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Date : 01/10/2021

Endeavour Group (ASX : EDV)

ASX :

EDV

Market Cap : $12.08 Billion

Dividend Per Share : $0.07

Dividend Yield : 1 %

Buy

52 Week Range : $5.77 - $7.50

Share Price : $6.98

A strong business with top class management and sustainable earnings. We recommend a "Buy".

Company Analysis

Endeavour Group (ASX: EDV) is the retail drinks business and used to be the most profitable business segment in the Woolworths Group. Given the drawbacks and growth bottlenecks present in the groceries and everyday needs business, Woolies decided to restructure by combining Endeavor Group and their Hotel business into a single entity – ensuring that the growing Endeavour Group can continue to accelerate its own growth aspirations and not be held back by the structural challenges of the groceries business.

Endeavour operates 1,643 stores under Dan Murphy’s and BWS brands, as well as Cellarmasters and Langton’s online platforms. In addition to the retail drinks segment, Endeavour also operates the Hotels segment, offering leisure and hospitality services, including food and drinks, accommodation, entertainment, and gaming in Australia. Totally, Endeavor manages 339 hotels, including bars, dining, gaming, accommodation, and venue hire operations.

Given the obvious benefits from the demerger and the fact that the retail drinks business was performing exceptionally well, Endeavour shares have had a fairly decent run since their IPO. However, throughout the year Endeavour Group was impacted by Covid19. The Retail business experienced elevated demand from the shift to in-home consumption while the Hotels business was impacted by closures and trading restrictions. There were 169 days in FY21 where one or more of the hotels was closed, with the Victorian and Queensland closures having the most material impact. Endeavour demonstrated agility and resilience throughout the year, closing and reopening hotels as needed, as well as driving new innovation in evolving contactless customer options such as contactless direct-to-boot pick-up in Dan Murphy’s, contactless one hour on-demand delivery for BWS and contactless order-and-pay in hotels.

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Source: Tradingview.com

Endeavour’s share price has come off recently given the impacts that the lockdowns have had on its pubs, gaming, and hotels business. We think this is a great opportunity to add this stellar business to your portfolios. Endeavour is a great defensive business that will keep operating smoothly as it is not affected by the macroeconomic and geopolitical situations that play out.

Solid Structure underpins a Great Business

We Aussies love our drinks. If there are lockdowns, Endeavour will sell you drinks via Dan Murphy’s or BWS, and if we are free to go out and about, chances are you are sitting at one of their 339 hotels/pubs/clubs and paying a mark up for your drinks! This makes their earnings and cash flows extremely sustainable, predictable, and non-cyclical – all characteristics of a solid defensive business. They lead the market by a massive margin in their segments and as a result, Endeavour will enjoy monopolistic margins.

Another great characteristic of Endeavour is that it is a founder led business. Bruce Lawrence Mathieson is a major shareholder, and he has been increasing his stake in his beloved Endeavour as shares fell in September. Bruce is one of the best hotel operators and he has just bought shares worth $55 million last month and has increased his stake to 15%. This gives retail investors confidence in the long-term future of Endeavour and the shareholder value it has the potential to generate.

During the year, Endeavour already focused on building foundations for the future, investing operational effort and $312 million in capital expenditure against their top growth priorities such as:

Growing digital engagement

  • Launched new personalisation capabilities
  • Improved web & app CX driving up conversion
  • Evolved the store enabled pick-up experience
  • Expanded the Jimmy Brings on demand delivery capability into BWS
  • Online penetration grew to 8.4%
  • Evolved Hotels food and beverage experience through contactless order-and-pay technology

Continued Expansion of network

  • Expanded physical footprint by 33 retail stores and 5 hotels
  • Renewed 64 stores and 26 hotels
  • Launched a new format Dan Murphy’s in Melbourne
  • Developed accommodation offering under the NightCap brand
  • Launched a new concept gaming room at the Sunnybank Hotel
  • Welcomed Oakridge to our premium Paragon Wine Estates portfolio

Optimisation of the Group

  • Reset the cost base for hotels
  • Rolled out Simpler for Stores program in Retail
  • Centralised support functions
  • Launched new digital tools
  • Launched 530+ new Pinnacle products and introduced 570+ new suppliers
  • Updated over 500 Electronic Gaming Machines (EGMs) across the network
  • Rolled out ticket in, ticket out (TITO) to the VIC & SA gaming fleet

It’s safe to say that Endeavour is not resting on its laurels and is fully committed to leveraging the demerger to aggressively expand and grow both – the retail and hotels business. In addition to the expansions, Endeavour has also looked to improve efficiency of their existing assets – with an aim of churning out more money for every dollar spent, that is, improving their profit margins and thus, return on equity.

The strategy is quite simple – Endeavour is investing in the future by increasing digital spend and they are building their brand and product capabilities to drive sustainable growth. This creates a snowball effect, and it is already showing in their FY21 numbers. In what was a challenging and volatile year, Endeavour Group has delivered a strong result. Group sales for the year were up 9.3% to $11.6 billion and EBIT increased 22.1% to $899 million when compared to the Equivalent F20 results. EBIT margins improved versus F201 for both segments – Hotels and Retail.

Retail Drinks continues to Grow

Both BWS and Dan Murphy’s are well positioned in the market with customer engagement improving again in FY21. The My Dan’s Membership program attracted an additional 1 million members, growing steadily over the year with total memberships now exceeding 5.5 million.

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Source: Endeavour Group

Retail sales for the year were up 9.6% to $10.2 billion while EBIT grew 17.6% to $669 million. Customers switched to in-home consumption, sparked by Covid19 related restrictions and the closure of on-premises venues which began in March 2020. This created increased retail demand which remained elevated across the first half of FY21. During the second half of the financial year, on-premises restrictions eased, and retail trading began to normalise.

All major categories of drinks saw growth in FY21. The trend towards spirits continued, with this category growing at over 20% in FY21 following similarly strong growth in FY20. The ongoing shift to premium products was also seen across many categories. There was particularly strong growth in craft beer, Champagne, and gin, as well as no-alcohol and low-alcohol alternatives.

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Source: Endeavour Group

The Group made targeted investments to enhance its digital customer experience including improved websites and apps, personalising the My Dan’s loyalty offer and improving online fulfilment through both pick-up and delivery. This created the foundation for Endeavour’s strong online sales which grew 34.7% in FY21. Online now accounts for 8.4% of total Retail sales, up from the prior year’s 6.9%. Endeavour’s digital business model leverages its extensive network to offer exceptional convenience to customers, including fast delivery and pick-up options. In FY21, sales fulfilled by pick-up grew ahead of delivery and the shift to digital has been sustained even as restrictions eased in various states.

The store network was selectively expanded during FY21 and at the end of the financial year, there were 251 Dan Murphy’s stores and 1,392 BWS stores in Australia. This represents a net increase of 33 stores during the period.

The current lockdowns in Sydney and Melbourne will have an impact on the FY22 sales in the retail segment. Once again, we expect to see increased sales volumes as restrictions on pubs and restaurants will push Aussies to drink at home, for which, Dan Murphy’s or BWS are usually obvious choices. Premium products, craft beers, champagne, and non-alcohol alternatives will provide strong growth opportunities in future years.

Hotel Segment has grown in a terrible year

The 2021 financial year was challenging for the Hotels business due to continuing COVID19 related trading restrictions and associated costs. Despite these challenges, sales were up 7.3% to $1.4 billion, while EBIT grew by 49.1% to $261 million with Covid19 having significant impacts on both the current and prior year results.

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Source: Endeavour Group

In the prior year extensive Covid19 restrictions were first introduced from March 2020 and full closures were in place for much of Q4F20. Restrictions ranged from full nation-wide closures to localised lockdowns and ongoing capacity constraints. To highlight the extent of the impact of, there were only 195 days where all of Endeavour’s hotels were open for trading. Additional expenditure was incurred as a result of the pandemic including security and cleaning costs.

Given the challenges presented by the pandemic, the quality of the result is a testament to the resilience of the business and the agility of the management. Once restrictions were lifted in each market, strong trading conditions quickly resumed as customers returned to hotels. However, towards the end of FY21 many jurisdictions returned to a state of lockdown or increased restrictions which has again impacted the operations and profitability of the Hotels business.

During FY21, Endeavour Group invested in 26 hotel renewals and 5 hotel acquisitions. The Hotels business also took the opportunity to upgrade a significant portion of its electronic gaming machine fleet, bringing down average fleet age, and to roll out new technology led innovation like facial recognition to facilitate self-exclusion, Ticket in Ticket Out (TITO) technology to enable cashless gaming and contactless order-and-pay.

Balances Sheet & Capital Management is Robust

We have established so far that both the business segments of Endeavour have been performing well and the firm continues to invest in growing their presence and also to increase efficiency of their existing assets. The higher retail sales were achieved without increasing trade working capital. This was enabled given Endeavour’s strong inventory management. The company has been able to forecast demand and cater to it despite the supply chain breakdowns affecting logistics during the pandemic.

Endeavour Group has historically been funded through a combination of internally generated cash flows, as well as financing facilities with Woolworths Group. As of 27 June 2021, Endeavour Group had $1.7 billion in intercompany borrowings from Woolworths Group and net debt was $1.3 billion.

At demerger, the intercompany borrowings were repaid and replaced with external financing facilities in aggregate totalling $2.5 billion, consisting of a five year $1.0 billion syndicated credit facility, a four year $900 million syndicated credit facility, plus four, three year bilateral loan facilities totalling $600 million. As a result, Endeavour Group has a robust balance sheet, supported by strong operating cash flow and available financing facilities. A cash realisation ratio of 117.3% was achieved in FY21.

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Source: Endeavour Group

Strong Long-term Outlook

The non-cyclical nature of Endeavour’s business means that earnings will be consistent in the long-term. In the short-term however, there may be some volatility due to the effects of the pandemic. The first 8 weeks of FY22 has thus gotten off to a shaky start. However, it has only been a minor decrease in sales. Retail sales are down 1.7% and Hotel sales are down 7.3% – resulting in the total Group sales declining 2.3%. This is a direct impact of the lockdowns in Sydney and Melbourne – two regions that are extremely important for the Hotel segment. As of 24th August, 41% of Endeavour’s Hotels were closed due to public health orders (54 in NSW & 85 in VIC).

In the long-term, in a post-pandemic Australia, we expect Endeavour to grow their revenues at around 6% over the next two years. This is a fairly high growth rate given the size of the business and the market share it already holds. The Retail Drinks segment accounts for 84% of the firm’s revenues and the Hotel segment accounts for the remaining 16%. Following a reopening, we expect the Hotel business to grow its revenues and Endeavour is also expected to boost its market share in the Hotels segment with strategic acquisitions.

The Hotels segment is also the high margin business. In FY21, the retail segment brought in $10.1 billion in revenues, but only $669 million in earnings. This represents an EBITDA margin of 6.5%. The hotels business on the other hand brought in $1.4 billion in revenues and an EBIT of 18.4%. These numbers show that the Hotel segment is 2.8 times more profitable than the Retail segment.

FY22 onwards, as a result of the increased revenues from Hotels from organic growth and via M&A, we expect the EBIT margin to expand to around 8%.

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FY21 delivered an EPS of $0.24, and the Board paid out a fully franked dividend of $0.07 a share in FY21. Based on our forecasts, the EPS estimate for FY22 and FY23 are $0.26 and $0.30, respectively. This means that the stock is trading at a FY22 Forward P/E of 26.5x and 22.9x for FY23. Relatively, Endeavour shares are trading cheaper than its peer – Wesfarmers.

Recommendation

Endeavour is an extremely well managed business that is now poised to grow after finally demerging from Woolworths. Their cash flows are extremely sustainable, predictable, and non-cyclical – all characteristics of an excellent defensive stock that will consistently grow. Both their business segments are positioned to perform well in a post pandemic world, and we expect profitability to grow. M&A is always a possibility with Endeavour as they look to increase their market share. With the recent pullback, their founder and Director has topped up his holdings – which is always a very good sign. We recommend long-term investors to “Buy”.

 

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