Due to the illiquidity of this name, this idea will probably not be suitable for institutional accounts.
David’s Tea is one of the leading premium loose leaf tea retailers in North America. The shuttering of the company’s closest direct competitor, Teavana, is a very positive development. The market has mostly ignored this positive for obvious reasons: illiquidity of the stock, uncertainty around the company’s own turnaround, and a high level of management turnover.
David’s Tea operates 236 stores, of which around ¾ are located in the Canada, and the rest are in the US. Teavana recently announced they are closing all 379 of its stores, a process that should mostly be completed by the end of the year. Teavana branded product will continue to be sold in Starbucks locations. 38 of David’s Tea’s stores in Canada and 19 of its stores in the US are directly located next to a closing Teavana store, representing 24% of David’s Tea’s store base.
Both David’s Tea and Teavana share a similar strategy to the loose leaf tea market:
·Premium price points compared to traditional grocery based tea brands
·A strategy of consistently introducing newness by releasing new proprietary loose leaf tea blends
·A real estate strategy focused on expanding in A malls
We believe the premium specialty leaf tea category remains an attractive and growing industry. The category resonates with millennials and the products align well with health and wellness themes. This explains why Teavana was acquired by Starbucks in 2012 for over 3x sales, even though their growth rates had already slowed materially at that point. However, barriers to entry are limited, and it remains to be seen whether The David’s Tea model of attacking this market is a viable strategy. With its high price points and expensive real estate strategy, this model appears to be good at building trial and attracting the holiday gifting purchases, but has proven to be less successful at building repeat, habitual usage. Teavana’s liquidation despite the support of Starbucks highlights these challenges. However, what may be a marginal business model could be greatly improved when the major competitor liquidates out of the market.
David’s Tea’s stock has traded very poorly since its reported financial metrics deteriorated significantly during late 2016. We believe this slowdown was in part due to Teavana’s own difficulties and elevated promotions. However, we believe that the fact that David’s Tea remained profitable over the past year in this environment while Teavana was likely to be substantially unprofitable speaks to the fact that David’s Tea is the superior business.
With DTEA trading at EV/Sales of 0.35x, we believe risk / reward is attractive given the potential for an improved operating environment following the exit of Teavana. There is also some valuation support at $3.6 / share of tangible book value and a large cash balance compared to the current market cap.
Even before any potential benefit from Teavana’s store closures, David’s Tea’s business has already shown signs of stabilization, with same store sales improving to flattish and the company making progress on elevated inventory levels, which as of Q2 were close to historical levels. However, in the short term, promotional activity from liquidating Teavana stores will likely be a headwind.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.