We have worked very hard on creating a performance-oriented culture; a culture of accountability, a culture of responsibility; and a culture with a sense of urgency.

2. Improving the customer offer

Particularly over the first year under Karl-Heinz Holland’s leadership, there was a huge emphasis on fixing basics: improving the assortment, store layout, logistics and supply chain operations.

Specifically, we see fresh fruit and vegetables as hugely important as a traffic driver, which is why we focused on that category across the board, in every country. This groundwork was critical to have had in place when COVID-19 hit, because having improved our basic store and commercial and supply chain operations allowed us to respond very effectively to meet our customer needs.

3. Resetting the franchise model

Approximately 50% of DIA’s stores in Spain are franchised stores. Our franchisees are key partners to the business, particularly in smaller stores where they are often much better at managing costs. DIA was not aligned with its franchisees historically, not investing in supporting them and not creating incentives for growth. We have made significant progress in resetting the franchise model, providing full transparency and clear rules in terms of how the stores should be operated and managed and the rewards for achieving growth and better performance. We have seen a strong recovery in franchise stores and are actively seeking to grow this business model.

4. Empowered countries

Initially, to achieve the first phase of fixing, it was key to operate a very centralised effort, run centrally at DIA. A year into taking control, we switched to a more decentralised operating model, empowering four country CEOs to lead their businesses. DIA is one group but it’s actually four local retail businesses.

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Decentralised operating model

DIA now has four separate country teams who work in their own languages, the language of their customers. This was an important shift in the way we sought to accelerate change at DIA a year after taking control.

As part of the second phase of its business transformation, DIA is now focused on building a modern proximity offer, an attractive value proposition, freshness, operational excellence, a win-win franchise model, and an outstanding own brand offer.

There are a number of positive indicators that point to underlying progress. In particular, higher average basket size, up 24.6% for the full year, more than offset any decrease in ticket volume as customers start to change the way they shop at DIA stores.

DIA’s new organisational model, which drives empowered country leadership, with support from a lean corporate centre, has been a key contributor to performance. During the year, DIA renewed the top positions in key markets, reinforcing the country leadership and capabilities.

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DIA’s structure allows it to effectively drive improvement across all areas of its business, focused on initiatives in three core areas:

1. Commercial value proposition

Thanks to the improved assortment with a focus on fresh produce and the development of a new private label offer combining quality, value-for-money and more attractive packaging, DIA has successfully rolled out optimised assortment and store layouts to over 1,100 stores in Spain. This focus on the fresh fruit and vegetable offer resulted in a 12% increase in net sales for fresh produce categories.

During the second half of the year, DIA launched over 800 new stock keeping units (SKUs) of private label products, including ready-made products, in Spain and in Brazil. It also began testing a new store model in Spain, with 26 stores featuring an improved look and feel, and a more customer-friendly layout.

The expansion of online and express delivery continues in all four countries to meet new customer purchasing trends accelerated during pandemic restrictions. Online currently represents around 2% of total net sales and has increased around 120% during the year.

2. New franchise model

DIA’s new franchise model saw a comprehensive rollout in the second half of the year and is now active for over two-thirds of franchisees in Spain and Portugal. The programme includes financial and operational support, a new merchandise payment and sales incentive system, as well as a simplified cost structure.

In Spain, DIA now has around 200 multi-franchisees that manage more than one store, and during the year it attracted new entrepreneurs with strategic vision that allowed it to transfer over 113 stores from owned stores to franchised stores. It is applying the learnings to its franchise models for Brazil and Argentina, adapted to the local needs of suppliers and franchisees.

3. Operational excellence

DIA is fully committed to achieving operational excellence. It is reducing complexity thanks to the ongoing redesign of its operations model across the whole supply chain and its logistics activity.

Having laid the foundations in 2019, 2020 saw DIA implement key commercial and operational improvements in each of its four countries of operation based on empowered country leadership.

Looking forward

From the outset we had a clear vision of where the business needed to migrate and an understanding of the operational and strategic levers required to deliver this. As long-term investors, we are seeking to achieve significant and sustainable value growth over a long horizon and not seeking to deliver short-term profitability.

We have had our fair share of what we call “adventure” at DIA over the last four years. At each turn, the team has responded dynamically, developing solutions to move the investment in a forward direction.

COVID-19 has reinforced in the company a huge sense of purpose because we’ve been serving society and the community as a proximity player. This is our guiding light at DIA.

Looking forward we will identify further areas of improvement. The role of technology and digital, along with the shift to a platform-based business model, is taking up increasing management time and will be at the forefront of future change.