Stockwatch: An AIM share 'past the tipping point'

Is the market overlooking a transformation at this AIM-listed retailer Majestic Wine if not showing jaundice with its stock?

Since declaring prelims to 3 April, last 15 June, the price dropped 18% from about 380p to 310p, then formed a modest "bowl" on the chart with a recovery currently to 325p.

It now emerges from an apparent late disclosure on 2 August, a non-executive director who is the chairman designate, bought 1,400 shares at 356p last 31 January and on 20 June, 3,600 shares at 331p, thereby owns 15,000 shares overall.

Quite whether this implies he's shrewd or there's an element of bravado as he steps up to the chairmanship; but he seems confident in Majestic's strategy and long-term value.

Forward PE in the mid-teens; yielding 2%

Forecasts look awry on Company REFS, hence I've super-imposed on the table what figures are published on Majestic's website, although the consensus dividend numbers I've located myself.

They are significant because Majestic's sense of trading "in line" accords with figures it maintains on its Investor Centre web page. That's good if Majestic can continue to match up, although the yield is no real compensation for holding risks if it doesn't.

A forward price/earnings (PE) ratio in the mid-teens initially looks "high enough", but is typically how the market rates a stock in anticipation of earnings recovery.

Such aspects explain why the stock has been sold by those less convinced, although the chart suggests near-term demand has re-balanced against supply. The risk/reward profile can tilt upside assuming Majestic delivers, so what are the chances?

Brit's most popular tipple

With 81% of 2017 financial year revenue UK derived, a key issue is how resilient wine sales prove now consumer discretionary spending is in a vice between low wage growth and rising inflation (and some would say, explains this year's surge in consumer debt).

Is wine so ingrained in British culture, its consumption won't be too affected as the costs of leaving the EU bear down?

Might more drinking at home instead of paying fat mark-ups to restaurants, provide a substitution effect?

Mind it's a competitive sector now supermarkets have expanded alcohol supply with "offers" partly targeted to tempt shoppers in.

Aldi has achieved very high scores in tastings for some of its wines. The front page of Majestic's website promotes "Save up to 30% on New Zealand Sauvignon" with Villa Maria a key promotion at £7.99 - although I believe I glanced it on the end of Sainsbury food shelves for £6.99. Meanwhile, Sainsbury's offers a private bin vintage online for £7.75 (save £1.25).

Competition from the supermarkets is significantly why Majestic began to lose its way, highlighted by poor Christmas 2014 sales that led to the chief executive being replaced.

Majestic will need to keep upping its game: in fairness it has a Price Match promise, although that begs questions as to margins if competition intensifies. Management's formula is to grow the customer base with customer retention, via "a market-leading proposition" helped by the loyalty of staff and suppliers. Great, if actions match words.

Chief executive: "We are past the tipping point"

Despite a challenging context for wine retailing, the June prelim results showed respectable 11.4% growth in underlying annual sales, with multi-channel accounting for 56%. International sales, representing 19.1% of total, rose 52%.

"We remain confident about the medium term outlook, despite tough economic conditions, as transformation benefits are coming through and our costs are coming down as a result of us reaching the next stage of the transformation plan," says CEO Rowan Gormley.

The last chairman described being at "the halfway point on a three-year journey", this and the 2015 acquisition of Naked Wines meaning "a very different position" from two years ago.

However, the operations story was sullied by weak first-half trading in the commercial division (10% of group revenue) and a failed direct mail effort by Naked Wines USA.

Towards the end of FY2017, an investment/budget review eliminated unproductive costs and low-margin sales, implying strong profit growth for FY2018 despite some moderation in revenue growth expected.

Such company-level actions help support forecasts despite the macro uncertainties. Margin recovery looks assured if tempered by lower sterling raising the cost of importing wines, a factor liable to persist during the Brexit years.

However, "we are moving into a lower risk and lower investment phase of our transformation plan", which ought to support financial recovery and growth.

The Rowan Gormley factor

Another key factor for Majestic's prospects is a South African-born chief executive who founded Naked Wines and came into the group with this acquisition.

His background seems appropriate: seven years in private equity then working for Richard Branson on new opportunities, setting up what's now Virgin Money.

He later left to pursue start-ups including the precursor to Virgin Wines (with Branson buying into the business in 2000). Thus Majestic is led by someone with entrepreneurial flair plus commercial discipline including a financial background.

That's a significant intangible - irrespective of PE or yield measures - for investment value. He owns just over 6% of the group, a stake worth £14 million, thus is incentivised to protect and enhance it. His operating review is thorough and frank, which also augurs well.

Strong balance sheet albeit an oddity

As of 3 April 2017 there was £33.5 million long-term debt, £12.5 million overdraft and £23.0 million cash, in context of £114.6 million net assets of which 45% constituted goodwill/intangibles.

The group trades comfortably within banking covenants. On such essential criteria the balance sheet is robust to withstand a consumer downturn.

I draw your attention, however, to the current liability "deferred angel income" up from £18.8 million to £28.4 million.

There's a sense how angel investors in Naked Wines were able to get wines at special prices but no note here to clarify - and there should be, given it's a material liability. Including it, however, the ratio of current assets/liabilities is a sound 1.3 times.

Dividends have resumed, with 29% of adjusted earnings being paid out in respect of FY 2017 and an objective for 35% going forward. Free cash flow has more than halved to £6.2 million as inventory rose, also £9 million debt was repaid, though the payout is said to signal confidence in cash generation.

So, while the shares look fairly priced for a business facing tough competition, there are reasons Majestic can carve out useful market share and achieve upside. It's not a big business - with nearly 4% (my estimation) of UK wine sales, Majestic can thrive if it supplies novel and quality drinking experiences versus the supermarkets. Watch for further director buying and consider steadily averaging in.