Category: Sectors

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LICs LICs

Post Holdings Inc Not Able To Command Price Premium

They need an advice. Young married couple talking while sitting on the therapy session with psychologist

Business Strategy and Outlook

Post has a unique portfolio of businesses. After spinning off its majority stake in the fast-growing BellRing Brands in March 2022, nearly half of its sales mix is cereal, which is highly profitable, but experiencing declining volumes. The other half of its portfolio consists primarily of egg and potato products, which possess a better growth profile, but carry low profit margins. It is alleged a competitive edge remains elusive, as Post has not demonstrated strong brand equities, preferred relationships with customers, or a cost advantage, which are the most likely moat sources for a packaged food company. 

The cereal business has been experiencing declining per capita consumption (prior to the pandemic) as consumers have shifted away from processed, high-sugar, high-carbohydrate fare. Adding to the challenge, no-moat Post, the third-largest player, has had to compete for ever-decreasing shelf-space with market leaders narrow-moat General Mills and wide-moat Kellogg. That said, Post’s cereal business is very profitable, with EBITDA margins around mid-20% and low-30% for the U.S. and European businesses, respectively. 

The refrigerated segments (52% of 2021 sales, with 32% food service and 20% retail) consists primarily of egg and potato products, but also side dishes, cheese, and sausage sold under brands such as Bob Evans and Simply Potatoes. While this business has more attractive growth prospects than cereal (growing 1%-2% versus cereal’s modest declines), agricultural commodities are difficult to differentiate and therefore generally do not command a price premium. As a result, this business has relatively low EBITDA margins (16%-18%) and does not offer the firm a competitive advantage, in analysts view.

Financial Strength

Post has a unique capital allocation strategy, preferring to carry a heavier debt load than most packaged food peers. Net debt/adjusted EBITDA has averaged 5.3 times the last 10 years, increasing following acquisitions and gradually declining as the firm uses free cash flow to pay down debt. Leverage stood at 5.5 times at the end of fiscal 2021 including BellRing Brands, and it is being modelled that the ratio remains above 5 times for the duration of experts forecast. Post’s legacy domestic cereal business generates significant free cash flow (about 12% of revenue, above the 10% peer average), although after acquiring the refrigerated foods, BellRing, and private brands businesses, this metric fell to a mid- to high-single-digit average in 2013 and beyond, now slightly below the peer average. Post’s interest coverage ratio (EBITDA/interest expense) has averaged 2.5 times over the past three years, compared with the 7 times peer average. While this ratio is quite tight, the firm has ample access to liquidity (even considering the uncertain environment caused by the pandemic), including $1.2 billion cash and $730 million available via on its credit revolver as of December 2021. Post has no intention to initiate a dividend. Instead, the firm plans to balance debt repayments, share repurchase, and acquisitions. Although it is likely that the firm will acquire additional businesses over the next several years, given the numerous uncertainties regarding these transactions, experts have opted to model free cash flow being used instead for share repurchase, which is foreseen as a good use of capital assuming it is executed at a value below analysts assessment of its intrinsic value.

Bulls Say’s

  • The refrigerated foods segment, half of Post’s business, is benefiting from consumers’ evolving preference for fresh, unprocessed high-protein eggs, and fresh and convenient side dish options. 
  • Although growth in the cereal business has been stagnant, it reports attractive profits and cash flows. 
  • Despite inflation and the uncertain economic environment that could ensue, demand for Post’s products should be relatively stable.

Company Profile 

Post Holdings operates in North America and Europe. For fiscal 2021 (restated for the separation of BellRing Brands), 47% of the company’s revenue came from cereal, with brands such as Honeycomb, Grape-Nuts, Pebbles, Honey Bunches of Oats, Malt-O-Meal, and Weetabix. Refrigerated food made up 52% of sales and services the retail (20% of company sales) and food-service channels (32%), providing value-added egg and potato products, prepared side dishes, cheese, and sausage under brands Bob Evans and Simply Potatoes. Post also holds a 60% stake in 8th Avenue, a private brands entity and a 14% stake in BellRing Brands, with protein-based products under the Premier Protein and Dymatize brands. Post launched a special purpose acquisition corp in 2021, but has not yet executed a transaction. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
ETFs ETFs

Large- to mid-cap exposure to US equities at an attractive fee

Tile letter on red rack in word ETF (abbreviation of Exchange Traded Fund) on wood background

Approach 

This fund uses full physical replication to capture the performance of the S&P 500 Total Return Index. The fund owns–to the extent that is possible and efficient–all the underlying constituents in the same proportion as its benchmark. 

Portfolio 

The S&P 500 is a free-float-adjusted market-capitalisation-weighted index of 500 US companies that offers both large- and mid-cap exposure. With a total value of over USD 40 trillion, the index covers around 80% of the free-float-adjusted market capitalisation of the US equity market. The US Index Committee maintains the S&P 500 and meets monthly. It aims to minimise index membership turnover. If a constituent no longer meets the entrance requirements, the committee will not remove the member immediately if it deems the change temporary. The index rebalances quarterly in March, June, September, and December. The largest sector exposure is information technology (29%), followed by healthcare (13%) and financials (12%). With the inclusion of Tesla TSLA and the continued success of many of the largest stocks in the index over 2020, the top 10 now represent over one fourth of the index. That said, concentration risk concerns remain subdued as the top 10 companies traditionally drive around 20% of the return, a fair attribution for many market-cap-weighted strategies.

Performance

Funds that track the S&P 500 Net Return Index have consistently outperformed the category average by a range of 0%-4% on a yearly rolling basis, making a strong investment case for low-cost passive instruments such as this when seeking broad US equity exposure. Further evidence is found in the superior risk-adjusted return profile of the S&P 500 relative to the average peer in the category. Passive funds in this category have generally had better or equal Sharpe ratios over short and long periods. In fact, this strategy has routinely captured more of the upside and less of the downside. Tracking error has also generally been tight, sitting at around 3-5 basis points. Valuations between large and small caps have shown some dispersion as US large caps rerated significantly following the volatility that markets saw in first-quarter 2020, suggesting that outperformance of larger companies over the last few years has come with steeper degrees of price risk.

Top Holdings of the fund

About the fund

The Fund employs a passive management – or indexing – investment approach, through physical acquisition of securities, and seeks to track the performance of the S&P 500 Total Return Index.The Index is comprised of large-sized company stocks in the US.

The Fund attempts to:

  • Track the performance of the Index by investing in all constituent securities of the Index in the same proportion as the Index. Where not practicable to fully replicate, the Fund will use a sampling process.
  • Remain fully invested except in extraordinary market, political or similar conditions.

 (Source:Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
LICs LICs

PPT delivered strong earnings growth for 1H22; Positive momentum in all of its divisions going and scaling globally

Young businesswoman sitting at the table with touchpad and communicating with senior woman

Investment Thesis 

  • Trades below our valuation and represents >10% upside to current share price. 
  • PPT is a diversified business with earnings derived from trustee services, financial advice and funds management.
  • PPT has an opportunity to increase FUM via its Global Share Fund, which has a strong performance track record over 1, 3 and 5-years and significant capacity, whilst PPT continues to maintain FUM in Australia equities which is near maximum capacity. This equates to flattish earnings growth unless PPT can attract FUM into international equities, credit and multi-asset strategies (and other incubated funds).
  • Retail and institutional inflow of funds is expected to be solid especially from positive compulsory superannuation trend and flow from Perpetual Private. 
  • Potential for Perpetual Private to drive growth in funds under management and funds under advice.
  • Cost improvements in Perpetual Private and Corporate Trust.

Key Risks

  • Any significant underperformance across funds.
  • Significant key man risk around key management or investment management personnel.
  • Potential change in regulation (superannuation) with more focus on retirement income (annuities) than wealth creation.
  • Average base management fee (bps) per annum (excluding performance fee) continues to be stable at ~70bps but there are risks to the downside from pressures on fees.
  • More regulation and compliance costs associated with the provision of financial advice and Perpetual Private.
  • Exposure to industry funds which are building in-house capabilities (~15-20% of total PPT funds under management). 

1H22 Results Summary :

  •  Operating revenue increased +37% to A$384.9m, primarily driven by the full contribution of Barrow Hanley Global Investors (Barrow Hanley), strong relative investment performance, higher average equity markets and continued growth in both Perpetual Corporate Trust and Perpetual Private. 
  • Underlying expenses increased +31% to A$275.3m, mainly due to the addition of expenses relating to newly acquired businesses Jacaranda Financial Planning, Laminar Capital and a full six months of Barrow Hanley, as well as higher variable remuneration and investment in technology.
  • Underlying profit after tax (UPAT) increased +54% to A$79.1m, which combined with +16% increase in significant items (comprised of transaction and integration costs associated with the acquisition/establishment of Barrow Hanley, Trillium and other acquisitions, as well as the amortisation of acquired intangibles) delivered +113% growth in NPAT to A$59.3m. 
  •  The Company ended the half with cash of A$130.9m, down -24%, primarily due to reduction in FCF (resulting from international expansion, tax and interest payments) and investment in growth initiatives/acquisitions. Liquid investments increased +16% to A$154.8m, reflecting an increase in seed fund investments relating to ETFs and mutual funds. 
  • Borrowings increased +13% to A$248.1m, reflecting the draw-down of debt to fund strategic initiatives with additional capacity remaining for further investment, leading to gearing ratio (debt/debt+equity) increasing +150bps to 21.5%. 
  •  The Board declared a fully franked interim dividend of 112cps, up +33% and representing a payout ratio of 80%, in line with Company’s dividend policy of 60-90% of UPAT on an annualised basis.

Company Profile

Perpetual Ltd (PPT) is an ASX-listed independent wealth manager with three core segments in (1) Perpetual Investments which is one of Australia’s largest investment managers; (2) Perpetual Private which is one of Australia’s premier high net worth advice business; and (3) Perpetual Corporate Trust which provides trustee services. PPT manages ~$98.3 billion in funds under management, ~$17.0 billion in funds under advice and ~$922.8 billion in funds under administration (as at 30 June 2021.

(Source: Banyantree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

Pro Medicus Ltd – reported strong 1H22 results reflecting earnings of $20.68m, up +52.7% relative to the pcp.

Investment Thesis:

  • The stock is trading below our valuation and represents >10% upside to the current share price. 
  • Proven and market leading technology (management believes they are 24 months ahead of competitors), with PME’s product commanding a price premium. 
  • New contract wins (more win rates plus higher value per contract) and increasing usage by existing clients. 
  • New product launches – Enterprise Imaging solutions and moving into other “ologies” such as cardiology and ophthalmology. Developing artificial intelligence (AI) capabilities. 
  • Leveraged to the digital health data thematic and industry’s transition to cloud. 
  • Expansion into new geographies.
  • Potential M&A activity.

Key Risks: 

  • High valuation which subjects the stock price to more volatility.
  • Timing (long lead time to close contracts) and scale of new contract wins disappoints relative to market expectations. 
  • Contract renewals (pricing pressure) and potential budget cuts at hospitals leading to the delay of software upgrades / investment. 
  • Increasing competitive pressures (from large scale players and new entrants with innovative technology). 
  • Systems reliability – data breach or drop in quality. 
  • Regulatory / funding changes – reimbursement changes leading to lower imaging volumes. 

Key Highlights:

  • Pro Medicus Ltd (PME) reported strong 1H22 results reflecting earnings (net profit) of $20.68m, up +52.7% relative to the pcp.
  • Revenue was up +40.3% to $44.33m driven by contract wins and renewals in the U.S. and an extension of a European contract to cover new regions.
  • Underlying profit before tax $28.8m, up +53.5%
  • Net profit of $20.68m, up +52.7%.
  • PME retained a strong balance sheet with cash reserves of $76.17m, up $14.91m and remains debt-free.
  • PME reported key contract wins which bodes well for future earnings: Novant Health (A$40m, 7-year contract), a community-based integrated delivery network that spans three U.S. states; Contract renewal with Allegheny Health (A$12m, 5-year), a health network in Pittsburgh, Pennsylvania; and extension of German government hospital to a fourth site.
  • Management also highlighted PME made progress with all key implementations being on or ahead of schedule, including Intermountain and UCSF.
  • The Board declared a fully franked interim dividend of 10c per share, up +42.9%.

Company Description:

Pro Medicus Ltd (PME) was founded in 1983 and provides a full range of radiology IT software and services to hospitals, imaging centers and health care groups globally. In Jan-09, PME purchased Visage Imaging, which has become a global provider of leading-edge enterprise imaging solutions, pioneering the best-of-breed, or Deconstructed PACSSM enterprise imaging strategy. Visage 7 technology delivers fast, multi-dimensional images streamed via an intelligent thin-client viewer. The company offers a leading suite of RIS, PACS and e-health solutions constituting one of the most comprehensive end-to-end offerings in radiology. Pro Medicus has global offices in Melbourne, Berlin (R&D) and San Diego (Sales).

(Source: Banyantree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Dividend Stocks

Qube Holdings Ltd – Revenue increased +27.6% to $1.2bn and EBITDA increased +18.9% to $110.9m

Investment Thesis:

  • Attractive assets which are strategically located.
  • Leveraged to improving economic growth (e.g., commodity markets, new passenger vehicle sales).
  • Additional project work in future years, leading to improved margins. 
  • Successful ramp up of Moorebank Logistics Park and offering logistics services at incremental margins.
  • Technological advances (and automations) at its ports and operations leading to better cost outcomes and improved margins. 
  • Potential bolt-on acquisitions to supplement organic growth.
  • Sound balance sheet position.

Key Risks:

  • Downturn in the domestic economy (or key end markets such as agriculture, retail), leading to excess capacity and pricing pressure.  
  • Margin pressure due to cost pressures. 
  • Potential direct and indirect impacts from coronavirus outbreak.
  • Value destructive acquisition (dilutive to earnings and a distraction for management).
  • Competitive pressures leading to margin erosion – Logistics industry is a highly competitive market.  
  • QUB does not meet market expectations in achieving capacity utilization at Moorebank Logistics Park.

Key Highlights:

  • Underlying revenue increased +27.6% to $1.2bn and underlying earnings (EBITA) increased +18.9% to $110.9m, despite pcp including ~$16.8m in JobKeeper benefits, driven by organic growth as well as the contribution from acquisitions and growth capex completed in the prior and current periods.
  • Underlying NPATA increased +16.9% to $96.8m and underlying earnings per share pre-amortisation (EPSA) increased +15.9% to 5.1 cents.
  • Despite ongoing impacts from Covid-19, global supply chain disruptions and some industrial relations challenges, as the Company managed to mitigate cost pressures through contractual protections, benefits of scale and operating efficiency and proactive engagement with customers to review and optimize broader supply chain activities.
  • Capex (gross) was $440.4m with ~74% spent in the Operating Division and the balance in the Property Division.
  • Operating Division was the largest driver of 1H22 result, generating underlying EBITA of $126.4m (+19.4%), with Logistics & Infrastructure activities contributing underlying EBITA of $69.9m (+36.8%), benefitting from high levels of container volumes across transport and container park operations, Ports & Bulk activities contributing underlying EBITA of $70.4m (+4.3%), driven by contribution from new contracts secured in the current and prior periods.
  • Property Division delivered underlying revenue of $8.9m (-27.6%). QUB receiving total up-front proceeds of $1.36bn with another $300m deferred consideration expected to be received after construction of Stage 1 of the MLP Interstate Terminal.
  • Patrick (50% share) delivered underlying contribution of $23.5m NPAT and $28.9m NPATA, an increase of +12.4% and +14.7%, respectively, and included QUB’s share of interest income ($6.1m post-tax) on the shareholder loans provided to Patrick. 
  • The Board declaring a fully franked interim dividend of 3cps (up +20% over pcp) and approving capital management initiatives of up to $400m commencing 2H22.  

Company Description:

Qube Holdings Limited (QUB) is a diversified logistics and infrastructure company providing logistics services for clients in both import and export cargo supply chains. The Company operates three main divisions: Ports & Bulk (integrated port services, bulk material handling and bulk haulage), Logistics (largest integrated third-party container logistics provider in Australia), and Strategic Assets (investing and developing future infrastructure).  

(Source: Banyantree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Small Cap

Norwegian liberally accessing the debt and equity markets since the start of the pandemic

Business Strategy and Outlook

Changes to consumer behavior surrounding travel–cruising in particular–as a result of the coronavirus could alter the economic performance of Norwegian Cruise Line Holdings over an extended horizon. As consumers resume cruising after the 15-month sailing halt that began in March 2020, cruise operators have had to add COVID-19-related protocols to reassure passengers of the safety of cruising in addition to the value proposition the holiday provides. On the yield side, it is anticipated Norwegian could intermittently see pricing competition to entice cruisers back onto the product once operators are back at full deployment. Further, there could be some pressure from the redemption of future cruise credits through 2022. On the cost side, higher spending to implement cleanliness and health protocols and oil prices could keep spending inflated. And the entire fleet will not be deployed until the second quarter of 2022, crimping near-term profits and ceding some scale benefits.

These concerns lead to average returns on invested capital, including goodwill, that is viewed, are set to fall below analysts’ 10.4% weighted average cost of capital estimate over a multiyear period, supporting analysts no-moat rating. While it is alleged Norwegian has carved out a compelling position in cruising thanks to its freestyle offering, the product still has to compete with other land-based vacations and discretionary spending for wallet share. It is resisted that it could be harder to capture the same percentage of spending over the near term, given the perceived risk of cruising, heightened by previous media attention. 

While liquidity issues remain concerning for cruise operators, Norwegian has liberally accessed the debt and equity markets since the beginning of the pandemic. Such capital market efforts signal Norwegian’s dedication to weathering a return to normalcy for demand. Given that the firm indicated cash burn is set to escalate to $390 million per month as it restarts the fleet, the $1.5 billion in cash of Norwegian’s balance sheet at year-end buys it sometime (even if there is no associated revenue) to facilitate a tactical full deployment strategy.

Financial Strength

Norwegian has accessed significant liquidity since the beginning of the pandemic, raising around $8 billion in debt and equity. In analysts’ opinion, these efforts signal Norwegian’s dedication to attempt to weather the duration of COVID-19. Given that the firm indicated cash burn should rise to around $390 million per month as it digests higher costs to restart the fleet, cash available to the firm should allow Norwegian time to successfully execute a tactical re-entry to sailing the seas, offering liquidity even in a tempered revenue scenario in 2022.With Norwegian’s 28 ships at the end of 2021, it is likely solid capacity expansion once cruising resumes, although it is likely some growth could be reconfigured, given shipyard closures. However, including recent debt and equity raises, Norwegian is likely to remain above its 2.5-2.75 times net debt/adjusted EBITDA target it had previously sought to achieve.  It is not seen Norwegian reaching around this range until 2028. The firm surpassed its debt/capital covenant of less than 70%, ending 2021 at around 84% (with restrictive covenants waived into 2022). The company is set to remain cash flow negative in 2022, but it is alleged could achieve positive EBITDA performance in the second half of 2022 (delayed a bit by omicron’s impact).Longer term, it is still held  that management will continue to order ships for delivery approximately every 18 months (and at least one per year in 2022-27) at its namesake brand and will opportunistically finance new ships through either compelling pricing in the debt markets or low-cost export credit agency guaranteed loans.

Bulls Say’s

  • As Norwegian is smaller than its North American cruise peers, it has the ability to deploy its assets nimbly as cruising demand rises, allowing for strategic pricing tactics. 
  • The rescission of restrictive COVID-related policies could allow cruises to appeal to a wider cohort of consumers, leading to near-term demand growth faster than is currently anticipated. 
  • Norwegian has capitalized on leisure industry knowledge from its prior sponsors as well as the addition of high-end Regent Seven Seas and Oceania brands, gathering best practices and leverage with vendors.

Company Profile 

Norwegian Cruise Line is the world’s third-largest cruise company by berths (at nearly 60,000), operating 28 ships across three brands (Norwegian, Oceania, and Regent Seven Seas), offering both freestyle and luxury cruising. The company is set to have its entire fleet back in the water in the second quarter of 2022. With nine passenger vessels on order among its brands through 2027 (representing 24,000 incremental berths), Norwegian is increasing capacity faster than its peers, expanding its brand globally. Norwegian sailed to around 500 global destinations before the pandemic. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Dividend Stocks

Engie is Well Positioned to Benefit from the Power Prices Rally

Business Strategy and Outlook:

Engie is one of the three largest integrated international European utilities, along with Enel and Iberdrola. Under the tenure of previous CEO Isabelle Kocher, the firm sold EUR 16.5 billion of mostly commodity-exposed assets– E&P, LNG, and coal plants–to focus on regulated, renewables, and client-facing businesses. This strategy lowered the weight of activities that typically have volatile cash flows and no economic moats. After she was ousted by the board in early 2020, the firm shifted its strategy to reduce the weight of these activities and sell stakes in noncore businesses. That drove the sale of Engie’s 32.05% stake in Suez to Veolia at an attractive price and of its multi-technical subsidiary Equans to Bouygues for EUR 7.1 billion. The latter is part of an EUR 11 billion disposal plan by 2023. On the other hand, Engie will increase annual investments in renewables from 3 GW to 4 GW between 2022 and 2025 and 6 GW beyond. 

Regulated gas networks, mostly in France, account for around one third of the group’s EBIT. Contracted assets comprise thermal power plants in emerging markets, especially the Middle East and Latin America, with purchased power agreements, or PPAs, securing returns on capital. Remaining merchant exposure is made up of gas plants across. Europe, Belgian nuclear plants and French hydropower assets. Gas plants are well positioned as the share of intermittent renewables increase. Nuclear and hydropower provide exposure to European power prices although Belgian nuclear plants will be shut by 2025. Taking that into account, the valuation sensitivity to EUR 1 change in power prices is EUR 0.16 per share, 1% of our fair value estimate. With net debt/EBITDA of 2.4 times, Engie has one of the lowest leverages in the sector. Still, the 2019 dividend of EUR 0.8 was canceled because of pressure from the French government, which has 34% of the voting rights, and the coronavirus impact. Still, the dividend was reinstated in 2020 and the 2021 dividend of EUR 0.85 is above the precut level. We project a 2021-26 dividend CAGR of 5% based on a 69% average payout ratio.

Financial Strength:

Economic net debt including pension and nuclear provisions amounted to EUR 38.3 billion at end-2021, implying a leverage ratio of 3.6. It is projected that the economic net debt to decrease to EUR 37.1 billion through 2026. Thanks to the EBITDA increase, economic net debt/EBITDA will decrease to 3.2 in 2026, averaging 3.1 between 2021 and 2026, comfortably below the company’s upper ceiling of 4. After the COVID-19-driven cancellation of the 2019 dividend of EUR 0.80 per share, Engie paid a EUR 0.53 dividend on its 2020 earnings implying a 75% payout. 

For 2021 results, the company will pay a dividend of EUR 0.85, implying a 70% payout in line with the 65%-75% guidance range over 2021-23. Ninety-one percent of debt was fixed-rate at the end of 2021. Meanwhile, 83% of the company’s debt was denominated in euros, 11% in U.S. dollars, and the balance in Brazilian real.

Bulls Says:

  • Engie’s strategic shift announced in July 2020 should be value-accretive as evidenced by the sale of its stake in Suez and of Equans.
  • In the long run, the group could convert its gas assets into hydrogen assets.
  • The group is well positioned to benefit from rising power prices in Europe thanks to its French hydro dams.

Company Profile:

Engie is a global energy firm formed by the 2008 merger of Gaz de France and Suez and the acquisition of International Power in 2012. It changed its name to Engie from GDF Suez in 2015. The company operates Europe’s largest gas pipeline network, including the French system, and a global fleet of power plants with 63 net GW of capacity. Engie also operates a diverse suite of other energy businesses.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks

Long term Narrative Intact for Domino’s, but Driver Shortage and Inflation Pose Near-Term Concerns

20025825 - closeup image of businessman drawing 3d graphics

Business Strategy and Outlook:

The coronavirus catalyzed sweeping changes across the restaurant industry, with operators scrambling to provide delivery-integration, build out e-commerce, and pivot to digital-driven models. For Domino’s, save for the firm’s rollout of contactless car-side carryout, very little changed. The operator’s historical investments in “anyware” ordering, a best-in-class e-commerce interface, and a mix that skewed toward delivery (55%) before the pandemic propelled global systemwide sales growth of 20%, despite the global food-service market remaining 11% below pre-pandemic levels at 

the end of 2021, per our calculations and Euromonitor data. 

Domino’s 2020 results strongly validated management’s strategies (automation of core processes, a focus on volume-driven traffic growth, shrinking service radii, and transparent delivery pricing), and encouraged by their relevance looking beyond the 2020 and 2021. Moving forward, the biggest challenges facing the firm are likely to be the democratization of delivery services (expanding consumer optionality and increasing price sensitivity as groceries and convenience stores enter the mix) and input cost inflation, both of which are at least partially addressed by current strategies. While peers have turned to menu diversification and quality to carve out a niche, Domino’s commitment to value and convenience as disciplined, doubling down on core competencies. Menu diversification is risky, with no guarantee that operators can provide competitive products, while adding stock-keeping units and operational risk. Minimizing delivery times and emphasizing the higher-margin carryout business through fortressing, while maintaining strong value positioning should allow Domino’s to effectively compete in a world where expanded consumer choice demands quality, convenience, and competitive pricing.

Financial Strength:

Domino’s remains in good financial health, with a steady stream of royalty receipts handily covering interest obligations throughout the explicit forecast. While forecast 5.9 times debt/EBITDA at the end of 2021 (on the upper end of management’s 3-6 times targeted range) appears high at first blush, it is consistent with other heavily franchised operators in our coverage (Restaurant Brands International sports 5-6 times, while Yum Brands targets 5), and debt service represents a manageable average annual outlay of 26.5% of operating income through 2026. Further, the projected free cash flow conversion (or cash flow to the firm as a percentage of net revenue) of 14% over the same period offers ample flexibility to channel capital toward its most efficient use- whether new unit growth, software development, store remodeling, or shareholder distributions.

With restaurants often featuring negative working capital, attributable to longer-dated payables and a cash-focused business model, the solvency metrics as a more appropriate evaluation of operator’s financial health. An average EBITDA coverage ratio of 4.1 times through 2026, which appears sound. An effective interest rate of just 3.8% in 2021 corroborates this view, with Domino’s recent issues hovering around investment-grade breakpoints (as they are secured by future royalties and intellectual property). The firm’s debt maturities are adequately spaced out, with a negligible amount of principal coming due over the next three years. The firm relies on approximately biannual recapitalization transactions to pay down maturing issues, repurchase shares, and maintain leverage targets (with the intention of minimizing the firm’s weighted average cost of capital), with the most recent occurring in April 2021. Dominos also maintains a $200 million variable note funding facility, of which $155.8 million was available as of Dec. 31, 2021.

Bulls Say:

  • Category-leading margins and a cohesive franchise network will continue to drive unit growth outperformance for Domino’s.
  • The firm’s fortressing strategy allows it to capitalize on core competencies (price and convenience), cementing its leading role in the U.S. QSR pizza market.
  • Master franchise relationships continue to push impressive unit growth in underpenetrated markets like Latin America, India, and China, which offer substantial space for greenfield development.

Company Profile:

Domino’s Pizza is a restaurant operator and franchiser with nearly 18,850 stores across more than 90 international markets. The firm generates revenue through the sales of pizza, wings, salads, and sandwiches at company-owned stores, royalty and marketing contributions from franchise-operated stores, and its network of 26 domestic (and five Canadian) dough manufacturing and supply chain facilities, which centralize purchasing, preparation, and last-mile delivery for the firm’s U.S. and Canadian restaurants. With roughly $17.7 billion in 2021 system sales, Domino’s is the largest player in the global pizza market, ahead of Pizza Hut, Papa John’s, and Little Caesars.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

InterContinental Hotels Group PLC with over 100 million loyalty members

Business Strategy and Outlook

It is alleged InterContinental to retain its brand intangible asset (a source of its narrow moat rating) and expand room share in the hotel industry in the next decade. Renovated and newer brands supporting a favorable next-generation traveler position as well as its industry-leading loyalty program will drive this growth. The company currently has a mid-single-digit percentage share of global hotel rooms and 11% share of all industry pipeline rooms. It is seen its total room growth averaging 3%-4% over the next decade, above the 1.8% supply increase is projected for the U.S. industry. 

With 99% of rooms managed or franchised, InterContinental has an attractive recurring-fee business model with high returns on invested capital and significant switching costs (a second moat source) for property owners, as managed and franchised hotels have low fixed costs and capital requirements, and contracts lasting 20-30 years have meaningful cancellation costs for owners. 

It is anticipated InterContinental’s brand and switching cost advantage to strengthen, driven by new hotel brands, renovation of existing properties, technology integration, and a leading loyalty program, which all drive developer and traveler demand for the company. InterContinental has added six brands since 2016; it now has 16 in total. InterContinental announced in August 2021 a new luxury brand, with details to be provided soon. Additionally, the company announced a midscale concept in June 2017, Avid, which the company sees as addressing an underserved $20 billion market with 14 million guests, under a normal demand environment. Also, InterContinental has recently renovated its Crowne Plaza (13% of total room base) and Holiday Inn/Holiday Inn Express (62%) properties, which will support its brand advantage. Beyond this, the firm has over 100 million loyalty members, providing an immediate demand channel for third-party hotel owners joining its brand.

Financial Strength

InterContinental’s financial health remains good, despite COVID-19 challenges. InterContinental entered 2020 with net debt/EBITDA of 2.5 times, and its asset-light business model allows the company to operate with low fixed costs and stable unit growth, which led to $584 million in cash flow generation in 2021. During 2020, InterContinental took action to increase its liquidity profile, including suspending dividends and deferring discretionary capital expenditures. Also, the company tapped $425 million of its $1.3 billion credit facility, which has since been repaid. As a result, InterContinental has enough liquidity to operate at near zero revenue into 2023. It is likely banking partners would work to provide InterContinental liquidity as needed, given that the company holds a brand advantage, which will drive healthy cash flow as travel demand returns. InterContinental’s EBIT/interest coverage ratio of 5.4 times for 2019 was healthy, and it is held for it to average 9.1 times over the next five years after temporarily dipping to 3.4 times in 2021. It is projected the company generates about $2.3 billion in free cash flow (operating cash flow minus capital expenditures) during 2022-26, which it uses to pay down debt, distribute dividends, and repurchase shares (with the last two starting in 2022).

Bulls Say’s

  • InterContinental’s current mid-single-digit percentage of hotel industry room share is set to increase as the company controls 11% of the rooms in the global hotel industry pipeline. 
  • InterContinental is well positioned to benefit from the increasing presence of the next-generation traveler though emerging lifestyle brands Kimpton, Avid, Even, Hotel Indigo, Hualuxe, and Voco. 
  • InterContinental has a high exposure to recurring managed and franchised fees (around 95% of total operating income), which have high switching costs and generate strong ROIC.

Company Profile 

InterContinental Hotels Group operates 880,000 rooms across 16 brands addressing the midscale through luxury segments. Holiday Inn and Holiday Inn Express constitute the largest brand, while Hotel Indigo, Even, Hualuxe, Kimpton, and Voco are newer lifestyle brands experiencing strong demand. The company launched a midscale brand, Avid, in summer 2017 and closed on a 51% stake in Regent Hotels in July 2018. It acquired Six Senses in February 2019. Managed and franchised represent 99% of total rooms. As of Dec. 31, 2021, the Americas represents 57% of total rooms, with Greater China accounting for 18%; Europe, Asia, the Middle East, and Africa make up 25%. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Technology Stocks

JD.com Inc : JD logistics and the Supermarket Category to hold back margin gains partially

Business Strategy and Outlook

JD.com has emerged as a leading disruptive force in China’s retail industry by offering authentic products online at competitive prices with speedy and high-quality delivery service. JD’s mobile shopping market share has increased from 21% in 2016 to 27% in 2020 on our estimate. JD adopted an asset-heavy model with self-owned inventory and self-built logistics, while Alibaba has more of an asset-light model. 

JD is a long-term margin expansion story driven by increasing scale from JD direct sales and marketplace, partially offset by the push into JD logistics in the medium term. JD is the largest retailer in China by revenue. Among listed Chinese peers, JD’s net product revenue in 2020 was two to three times higher than for Suning, the second-largest listed retailer. JD’s increasing scale in each category will allow it to garner bargaining power toward the suppliers and volume-based rebates. Since 2016, JD no longer fully reinvests its gains from improving scale and is committed to delivering annual margin expansion in the long run. Gross margin improved yearly from 5.5% in 2011 to 15.2% in 2016, and following the consolidation of JD Finance in second-quarter 2017, gross margin improved year over year from 13.7% in 2016 to 14.6% in 2020. 

In the medium term, it is likely to see the investment into community group purchase, JD logistics and the supermarket category will hold back some of the margin gains. JD is unlikely to have non-GAAP net margin increase in 2021. Starting in April 2017, the logistics business became an independent business unit that will open its services to third parties. Management is squarely focused on gaining market share instead of profitability at this point, and to do so, it has invested heavily in supply chain management, integrated warehouse, and delivery services to penetrate into less developed areas. As the logistics business gains scale and reaches higher capacity utilization, gross profit margin improvement can be seen. Management believes it is not time to turn profitable in the supermarket category in order to be a category leader in China.

Financial Strength

JD.com had a net cash position of CNY 135 billion at the end of 2020. Its free cash flow to the firm has continued to generate positive FCFF at CNY 8.1 billion in 2020. JD has not paid dividends.JD.com has invested heavily in fulfilment infrastructure and technology in recent years, leading to concerns about its free cash flow profile and margin improvement story. It is held management will put more emphasis on growing revenue per user, expansion into lower-tier cities and the businesses’ profitability. Therefore, JD will not invest in new areas as aggressively as before, so it is likely JD will be able to maintain positive non-GAAP net margin versus being unprofitable before. its financial strength will improve in future. Most of the initial investments in the third-party logistics business have been carried out, and utilization of the warehouses has picked up. Its technology team is already in place without the need to add substantial headcounts. JD will also be cautious in its investment in the group-buying business and new retail, given a profitable business model has not been established in the market. JD has tried to improve its asset-heavy model by transferring a portfolio of warehouses to establish a CNY 10.9 billion logistics property core fund in partnership with the sovereign wealth fund of Singapore, GIC. JD will own 20% of the fund, lease back the logistics facilities and receive management fees for managing the facilities. The deal will be completed in phases with the majority of them completed in 2019.

Bulls Say’s

  • JD.com’s nationwide distribution network and fulfilment capacity will be extremely difficult for competitors to replicate. 
  • The partnership with Tencent could allow JD.com to gain significant user traffic from Tencent’s dominant social-networking products in China. 
  • JD is now the largest supermarket in China, the high frequency FMCG categories have attracted new customers from less developed areas and can drive purchase of other categories.

Company Profile 

JD.com is China’s second-largest e-commerce company after Alibaba in terms of transaction volume, offering a wide selection of authentic products at competitive prices, with speedy and reliable delivery. The company has built its own nationwide fulfilment infrastructure and last-mile delivery network, staffed by its own employees, which supports both its online direct sales, its online marketplace and omnichannel businesses. JD.com launched its online marketplace business in 2010. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.