Interactive Investor

Stockwatch: Time to sell this AIM star

10th November 2017 10:02

Edmond Jackson from interactive investor


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Is £700 million AIM-listed retailer/wholesaler Conviviality mainly of alcohol, set to benefit from relatively high prices in pubs/restaurants boosting more drinking at home? Or perhaps its storming share price this year reflects classic momentum in a late-stage bull market, favouring small to mid-caps, its earnings advance driven by acquisitions. If the former applies, then it will enjoy longer-term upside; but if the latter, then lock in at least some gains.

PE multiple has soared to a growth rating

Conviviality shares have doubled to 425p - currently 412p - since I drew attention last December at 211p on a single-figure price/earnings (PE) ratio and 6.8% prospective yield.

A year ago, the market was cautious to recognise financial benefits from acquisitions despite strong organic performance across all divisions. The group's four-year history on AIM had seen vertical integration from a base as drinks wholesaler and operator of the Bargain Booze chain, strengthening capabilities in logistics and sourcing.

Transformational acquisitions from autumn 2015 were the wholesaler Matthew Clarke, bar and events' company Peppermint, and Bibendum, a wine, spirits and craft beer distributor. A key aspect of the investment rationale was, therefore, economies of scale to improve weak operating margins (on a declining trend to 2.3%, see table), plus cross-selling opportunities among the retail outlets which nowadays include Select Convenience and Wine Rack.

Frankly, that's yet to be seen, despite the 12-month forward PE multiple rising to 17 times.

Cash flow valuation remains modest

The table shows cash flow per share trending substantially ahead of earnings per share (EPS), a healthy sign, though mind "2.3 times EPS" in the last financial year may be a snapshot in context. It may explain why some investors see fit to chase a stock that isn't really in a growth industry; being more a play on efficiencies and capable franchising.

This strong cash flow profile provides a high element of cash for distribution, thus a substantive dividend despite material capital expenditure – meaning a 3.5% yield despite the stock's advance.

On the other side of the value equation, however, the April 2017 balance sheet showed a further deterioration in trade payables versus trade receivables from 0.83% at end-December to 0.74%. Total debt was also up 11% to £106 million versus cash up 9.3% to £10.4 million; this in an assets context of goodwill/intangibles representing 132% of net assets (mainly due to acquisitions).

While it doesn't remind me of acquirers' over-stretched balance sheets in the late 1980's which led to busts amid early 1990's recession, it would seem Conviviality's cash flows should also be applied to reduce debt and trade payables – i.e. if the balance sheet was made stronger like it should be, there wouldn't be the same extent of payout as currently.

It appears the board has quite "played to the market" with acquisitions and relatively high payouts, successfully in terms of a high share price. Yet this game may have a limited time-frame if balance sheet issues remain uncorrected, at least in terms of attracting fresh buyers over traders taking profits.

Underlying trend looks high single-digits

Consensus – with all five brokers advising 'buy' from May to September – is for a 45% jump in earnings growth in the current financial year to end-April 2018, moderating to 7.5% in the 2019 year.

A latest trading update for the second half to end-October cites a 9.2% like-for-like increase in total revenue to £836 million and a 7.9% increase on the previous period. The outlook statement says performance is in line with the board's expectations "however reflecting the phasing of cost savings, profits for the full year will be more H2 FY2018 weighted."

That may be fair enough, but mind that in context of a pressured consumer environment it could morph into a more genuine warning given recent exuberance as shown by the 45% EPS growth projection.

While trading updates admittedly do tend to focus on revenues, given margins are (or should be) in focus here, it would have helped to learn more about progress in this respect. Without such, the question for holders is behavioural: are well-managed off-licences poised to attract more business?

Less drinking yet value-pricing may win through

Drinkers' behaviour is some cocktail. A stock-picking lesson from the 2009 recession was people – at least in London and the South East – unwilling to compromise on eating/drinking out, if anything prioritising it such that pub operators like Young's did very well.

More recently, in July, this group cited an 8.6% like-for-like sales increase helped by fine spring/summer weather. At the "value" end of the food-and-drink pub chains, J D Wetherspoon has just declared a 6.1% like-for-like sales increase for its first quarter to end-October.

For now, the well-managed pubs are doing well despite surveys showing a persistent steady decline in UK alcohol consumption, especially among those aged 16-24.

The percentage of all people aged 16 or over, who had a drink in the week before being interviewed, has fallen from 64.2% in 2005 to 56.9%, and 21% of adults don't drink at all. Yet people earning £40,000 and above tend to drink frequently, those in professional jobs more likely to drink five days a week or more and drink more heavily in a single session. This likely reinforces a London/South East bias – or at least affluent cities - to pub prosperity.

So, it would appear there's a constituency of drinkers able to support quoted companies' prosperity despite the likes of Tim Martin pointing out a danger by way of tax disparity: this and other factors mean the average cost of a pint of beer is £3.60 in a pub versus more like £2 for most litre bottles in supermarkets and off-licences.

With discretionary spending in a pincer of inflation (with higher oil prices soon to raise fuel/energy costs) and sluggish wages, a key behavioural aspect is what extent of people will opt for more drinking at home - and within this segment, impromptu buying of alcohol that off-licences enjoy relative to a major shop at a supermarket.

Growth in home entertainment systems linked to the internet may also have a marginal effect, especially if the UK economy falters. So, the social trends affecting off-licence and convenience store demand for alcohol are sketchy if likely favourable.

Lock in gains but keep on watch list

Conviviality's current rating appears to price in the good potential before e.g. margin improvements are established, and it's by no means guaranteed that off licences will benefit from drinkers switching from pubs to home.

On a medium to long-term view, a business like this is respectable to achieve high single-digit revenue growth overall – like it's doing – which doesn't accord with its shares on a growth rating unless efficiency improves.

Whether an earnings or cash flow valuation should apply is debatable. Anyway, at 410p, a prospective yield of 3.5% won't support the stock, nor will the balance sheet, if the narrative changes adversely.

I may be over-cautious, but in the current climate I would mind any board citing "second-half weighted" results. It, therefore, looks prudent to lock in gains according to your risk tolerance and keep Conviviality on a watch list. People may shift their drinks' buying to off licences, but the upshot is speculative. Take profits.

Conviviality - financial summary           Consensus estimates
year ended 30 April 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 374 356 364 864 1,560
IFRS3 pre-tax profit (£m) 6.6 4.8 9.0 9.1 22.5
Normalised pre-tax profit (£m) 7.1 9.3 9.7 18.9 33.1 53.1 58.2
Operating margin (%) 2.9 2.8 2.7 2.4 2.3
IFRS3 earnings/share (p) 7.2 5.7 10.1 4.4 10.4
Normalised earnings/share (p) 8.1 13.0 11.1 12.7 16.5 24.0 25.7
Earnings per share growth (%) 16.1 61.7 -14.9 14.4 29.7 45.3 7.4
Price/earnings multiple (x)         25.7 17.7 16.5
Price/earnings-to-growth (peg)         0.9 0.4 2.2
Annual average historic P/E (x) 18.7 15.6 13.5 17.7 21.1
Cash flow/share (p) 27.8 10.4 15.0 18.9 38.0
Capex/share (p)   2.5 7.2 10.1 7.9
Dividend per share (p)   2.0 8.0 8.4 11.6 13.8 14.4
Yield (%)         2.7 3.2 3.4
Covered by earnings (x) 5.4 6.3 1.5 2.1 1.5 1.7 1.8
Net tangible assets per share (p)   20.3 11.9 -39.2 -40.0
Source: Company REFS              

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