Stockwatch: A quality AIM share to buy on the dips

What next for AIM-listed mainly alcoholic drinks wholesaler/retailer Conviviality? It's best-known for the Bargain Booze and Wine Rack retail chains, and ventured into supplying bars and restaurants with the 2015 purchase of Matthew Clark wholesaling for £200 million.

I drew attention last December at 211p along a rationale that its operating story would continue to improve during 2017 as acquisition synergies kick in. The shares looked cheap too on a price/earnings (PE) multiple reducing to single figures and prospective yield of 6.8%. Earnings cover for the dividend was about 1.7 times and the cash flow profile is improving.

With the stock in a sideways trading range, the market was therefore overlooking integration benefits, especially after a 1 November update had cited "strong performance across all divisions during a transformational period".

The stock re-rated progressively to 342p by end-May then dipped near 300p on profit-taking in June, but is responding positively to latest prelims at about 335p.

These results are broadly in line with consensus - a slight beat with revenue up 85% to £1.56 billion, although the operating margin remains flat, 2.4% being at the low end of the recent years' range up to 2.9% (see table).

Very strong earnings per share (EPS) growth divided by a PE multiple now in the mid-teens makes for a low price/earnings-to-growth (PEG) ratio of just 0.2, which growth buyers may have latched onto given sub 1.0 is assumed to imply value.

Like-for-like revenue, arguably the true test of a growth business, is 5.8% "with all areas of the business performing strongly". On simple comparisons, therefore, it looks as if the stock has justifiably re-rated for now, but is it worth holding for longer-term gains or "buy any dips"?

British drinking tends to be resilient

This is the crux reason for investment exposure to alcohol supply: demand tends to be relatively stable through recessions as people are unwilling to compromise on this aspect of enjoying themselves, whether drinking at home or going out.

A long-term risk is UK alcohol sales having peaked in 2004 and being down over 20% since then, the number of younger teetotallers rising and binge-drinkers falling.

Possibly offsetting this for the medium term, however, is the extent of alcohol consumed by affluent middle-aged/pensioners - reaching near-epidemic proportions, is the warning.

So, while supplying it is no new growth industry, it's certainly one where steady growth can be enhanced by acquisitions and synergies.

Underlying basis for progress, and a latest up-tick

Conviviality cites £6 million operating synergies achieved over the latest year, in context of £32.5 million normalised pre-tax profit. Logistics improvements include a depot re-organisation, more efficient route planning and continued growth in the digital platform.

The group's "Direct" side, which is the UK's largest independent wholesaler, grew revenue by 6.4% to £1.04 billion with a 4.8% revenue rise per outlet and 235 new customers, helped by a new contribution from Bibendum wine wholesaling.

The "Retail" side improved 6.1% to £378 million as 39 franchisees joined and 23 increased their store portfolio; while "Trading" was the relative slouch, up just 1% like-for-like to £146 million (albeit the smallest contributor) despite sales to festivals and outdoor events up 37%, i.e. implying weakness elsewhere in this division.

In terms of like-for-like progress, during the nine weeks to 2 July the largest side, Direct, saw revenues up 9%, Trading up 7.6% as the number of events served jumps 27%, although Retail is mixed with a 4% rise at Wine Rack offset elsewhere for Retail edging up just 0.5% overall.

Scope for further organic/acquisitive development

The chief executive speaks of "potential for significant organic growth... with further potential opportunities to build on the current platform" as if they are looking at acquisitions.

The end-April balance sheet shows some flexibility, if no big stretch in prospect: with £10.4 million cash (up 10%) in context of £24.7 million short-term debt and £81.5 million longer term (up 20%), and the net interest charge covered 7.2 times by £37.7 million normalised operating profit.

So, if the board wants to be prudently cautious lest a UK consumer slowdown materialises, it shouldn't add significantly to this debt. More positively, cash generated from operations soared 187% to £78.3 million thereby assisting £43.5 million spent on acquiring subsidiaries and £19.1 million for taking on their net debt.

A total £86.2 million investment was also helped by financing: £31.8 million from the sale of shares and £30 million from term loans. Covenants with regard to £95.7 million net debt allow for some increase, but whether that's prudent with respect to consumer spending.

With the stock having re-rated, however, it's possible institutions would be supportive of a placing if an attractive deal was presented.

Dividend policy underlines management confidence

The proof is often in payouts than enticing words, hence encouraging how the board not only hikes the total dividend by 33% to 12.6p for the latest year, but targets marginally raising earnings cover from 1.7 times to 2 times on a three-year view.

It affirms confidence in the group's cash generation, and a prospective yield over 4% should also be attractive to institutions, thereby making this £580 million AIM stock a quality buy/hold.

In May, Old Mutual raised its stake to over 8%, also reflecting confidence because at this extent it is committed through whatever cycle in consumer spending.

Last December I critiqued how cash was also being "generated" by way of a 0.83 ratio of trade receivables to trade payables, as if the group was marginally living off its creditors. Mind this ratio has deteriorated to 0.74 and is not explained by way of a note or in the financial review.

While this may part-reflect the May 2016 acquisition of Bibendum, I'd want to see the ratio improve, otherwise you begin to wonder if the accounts need normalising against this "benefit".

Overall, Conviviality looks on track: ideally another acquisition would help for the medium/longer term, equity-financed now the rating has improved.

Since the group has effectively been transformed by a string of deals I'd expect this culture to continue, with a consumer slowdown potentially beneficial as to target availability and price. So, despite the stock appearing fairly valued currently it rates a "strong hold" or "buy on dips".

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise.The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.