Three leisure stocks to buy - and three to avoid

Eating and drinking out has always been a staple way of consuming in many foreign countries, as you will observe if you notice the plethora of food programmes on television dedicated to American dining experiences.

Brits have taken a while to cotton on to this, but it looks as though they are doing so more and more often. According to a survey run by Greene King, UK consumers spent £201 per month on average on leisure activities during 2016.

The majority of this (£86.57) was splurged on eating out, while £46.22 was spent on drinking. The rest was accounted for by heading out to sporting events, the cinema, live entertainment and other activities.

Whether this will continue, with inflation rising and potentially constraining consumer spending, as recent data has shown it has done with big-ticket retail items, remains to be seen.

However, broker Liberum thinks it might and has initiated coverage of a number of leisure stocks. Below, we list their top picks in the sector, as well as those they believe will continue to struggle.

Two stocks to buy for growth

Caterer Compass operates in a "structural growth market", which means it has revenue growth and margin momentum. "Additionally, its disciplined approach to free cash flow allocation provides long-term growth and periodical shareholder returns."

While its yield is a modest 2.2%, it's already promised shareholders a £1 billion special dividend. And Liberum reckons there should be a pot of around £1.4 billion for similar over the next three years.

"This, combined with its defensive qualities, justifies its place as a core portfolio holding," explains analyst Anna Barnfather.

It's also a "powerhouse" in North America and saw underlying organic growth of 7.2% in the first half across the pond. Forecast earnings per share (EPS) for 2018 of 77.1p give the stock a price/earnings (PE) multiple of 20.5 times, which is "in line with its international food service peers". A target price of 1,850p gives potential upside of 17%.

Another "structural winner" is travel food supplier SSP, which floated back in September 2014 and has blossomed since.

It's "uniquely placed to capitalise on global investment in travel infrastructure and the trend towards convenience foods". Double-digit earnings growth is expected by the Liberum team, with new contract wins providing momentum and earnings visibility.

SSP's 'buy' rating and 540p target price is against consensus. Panmure Gordon's Mark Irvine-Fortescue thinks it's valuation looks full, with a PE of 24 times meaning SSP is trading at historic peak levels.

But Barnfather says her target price puts the shares on a forecast 2017 EV/EBITDA of 11.8 times. Its nearest peers trade on an average multiple of 10.7 times. "We believe high-quality earnings and greater momentum justify a premium rating."

While Compass and SSP have retraced 6.9% and 7.3% respectively since hitting all-time highs within the last fortnight. They are both up year-to-date. Compass has seen gains of 4.7%, while SSP is up 22%, but "it is premature to take profits".

One stock to buy for yield

Greene King has gone in the opposite direction. The brewer is 6.6% down year-to-date, with industry headwinds telling and management remaining cautious. However, Barnfather reckons it's well positioned to tackle these headwinds and sees today's 663p price as "a good entry point".

"Positive life-for-like and clarity on progress and return on invested capital achieved in conversions could reassure and help the stock regain lost ground," she says.

It currently trades towards the bottom of its historic range at 8 times EV/EBITDA and a PE of 9.5 times. Combine this with a meaty dividend yield of 5.2% and the investment case looks compelling with a target price of 780p.

"Furthermore, 84% of assets are freehold - net asset value of 885p per share."

Three stocks to sell

On the flip side, Liberum is negative on three firms in the sector. Several successive chief executives have attempted to turnaround flagging pub and restaurant chain Mitchells & Butlers, but have failed.

While Liberum thinks the current incumbent, Phil Urban, is getting closer than his predecessors, "market dynamics are changing faster than he can fix things".

"The rapid roll out of relatively untested brands makes us nervous. We forecast earnings to decline over the next two years." A target price of 210p gives potential downside of 9%.

While Mitchells is a 'sell', fellow struggling pub chain JD Wetherspoons has a 'hold' rating. While a target price of 1,050p represents potential upside of 9.5%, it's still one to avoid.

JD has been in an earnings upgrade cycle after successive profit warnings throughout 2016. However, Liberum reckons this phase could be coming to an end and that the threat of margin pressure looms large again.

"A recent profit upgrade should support near-term valuation, which leads us to 'hold' despite growing concerns."

Finally, Domino's Pizza, a pizza takeaway franchise. It is "misunderstood" , according to Liberum, as it is a highly successful food distribution business but not an owner/operator unlike other Domino's systems.

"It has historically destroyed shareholder value when attempting this, particularly in new markets. Hence, we are rather cautious when it comes to its new M&A strategy.

"It is not an online digital fast food operator hence its valuation needs to reflect this. With risks rising, competition getting tougher, and franchisee profitability on the decline, we think a re-basing of expectations is required." Sell at 250p, the broker says.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.