Interactive Investor

Stockwatch: Exploit this 6.6% yield

20th December 2016 12:21

Edmond Jackson from interactive investor

Is the AIM-listed drinks wholesaler and off-licence retailer Conviviality set for better stock performance?

It has spent 2016 stuck in a 168p-238p range, after re-rating from about 150p in the autumn of 2015 to 211p today. Acquisitions have boosted forecasts, reducing the price/earnings (PE) multiple to single-figure status and implying a prospective yield of 6.6%, but the market is yet to actually witness any integration benefits.

Still, the group spoke of a "strong performance" during a "transformational period" in its 1 November update, with the mix of organic business underpinning the business's reputation in the UK drinks market.

Leading the market

Conviviality floated in July 2013 as a UK-oriented, alcohol-based convenience store franchiser and supplier. Although franchisees have previously been incentivised with shares in the group if targets are met, Conviviality makes more profit by supplying franchisees rather than from franchise fees.

The group's made three flagship acquisitions since 2015 - drinks wholesaler Matthew Clarke in October 2015, bar and events' company Peppermint in the December and craft beer distributor Bibendum in May 2016.

Despite £1.4 billion forecast annual revenue, be wary: low operating margins limit profit.It has three divisions: Direct, Retail and Trading. As the UK's largest independent wholesaler, sales from the Direct division - which serves 23,000 outlets from hotel chains to independent food-led pubs and restaurants - rose 5.2% in the first half, while the revenue from the Trading business increased 5.1% by supplying UK supermarkets with beer, wine and spirits. The UK's top franchised off licence and convenience chains managed to increase turnover by 2.5% in the Retail arm.

Altogether, supplying 23,000 establishments, mainly hotels, restaurants and bars, gives Conviviality an 11% share of the drinks market, which is five times greater than the next operator.

This makes the £365 million market capitalisation sound modest, especially given forecasts of £1.4 billion pro-forma annual revenues - be wary that the low operating margin limits profit, however.

Economies of scale

Integrating Matthew Clarke ought to improve the operating margin, enabling lower-cost delivery to customers thanks to network efficiencies and a wider product range.

Cost-savings of at least £4 million are targeted as the group scopes out cross-selling opportunities, but the early 1 May 2016 year-end meant the benefits were missing from the maiden results of the combined group. In fact, the operating margin slipped to its lowest since 2012.

Hands were shaken on the Bibendum deal after the 1 May year-end, so the mid-July prelims didn't fully reflect the sense of "continuing operations" - normalised pre-tax profit rose 124% to £21.7 million on revenue up 137% to £864.5 million.

Assuming some margin improvement, revenue and profit forecasts look attainableThis was better conveyed by the 1 November trading update for the 26 weeks to 30 October, citing revenues up 211% to £783 million against £874 million for the last financial year as a whole.

Assuming some margin improvement, the forecasts look attainable - if not exactly conservative.

"The company is making strong progress with the integration of Matthew Clark and Bibendum ahead of plan and the plan to deliver synergies remains on track," the firm assures.

Strong management

Diana Hunter has been chief executive since February 2013, having previously been a director of Waitrose, where she led growth of the stores estate, including the convenience fascia. Before that she worked at Sainsbury's for 13 years, in various development roles. Conviviality's flotation and acquisitive development is very much her stamp.

The Direct business is led by the (ex) managing director of Matthew Clark, who is said to be "instrumental in helping realise benefits" from this acquisition. Trading is run by the old chief executive of Carlsberg UK and Retail is headed up by the last chief operating officer of Argos.

If forecasts are fair, management should continue to cut debt, while re-rating the dividendWhile there still seems plenty to do to integrate the acquisitions, the team looks a strong one to leverage Conviviality as an AIM-listed company.

The cash generation profile appears good, even if it is early days to assess the new group. The last annual cash flow statement showed £27.3 million generated from operations before £2.9 million was paid in interest, in context of £28.1 million short-term debt and £67.5 million longer-term debt. There is £9.5 million cash in the bank.

If forecasts are fair, then management should continue to cut debt, while re-rating the dividend, given the 8.5p distributed per share involved £7.4 million. Dividend expectations assume about 1.7 times earnings cover, which is fair enough; hence, a 6.6% yield also hints at upside in the equity.

Fair balance sheet barring two issues

Goodwill and intangibles represent 131% of net assets, which reflect its acquisitions and a change of control before listing. Also the ratio of trade receivables to trade payables is 0.83, as if the group is marginally living off creditors - not exactly what discerning investors prefer to see.

The next indicator will be interims at end January, featuring a capital markets day The chief risk would seem to be a UK consumer slowdown, although alcohol sales tend to be relatively stable around recessions.

The long-term risk is a trend showing that UK alcohol sales peaked in 2004, falling 20% since then. There appears a demographic split with the proportion of younger teetotallers rising and binge-drinkers falling, amid warnings of excess drinking by the affluent middle-aged. But the next two to three years should be a fair enough sales context.

It therefore looks timely to exploit the stockmarket's less-than-convivial attitude while this stock is rated modestly. The next indicator will be the interims at the end of January, when a capital markets day will be held - the company seems keen to promote its progress.

For more information see the website.

Conviviality - financial summaryConsensus estimates
year ended 1 May2012201320142015201620172018
Turnover (£ million)395374356364864  
IFRS3 pre-tax profit (£m)5.46.64.89.09.1  
Normalised pre-tax profit (£m)6.47.19.39.718.945.353.5
Operating margin (%)2.92.92.82.72.4  
IFRS3 earnings/share (p)5.67.25.710.14.4  
Normalised earnings/share (p)7.08.113.011.112.720.324.0
Earnings per share growth (%)11.216.161.7-14.914.459.818.0
Price/earnings multiple (x)    16.610.48.8
Price/earnings-to-growth (peg)    1.20.20.5
Annual average historic P/E (x) 18.715.613.517.7  
Cash flow/share (p)-3.127.810.415.018.9  
Capex/share (p)  2.57.210.1  
Dividend per share (p)  2.08.08.412.514.0
Yield (%)    4.066.6
Covered by earnings (x) 5.46.31.52.11.61.7
Net tangible assets per share (p)  20.311.9-36.6  
Source: Company REFS

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