Stockwatch: Buy, hold or sell this summer sizzler?

Is a 28% rise in a pub stock this year, to an apparent 50% premium to net assets, 25 times earnings for the latest financial year to 2 April, and a mere 1% yield, really sustainable?    

Chart-wise, at 1,685p, Young & Co's Brewery's AIM-listed voting A shares (YNGA) look an enticing momentum play if you trust the chief executive's claim as to "superior shareholder returns" from quality eating/drink locations in the relatively wealthy London/South East.  

Or does modest underlying growth, hampered by rising business rates and employment costs, with London possibly more exposed to the risks of Brexit, imply this stock has simply run too far for now?  

Disparity between voting/non-voting market values

I have drawn attention variously to the A shares since 600p in July 2012 as a long-term tuck-away, although a substantial gap has opened up versus the non-voting shares (YNGN), presently 1,285p.  

Their chart is not dissimilar to the A shares but, on fundamentals, you are looking at a price/earnings (PE) of 19 times latest underlying earnings per share (EPS), a yield of 1.5% and a 14% premium to net assets - a more tolerable growth rating.  

Thus, it's tempting to consider a switch, albeit that if a takeover offer was to appear then the rules are benchmarked around average mid-prices in the market over six months, reinforcing the disparity.  

Perhaps the more realistic issue is market downside risk in percentage terms; whether YNGN is less risky if underlying performance reduces further, although the only certainty of switching (if outside a tax-free wrapper) is a capital gains tax bill.

Young's prelim statements make no mention of A versus N shares, such detail is buried well down the 2017 annual report (available online) under note 27, page 55. It clarifies 48.8 million total shares issued: 29.6 million A voting shares and 19.2 million non-voting, with only an increase in the "A" accounting for more shares issued over the financial year.  

Tables such as Company REFS appear to overstate net assets per share, using the A's and not adding the N's, whereas Young's latest prelims RNS correctly highlight an 11.3% advance in net assets per share to 1,124p.  

Source: Company REFS            Past performance is not a guide to future performance

Balance sheet versus cash flow approaches to asset value?

A strong balance sheet is conveyed by property/equipment constituting 135% of net assets, goodwill just 3.6% and net debt 25.6%.  The risk profile of the company is thus low, but shares trading at premiums of 14% (N) and 50% (A) to net asset value suggests the market is pricing in some significant asset growth ahead.  

Bulls might argue that a balance sheet approach does not fully convey the net present value of future cash flows from the properties - their asset values plus income arising, when managed well - which is necessarily higher.  

But if Young's has accumulated only £19.7 million goodwill over its development history, that shows management unwilling to pay significant premiums to balance sheet asset value – so what’s the likelihood that a bidder will?  

A cash flow approach also derives a wide range of values according to the discount rate used, making it somewhat speculative.  Within the chief executive's statement under "Property, Treasury (etc)", he says:

“Each year we undertake an exercise to revalue our pub estate to reflect current market values”

crediting upside to the balance sheet revaluation reserve and falls below depreciated cost to the income statement.  

A radical revaluation in response to a hostile bid therefore seems unlikely.  

What realistic potential for further development?

So, prospective valuation shifts to what extent Young's can enhance and extend its asset base.  Will enough suitable sites become available in its stamping ground of London/South East, extending westwards nowadays to include the Costwolds and West Country?  

This last financial year the pubs estate has increased by only 3 to 255 e.g. last November acquiring Smiths of Smithfield and its smaller sister site in London's Cannon Street (completing a major refurbishment to offer a unique experience on each of its four levels) also a pub on the banks of the river Avon.  

On the hotels side, two acquisitions in Teddington and Chertsey have increased bedrooms by 19% to 580 rooms, as if these acquisitions are happening relatively easier.  

The CEO's statement "developing growth opportunities" also cites many such "within the existing estate", although in fairness management probably just wants to keep a firm grip on quality across its estate, than dilute it with a larger opportunistic acquisition.  That still doesn't justify the extent of Young's premium rating in terms of “pipeline” for development.

Spring re-rating looks linked to fine weather

At first glance it seems odd that Young's first half to 2 October 2017- double-digit profit/earnings growth on revenue up 6% - sported better dynamics than H2 considering prelims show 1-2% profit/earnings growth on revenue up 3.9%.  

Although a stronger H1 applied similarly to full-year 2017 and, in terms of the first seven weeks of the new financial year, pubs revenue is up 11% overall and 7.5% like-for-like, despite strong comparatives.  

This suggests the fine springtime has boosted sentiment, where there's a read-across to Greene King (GNK) also in the Mid 250 index, up 36% from a two-year low of 463p this year.  

At about 620p, Greene King trades on nearly three times net tangible assets, albeit on a prospective PE multiple of about 9.5, yielding 5.5% nearly twice covered by earnings and with cash flow higher than earnings.  

Meanwhile, Young's net cash generated from operations is down 3.3% to £61.4 million, its financial review doesn’t really explain.  Its operating margin is 16.8% on an adjusted basis or 15.6% statutory, although Greene King was on 18.3% statutory at its last interims.

Fixed costs have also re-rated in hospitality

Young's cites a second consecutive business rates due - around £1.5 million compared with £1.8 million last year - with the National Living Wage, Apprenticeship Levy and increases to pension auto enrolment adding over £4 million in costs, hence admin costs as a percentage of group turnover rising from 82.9% to 83.2%.  

This was the main change in Young’s cost base, with finance costs and taxes fairly constant, making 1.9% growth in operating profit look respectable enough.  The question remains, whether the stock’s premium rating is justified.

In terms of context, management also mentions "declining real wages, heightened food and energy costs", but if economists are to be believed then the UK is at a watershed of renewed wage growth; and if Tim Martin (Wetherspoon (J D) Brexit-crusading boss) is credible, then leaving the EU will usher in lower food prices.  

So, it's hard to say beyond the 2009 recession establishing Brits (at least in affluent areas) as unwilling to compromise on eating and drinking out. 

Model executive remuneration policy

Young's pays bonuses mainly in "restricted shares" i.e. to be held for a minimum of three years; which is as good practice as it gets, providing incentives for management to create sustainable long-term value.  

The chief executive and finance director are two of three getting their bonuses - £241,752 and £170,085 respectively 100% via shares.  That still doesn't guarantee upside.

No way is Young's a short-sell or likely to be targeted as such.  Its shares continue to have attractions as a quality means via AIM, to mitigate inheritance tax (unless a Labour government pulls this rug).  

According to forecasters, we are set for a long hot summer, so hospitality stocks may continue to soar.  But, in terms of valuation, Young's is already getting a bit close to the sun, so consider using this period to lock in some gains.  Take profits.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.