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We believe that the leisure sector remains attractive to investors, with long-term secular tailwinds, ongoing innovation and efficiencies combining to overcome short-term economic headwinds. We prefer those companies that have an ‘experiential element’ to their offering and can demonstrate a continually evolving customer proposition, as well as those de-risking balance sheets.
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Stonegate has offered 285p per share representing a 39% premium to yesterdays closing price and 4.3% premium to Tangible NAV as at 31 March 2019. This values the business on EV/EBITDA of 9.7x FY19E.
EI Group
It’s fair to say we didn’t see a 285p per share bid for EI Group, formerly known as Enterprise Inns, coming. The all-cash, agreed offer from rival pub group Stonegate values the 4,000 strong tenanted, leased and commercial pub group at £3.0bn or 11.4x underlying EBITDA of £261m. To some degree we struggle to see the commercial logic of combining Stonegate’s managed, predominantly town-centre estate with EI Group’s tenanted estate, beyond the defensive measure of balancing Stonegate’s current position (circuit bars), synergies and property management (including conversions to Stonegate’s brands). Ironically, in a previous research note “Solving the Gordian Knot” (July 2018), we explored the opportunity of combining Stonegate with Marston’s, although the conclusion was that the pro-forma debt metrics appeared elevated. Our long-standing negative recommendation on EI Group has been predicated on high debt levels and limited free cash generation (post-capex free cash flow of c£30-40m), with disposals funding mandatory deleveraging; the result being little earnings growth, no dividends and modest underlying deleveraging, albeit disposals have accelerated this process. Post the agreed offer we upgrade from Sell to Hold.
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Trading is encouraging with LFL net income growth of 1.9% across Publican Partners, LFL sales growth of 6.0% in Managed Pubs, solid income of £65.6k pa per property across the retained Commercial Properties and improved operating cash generation of £132m (vs £125m). The disposal of 348 commercial properties has largely completed helping reduce net debt to £1.7bn (vs £2.1bn) and is expected to fall from 7.1x EBITDA to 6.4x by year end.
Ei Group is hitting its straps with an acceleration in core trading, a transformational disposal and a share buyback programme concurrently underway. The potential for a material reduction in debt, alongside the validation of NAV should continue to support a share price re-rating.
Ei Group's successful disposal of a large portfolio of commercial properties is a game changer, allowing more rapid deleverage and leaving scope for cash returns to shareholders while underscoring the underlying net asset valuation of the Group. This is not a one off, but should now be an ongoing strategy transferring value from debt holders to shareholders. 370 commercial properties are being disposed of raising proceeds of £348m - inline with NBV and equivalent to 13x earning. We reiterate our BUY recommendation and raise our target price to 250p (from 215p).
Trading is improving across all divisions with disposals and more rapid deleveraging now a realistic near term prospect. Ei Group is exploring the sale of its 400+ commercial pubs portfolio and has received strong indications that it “is of considerable interest to potential buyers”. This follows Unique note-holders' consent to allow the disposal of non-tied pubs with proceeds used to prepay debt, thus accelerating the deleveraging and easing cash flow constraints in the future. In the meantime trading is stable and cash flow is strong with the second £20m share buyback programme announced today. Furthermore its balance sheet is also improving with a NAV of 334p per share, and net debt of £2.0bn (net debt/EBITDA to 6.95x). We believe that the Commercial division could be worth c£320m which would exploit the NAV to equity arbitrage and improve all key valuation driving ratios. We reiterate BUY.
Against a challenging backdrop, growth has been maintained across all divisions and the company remains confident of achieving positive growth for the year as a whole. The transformation plan has been flexed (ie slowed) reflecting better tenant relations and a slower take up of MRO than originally expected, with the company signalling further commercial property disposals. While forecast visibility remains poor given the external environment and scale of the transformation, it is improving. Additionally confirmation of debt repayment and rising NAV to 326p per share should provide valuation support. we keep our HOLD recommendation with TP of 140p.
While growth has been maintained across all divisions, we find the 0.5% LFL net income growth across the leased and tenanted estate disappointing given the relative out performance of the wider wet-led market. Adverse weather undoubtedly played its part and the company maintains that trading is in line with expectations, guiding for c1.0% LFL net income growth for FY18E. The stock remains at a 57% discount to NAV but progress on reducing that gap is likely to be hampered by the lack of earnings visibility during this vital stage of its transformation programme.
Today’s AGM update highlights that the good trading and strategic momentum witnessed in the last 18 months has been sustained into FY17. LFL net income growth of 1.6% is reported vs a 1.6% comp for the 18 weeks to 4th February. This is solid, albeit we were anticipating a figure closer to 2% give the sector enjoyed a strong Christmas given industry data. Strategic commentary suggest things remain on track in terms of re-profiling the estate to maximise shareholder value. The other main news item this morning is the planned change of name to Ei Group, which seems sensible in our view given the strategic changes afoot. We note there is no mention of further share buy backs over the next 12 months. We were half expecting an update on this front but note this initiative was signalled with the H1 trading update in late March last year so expect to hear something concrete next month. We do not envisage any change to consensus expectations post today’s in-line update. We recently met management and like this company as the new strategy has a substantial long-term impact on its earnings composition. Further, the recent Punch deal highlights the inherent value in this area of the sector, especially given the freehold backing. Execution of the strategy and de-leveraging (c.£400m over 5 year) should result in a much higher equity value on a 2-3 year view. The shares have had a strong start to 2017 rising by 14.5% YTD. They currently trade on a cal’17 P/E of 7.2x with an EV/EBITDA multiple of 9.3x. Leverage falls from 7.4x FY16a to 6.6x FY19e. We have undertaken a SOTP analysis to help capture what successful strategic execution should mean for valuation. We arrive at a short-term fair value of 172p based on FY17e, or 155p if one is more conservative and applies a 10% execution discount. We are positive on the stock on recovery / special situation considerations.
These results were in line with expectations with original 2020 milestones reiterated. Headline numbers in line with Revenues of £632m (PGE £629m), EBITDA of £292m (PGe £293m), PBT of £122m (PGE £123.4m) giving adj EPS of 19.6p (PGe 20.0p) with net debt marginally lower at £2.2bn (PGe £2.3bn, 7.9x Net debt/EBITDA). With the stock trading on 9.3x EV/EBITDA and PE of 4.7x – this is a highly geared play on wet-led pubs – a sector that is seeing somewhat of resurgence from benign duty environment and craft beer movement. However MRO implementation uncertainties and high leverage keep us at Hold.
The sector has de-rated 24% over the last 18 months as fluctuating LFL trends and oversupply concerns have been compounded by wider economic and political worries. Having examined the underlying trends in depth, we remain confident that industry growth will be sustained driven by: 1) rising population; 2) rising wealth and; 3) our social need for a ‘third space’. However shifting consumer preferences continue to accelerate refresh cycles which, combined with inflationary headwinds, create operational challenges for the less fleet of foot. Hence we place more emphasis on management track record and ‘self-help’ in assessing each company’s ability to remain the ‘third space’ of choice to defend top line growth, mitigate cost inflation and drive continued shareholder returns.
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The Interim results show solid performance with tangible progress made towards the strategic plan with all targets in sight. LFL is up, business failures down and planned disposals are progressing well. The second half has started ‘broadly in line’ and holds some uncertainty with Euro 2016 in June/July perhaps offset by the uncertainty around the implementation of the new Pubs code. With the stock trading on 9.3x EV/EBITDA and PE of 4.7x – this is a highly geared (8.0x Net debt/EBITDA) play on wet-led pubs – a sector that is seeing somewhat of resurgence from rising consumer confidence/spending, benign duty environment and craft beer movement- and on commercial property. However MRO implementation uncertainties and refinancing risks keep us at Hold.
Like-for-like new income growth of 1.5% in the first half (the 11th quarter of successive growth) combined the £100m per annual debt reduction is encouraging and backs up our current forecasts. Additionally, yesterday’s Capital Markets Day – with presentations from across the business – demonstrated the clear progress on the company’s ambitious transformation strategy. And finally, the announced £25m share buyback is c5% accretion (we estimate). Risks remain with new MRO legislation coming into effect this year and significant £350m bond refinancing pre end of 2018, however the pieces are coming together.
Trading over the 19 Weeks to 6 February has been relatively solid with Like for like net income in the leased and tenanted estate +1.6%. Management also comment that the strategic transformation plan is on track to have more than 100 managed houses and 300 commercial properties by the end of September. The shares have fallen 34% YTD from 110p to 73p primarily on balance sheet (net debt/EBITDA 8.0x) and refinancing fears with £350m bond due for in 2018. We believe that this solid trading and confirmation that transformation is on track should reassure the market in the short term. Significant execution risk keeps up at Hold with a reduced target price of 100p (from 125p) with the stock trading on EV/EBITDA 9.4x and PE 3.8x.
Selling underperforming assets into a buoyant property market and transitioning into a hybrid pub manager-tied-commercial property-company should unlock significant value in the long term. However debt levels are high and operational leverage is increasing at a time when supply and inflationary cost pressures are mounting. While these results demonstrate progress with improved trading, reduced business failures and steady transformation, 2016 sees the next stage in implementing the MRO, which could destabilise the tenanted business. We retain our Hold recommendation.
Selling underperforming assets into a buoyant property market and transitioning into a hybrid pub manager-tied-commercial property-company may well unlock significant value in the long term. However debt levels are high and operational leverage increasing at a time when supply and inflationary cost pressures are mounting. Results in line (LFL +.05%) but execution risk is high. Our estimates remain unchanged and we retain our Hold recommendation.
The sector is going through a period of unprecedented change with robust consumer demand driving increasing supply and convergence across categories. Changing consumer preferences are driving market share shifts and a surge in supply is leading to accelerating rent and wage inflation. As we stand, we believe branded restaurants are taking share from pubs and independents and the winners and losers will depend on balancing site expansion with constant menu and brand re-development. We expect valuations to diverge recognizing those with strong brands, high returns and which can deliver on expansion targets.
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