Leading sector analyst Douglas Jack has said the time is right to buy shares in Spirit Pub Company, which he says are “undervalued”.
In a note entitled “Undervalued: time to Buy” ahead of Spirit’s full-year results on 22 October, Jack, of Numis, said: “Despite the forecast upside and c.£80m of cash tax credits, Spirit has the lowest valuation in the managed pub sector on all metrics. We believe this reflects the onerous lease provision (which should be down to just £5.5m pa in 2014E), a past slowdown in LFL sales and aggressive bond amortisation in 2015E.
“We would buy the shares, which, in our view, underestimate management’s ability to grow LFL sales and refinance the A1/A3 bonds (should it choose to).”
Jack issued a Buy recommendation for Spirit at a 90p Target Price.
Regarding his projections, Jack said: “We forecast PBT of £54.1m (up 6%; or up 12% for those who prefer to value the company on an ex-OLP basis); consensus is £54.7m. The detailed full year trading statement left little room for surprise; attention should focus on current trading, cost inflation, capex and bond refinancing plans.
“We believe a solid update on these areas should help to rerate the shares from the 12% equity free cash flow yield (2013E).”
He added: “Like-for-like sales rose 1.6% in 2013E, having increased 4.1% in Q4. We believe recent share price weakness reflects sceptics’ belief that Q4 was all due to better weather and that LFL sales should be minimal in Q1 2014E. We are more optimistic re trading as: Q4 2013 LFL sales were driven by food (+4.7%), not drink; pricing has been rebalanced; service standards/product range are improving; and comps are easy in Q1-3 2014E.
“Managed EBIT margins should be up over 100bps, following a 147bps increase in H1. This was driven by central cost savings, higher food margins and improving like-for-like sales. Although their roll out is complete, new systems should help margins to grow further in 2014E through capturing and exploiting better management information.
“Tenanted like-for-like net income fell 2.1% in 2013E. In Q4, LFL turnover rose 2.2% with beer sales up (aided by favourable summer weather) and food sales also up. Spirit is rolling out a food menu package. Although Spirit’s food margin will be minimal, this food menu package is driving up food sales, boosting tenant profitability (at a c.60% food gross margin) and supporting rent (which is now stable).
“We expect to hold our 2014E forecasts (PBT £58.0m; consensus £59.7m) which cautiously assume 2.2% managed LFL sales, 30bps managed margin growth and -0.9% leased.”
