Leading City analyst Douglas Jack has issued a 75p target price for managed pub operator Spirit Pub Company, saying it has “sufficient self-help potential” to boost earnings and reduce debts, and suggesting it could become a bid target.
Spirit, which demerged from Punch Taverns at the start of August, is set to issue a pre-closing trading update tomorrow (1 September).
Jack, of Numis, said: “We initiate coverage of Spirit with a Buy recommendation and 75p target price that is based on peer group EV/ebitda valuation multiples.
“Despite a tough trading environment, Spirit has sufficient self-help potential to drive a 15% earnings CAGR (2011E - 2013E), reduce net debt:ebitda (from 5.2x to 4.5x in 2013E) despite intending to pay a 3x covered dividend that yields 4.8% in 2012E, by our estimates.”
He added: “Managed pub post-centrals ebitdar margins are 430bps (2010) below Mitchells & Butlers’. We forecast half of this gap to be removed over the next three years due to strong returns from re-branding, prior to operational initiatives, which drove 1.5% of Q1-3’s 5.7% LFL sales growth.”
Jack said Numis forecasts assume that Spirit’s re-brandings will continue to achieve the 25% cash return-on-investment target.
“To date, the company has exceeded targets and the programme completes in 2012E. We cautiously assume no benefit to average sales from disposals and conversions as well as no growth in gross margins despite the benefit of EPOS roll-out and lower price discounting after re-branding work is completed.”
Jack explained that the 75p target price is based on peer group EV/ebitda multiples of 8.5x 2011E, falling to 7.5x in 2014E, after adjusting for the £83m onerous lease provision, offset by £80m of tax credits.
“We believe Spirit’s valuation does not fully reflect the company’s potential despite it showing in Q1-3 that its strategy is working and providing a clear roadmap for further progress through to 2014E.
“In our opinion, investment attractions include: above-average growth at a discount valuation, an attractive dividend policy; improvement in the earnings quality; falling net debt:ebitda; scope to use PLC cash to either buy back shares (we estimate a £50m share buy-back would be 15% accretive at current prices) or through being acquisitive.
“In a sector that may have to use expansion/acquisitions to offset rising cost pressure, there is a risk that Spirit could become a bid target.”
