Leading analyst Jamie Rollo at Morgan Stanley has named Mitchells & Butlers (M&B) as one of his top share picks for 2015, whilst highlighting JD Wetherspoon (JDW) as one of his four “stragglers” as its high premium to peers, provides risks to forecasts in the short term.
He also said that possible surprises for the year ahead include Whitbread acquiring a fast-growing business in another segment and foodservice operators disappointing due to competition and labour costs. Rollo highlights UK high street food and drink outlets (e.g. grab and go, other hot beverages, freshly made / baked food, with the high street morphing from a retail to leisure destination) as some obvious areas that would play on Whitbread’s strengths
On M&B Rollo said: “We are upgrading our M&B rating from Equalweight to Overweight, as we think the shares are cheap and the company is reaching an inflection point on LfL sales growth and dividend resumption at a time when the industry is consolidating.
“M&B is the UK’s second-largest managed pub operator (after Greene King’s proposed acquisition of Spirit), and has a high quality pub estate as measured by estate “churn”, food penetration, unit sales, branding penetration, geographic location, and tenure mix. After many years of LfL sales outperformance, M&B’s organic sales have underperformed for several years due to it being overambitious on price (which has lost it volume), a high degree of senior management turnover, and more intense competition.
“Prices and margins have been rebased, and volumes are now starting to improve, with LfL sales in the last 8 weeks +2.4%, against under 1% in the last two financial years (we assume +1% for FY15). Industry LfL sales also appear to be improving after a summer lull, with Coffer Peach LfL sales running c. 2.5% over the last 3 months versus c. 1% over the previous quarter, despite tougher comps, so the two year rate is improving sharply. Cost pressures are also significantly lower this year.
“Meanwhile the Orchid acquisition should deliver a 10% EBIT boost once the sites are converted, which combined drives a 15% EPS CAGR 2014-17e. We also think a dividend can be resumed in FY16, when the company is generating cash post bond amortisation. So with improving LfLs, a strategy that seems to be working, a strong consumer, and a dividend resumption, we think the shares deserve a more normal valuation than the somewhat distressed levels they currently trade on.”
On JDW, Rollo said: “We are downgrading our JD Wetherspoon rating from Equal-weight to Underweight. This reflects the strong performance of the shares, slowing top-line momentum, ongoing pressure on margins, and the significant valuation premium to the peer group. While we see Wetherspoon as a strong and well-run operator with a proven and popular concept and an excellent long-term record, we think the attractions are fairly reflected in its premium multiple at the moment, and see downside risks to forecasts in the short term owing to ongoing margin pressure.
“We see 26% downside to our bear case and 24% upside to our bull case, leaving a wellbalanced risk-reward profile. With more attractive upside potential elsewhere in the sector, we downgrade to Underweight, with a relative preference for M&B.”
On Whitbread, Rollo set out the scenario: “Whitbread acquires a fast-growing business in another consumer-facing segment to accelerate its growth. The company has proven skills in creating strong brands, customer service, and property management, and it is already expanding into other developed markets such as Germany and France. The acquired business is seen as the “next Costa”, and Whitbread shares enjoy a rerating as investors value the new business significantly above what the company paid for it. This third leg means the company can commit to a similar rate of growth when it extends its 5-year milestones from 2018 to 2020 with its FY results in April.
“Some obvious areas that would play on its strengths include UK high street food and drink outlets (e.g. grab and go, other hot beverages, freshly made / baked food, with the high street morphing from a retail to leisure destination), and alternative accommodation formats both for the UK and overseas (e.g. boutique budget, hostels, student, themed, pods).
“It could also make sense to acquire an existing hotel or coffee chain in its international markets (particularly Germany, where it is trialling Premier Inn, and France where it is trialling Costa) in order to get critical mass, and convert the new brand to its own. The company certainly has a strong enough balance sheet for a good-sized acquisition, and though it is fairly close to its 3.5x adjusted leverage target, this is a conservative ratio.”
