Interactive Investor

Stockwatch: Buy if you accept the speculation

14th April 2015 10:18

Edmond Jackson from interactive investor

Can the purchase of Naked Wines revitalise Majestic Wine's prospects? The AIM-listed shares were touted by brokers as a growth play up to 2013; however, this wine retailer lost its mojo last year amid greater competition online and supermarkets upping their game in fine wines and discounting to entice shoppers in. In recent years Majestic has traded on an annual average price/earnings (P/E) of about 18 times albeit with increased volatility.

Then, a surge from about 400p to near 600p in the second half of 2013 created scope for a reversal and self-reinforcing downward trend as fundamentals went ex-growth. The table shows turnover and profit levelling in the last two years, and news of the Naked Wines acquisition came with a trading update that guided down the normalised pre-tax profit expectation from £22 million to £21 million for the year to end-March 2015. In listed company terms, Majestic is seriously drifting and is in need of a radical development move.

Naked deal looks good fit but compromises near-term earnings/dividends

For £50 million cash (via new debt) and £20 million deferred consideration in Majestic shares, Naked introduces £74 million sales in 2014 - up 40% on 2013 - relative to Majestic's annual sales possibly near £290 million. The companies have seen each other as chief rivals for some time, Naked with over 300,000 customers versus Majestic's 640,000. Naked is a well-regarded growing operation, named Online Business of 2011 at the National Business Awards.

Majestic Wine - financial summary
Consensus estimate
Year ended 31 Mar2010201120122013201420152016
Turnover (£m)233257280274278 
IFRS3 pre-tax proft (£m)1620.323.223.723.8 
Normalised pre-tax profit (£m)1620.323.223.723.92223.1
Normalised earnings/share (p)18.322.62626.626.825.927.2
Earnings growth rate (%)30.523.115.42.20.7-3.45.1
Price/earnings multiple   (x)   12.112.511.9
Cash flow per share (p)2727.429.433.117.6
Captial expenditure per share (p)1013.117.319.315.1
Dividend per share (p)9.810.813.515.8161616.5
Yield (%)  555.1
Covered by earnings (x)1.92.121.71.71.61.7
Net tangible assets per share (p)72.589.9107121132
Source: Company REFS.

Its customers pay £20 a month (against future purchases) to fund emerging producers, thereby cutting out wholesalers and importers while retaining the culture of a wine club. These "angels" later review purchases on the Naked website where producers agree to talk back. There are nearly 150,000 such angels in the UK, 50,000 in the US and 25,000 in Australia, so the deal offers Majestic the opportunity to diversify its present UK exposure.

For its part, Majestic introduces 210 stores enabling Naked to develop a Click and Collect service instead of adding delivery costs to customers' bills. Such a change should help Naked reduce last year's £3.3 million operating loss although it appears Majestic's £23 million profit consensus for 2015/16 will get downgraded. The seven year-old Naked has previously received £30 million backing by German wines group WIV, a sale which begs questions when Naked's revenues are soaring. However, the synergies do look to be with Majestic.

Better transparency would have helped, i.e. disclosing any profit levels and timescale for the deferred consideration to be triggered, as the deal would not have been struck without Naked making projections. Majestic shares have risen from about 300p to 340p where the 12-month forward P/E multiple looks 13-14 times, although dividend expectations (see table) have been dashed. Possibly reflecting Naked's near-term cash needs, "the final dividend for FY 2015 and the interim dividend for FY 2016 will be withheld, with future dividends to be progressively re-instated by FY 2018." So mind there will be no dividend for the time being and its resumption rests on the merger working.

Naked's founder becomes group CEO

This resolves the gap from Majestic's boss departing on 19 February, and Rowan Gormley is a proven entrepreneur from the Richard Branson mould - part of founding of Virgin Wines, the Virgin ONE account and Virgin Money. He must still prove himself regarding the demands of listed companies - we have seen how the founder of Supergroup got into managerial problems, leading to a seasoned professional CEO being introduced. Another aspect to watch is how the potential merger benefits evolve. It is odd how the frequently asked questions page on Naked's website says "both businesses will remain completely separate" which is not at all what a potential investor would expect. In principle there is a lot to be gained here by "sharing activities and transferring skills" which tends to define the more successful mergers and takeovers. Concern is also being expressed by some angels on the founder's blog that joining the plc fold will change Naked's culture of enthusiasts financing wine-makers directly, the unique modus operandi accountable for its growth.

Majestic's balance sheet has offered strength, to gear up

The last published accounts for end-September 2014 showed £9 million overdraft and no long-term loans, relative to £4.2 million cash. Net assets of £94.7 million included £72.9 million property/plant/equipment and only £9 million goodwill; meanwhile the income statement for the first six months of Majestic's financial year involved just £66,000 net finance costs versus £8.6 million operating profit. So the company has been in adequate financial position to make this development move with debt.

Speculative, albeit potential to create a major wine retailer

Some caution is necessary but there is a substantial prize at stake - to become an international retailer with more personality than supermarket wine-buying and potentially more variety than traditional merchants. In principle. A marketing crux is how many wine drinkers can be tempted to become regular payers to Naked's "wine club" or buy a minimum 6 bottles at Majestic, than continue buying their regular quaff or something special from supermarkets' extensive ranges - with Aldi now making a genuine effort in fine wine. In a buoyant "risk-on" stockmarket, eager for fresh stories, Majestic's stock is rising and the P/E will establish higher than 13 if the merger proves successful. So buy if you accept the speculation, otherwise watch for more evidence.

For more information see majestic.co.uk.

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