Interactive Investor

Stockwatch: A "speculative buy" yielding 8%-plus

17th October 2017 09:00

Edmond Jackson from interactive investor

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Can Elegant Hotels' valuation criteria coincide with a fundamentally sound business?

At 87p, the Barbados-based luxury hotel owner/operator trades on a whopping 50% discount to intrinsic net asset value, a prospective yield over 8% and a 12-month forward price/earnings (PE) multiple of about 8.5 times - if the 2018 forecast is fair.

The AIM-listed stock has most frequently yielded 7% or better since flotation at 100p in May 2015. Back then the group raised £63 million gross, albeit only £32.2 million gross receivable by the company, of which £27 million was applied to reduce debt - with $61 million net debt (£46 million) remaining as of last March's balance sheet.

That's a tell-tale sign of an ex private equity-owned business that geared up and in due course floated to enable key shareholders to exit and debt to ease to a more acceptable level.

Vision Capital, a London-based private equity house, bought the business from Credit Suisse's private equity side in 2004, and appeared to sell its residual 12.5% stake to financier Luke Johnson about a year ago - then he became a non-executive director last May.

No price was reported in RNS Holdings announcements but according to the chart he appeared to enter at about 70p, unless the price was negotiated down.

Not all of Johnson's investments work out as well as "the old PizzaExpress" or Patisserie Holdings, but he's obviously incentivised to see this stock deliver investment value.

Technical trend reflects market doubts

Over some two-and-a-half years the chart doesn't look encouraging: trading sideways until mid-2016, then a slide to 63p after those June interims showed flat revenue and normalised operating profit up just 2%.

Confidence was also likely knocked by sterling's Brexit-related plunge, with customers of the hotels being mainly affluent Brits affected by the sterling/US dollar exchange rate.

The price then recovered to 98p mid-2017 but has drifted again despite the prospective yield rising over 8%. This persistently modest valuation implies scepticism as to the timing of private equity flotations - needing to see more evidence how the business will perform - as well as exchange rate factors more recently.

Furthermore, expansion of lower-cost flights is prompting demand for less-pricey hotels, although the clientele for Elegant's four and five-star hotels is likely to be older/affluent - e.g. enjoying comfortable final salary pensions - so may have relatively durable spending power than people with mortgages, for example.

Prospective yield over 8% if 7p payout applies

It's still early-stage in the company's dividend record and the only published forecast is from Zeus Capital, the company's broker and financial adviser. But a 7p payout is expected to persist, albeit with modest earnings cover of 1.1 to 1.5 times and which may need roughly twice cash flow cover considering the capital spending context.

Encouragingly, the interim payout was 3.5p per share and a latest trading update in respect of the financial year to end-September 2017 has affirmed expectations, adding that 12 days into the new financial year bookings are tracking ahead of the same period last year. It would seem to need a major terrorism incident putting people off foreign travel for a while to dent this.

Near 50% discount to underlying net asset value

Reporting in US dollars, the company's end-March balance sheet had $173.8 million property, $1.7 million net current liabilities and $57.9 million longer-term debt, no goodwill/intangibles. This derives net assets of $118.3 million equivalent to 100.3p per share, thus a 15.3% discount to net tangible assets with the share price currently at 85p.

Moreover, there's an implied net asset value of $195 million based on intrinsic surveys (explained in last June's interims) equivalent to 165p per share at current exchange rate. Adding to this is last April's acquisition of Treasure Beach Hotel for $10.5 million.

Obviously, hotels, compared, say, with residential property, reflect the net present value of expected bookings - thus a play on whatever long-term trend.

Elegant's portfolio is about twice as large by room number as its closest competitor, representing about a third of the Barbados four to five-star hotel market - the brand well-recognised by tour operators and online packaged holiday providers.

A long-term objective is to expand further within the Caribbean: the first move outside Barbados was nearly a year ago by way of a management contract with Hodges Bay Resort in Antigua, a 122-room luxury beachfront resort and spa, expected to enhance earnings in the current year to end-September 2018.

Is a near 30% profits/earnings growth forecast, realistic?

Most likely investors have lacked enthusiasm until a sounder bookings record is manifest, to justify asset values. Like-for-like comparisons within the first half-year were blurred by Easter falling after the period end, also Daphne's restaurant closed for refurbishment before Christmas.

The 1.9% fall would have been lower without the opening of the 70-bedroom Waves Hotel & Spa from August 2016, redesigned and refurbished after its acquisition for $18 million in March 2016.

Adjusting for this year's timing of Easter, room occupancy would have been 2% ahead instead of a 3% fall to 66%, the room count up 15% to 553 as of end-March 2017. Normalised operating profit fell from $16.7 million to $15.3 million.

Thus, it's some act of faith to assume the company broker's projection - made on 3 April 2017 - for about 28% profits/earnings growth in the current year. The Barbados tourist board has indicated lower demand for luxury accommodation by UK travellers despite higher arrivals.

The interim income statement shows the gross margin down to 65.5% from 67.4%, the operating margin hit by exceptional factors albeit recurring expenses up 9.6% to £10.8 million, and as a percentage of revenue from 27.5% to 30.2%.

Thus, work needs doing to drive profits as expected: direct importation of goods from late 2017 is expected "to deliver significant savings on a large proportion of food and beverage items".

Elegant Hotels Group - financial summary       
year ended 30 Sep      Consensus estimates
  2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 29.3 33.4 34.7 38.9 40.1    
IFRS3 pre-tax profit (£m) 0.8 5.0 6.9 3.8 11.1    
Normalised pre-tax profit (£m) 0.8 5.0 8.0 10.1 9.6 9.1 11.8
Operating margin (%) 14.7 22.4 28.7 31.0 27.1    
IFRS3 earnings/share (p) 0.7 4.4 6.4 4.7 10.9    
Normalised earnings/share (p) 0.7 4.4 7.6 13.9 9.2 7.9 10.2
Earnings per share growth (%)   524 74.6 81.9 -33.5 -14.0 28.3
Price/earnings multiple (x)         9.4 10.9 8.5
Historic annual average P/E (x)       11.4 7.2 9.6  
Cash flow/share (p) 2.2 9.1 9.3 7.9 12.0    
Capex/share (p)       3.3 7.1    
Dividend per share (p)       3.5 7.0 7.0 7.0
Dividend yield (%)         8.1 8.1 8.1
Covered by earnings (x)       6.1 1.6 1.1 1.5
Net tangible assets per share (p)       78.7 97.9    
Source: Company REFS       

"Speculative buy" despite the asset backing

A pinch of salt looks wise to assume the 2018 growth forecast: the new financial year has started well but remains quite sketchy, thus plenty depends on news flow improving further.

A "speculative" tag should strictly apply despite the discount-to-assets, which can only really be proven in a business sale. Yet Johnson has opted (effectively) to lock himself in and should be able to contribute useful insight as a successful entrepreneur in hospitality services.

A worse-case scenario would be a warning on 2018 numbers re-pressuring the stock. But if the business now trends to plan then it should rise over 100p - at least - with the advantage of securing a very attractive yield for current buyers.

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