Description

Thesis

Conviviality PLC (CVR LN) is the largest alcohol distributor in the UK. They recently made two transformational acquisitions (Matthew Clarke and Bibendum) that will lead to substantially higher eps due to business synergies, even in a post-Brexit world. They have low leverage (< 2x D/E) and are trading at 10% free cash flow yield on FY 2018 eps (April). The company also pays a roughly 4.5% dividend yield that will be increased in line with the new earnings.

Summary

Pro forma revenues for the group are expected to be over £1.4 billion. For FY 2018, we estimate that:

• Matthew Clarke will comprise 58% of revenues and 63% of EBIT. This is a higher margin business.
• Legacy CVR business 25% of revenues, 21% of EBIT. This illustrates the acquisitions size vs. the old biz.
• Bibendum will comprise 17% of revenues, 17% of EBIT.

Because Matthew Clarke is so large and has higher operating margins, the EBIT margin of the combined company will increase substantially vs. the legacy results.

After these acquisitions Conviviality is now one of the biggest buyers of wine with the broadest UK portfolio, with over 450 suppliers and 6,500 SKUs. Conviviality buys 171m bottles of wine a year, more than SBRY 159m, Asda 122m, Morrison 86m, Aldi 85m, only exceeded by Tesco 231m. 

Market Mix of Old World vs New World Wines:

• 56% of CVR’s wine sales are from Old World (France, Spain, Italy & Germany).
• 44% of CVR’s wine sales are from New World (Australia, USA, Argentina, South Africa & New Zealand).
• The impacts of any fx movements are different across on- and off-trade as well as New World/Old World

Post acquisitions, the company is broken down into three business lines: 

1 ) Conviviality Direct: Full service on-trade wholesale distributor. This is mostly a combination of Matthew Clark and the on-trade part of Bibendum. The on-trade clients are pubs, bars, restaurants, nightclubs and sporting events. 

CVR made a transformational acquisition of Matthew Clark in late 2015. This acquisition will be accretive and provide significant synergies. Matthew Clark is the UK’s largest independent alcohol wholesaler and distributor to the on-trade drinks sector, generating more annual revenue than the aggregate of its seven largest independent drinks wholesaling competitors. MC delivers to approximately 17,000 on-trade premises each year and delivered over 48 million bottles of wine, 22 million bottles of spirits, 171 million pints of beer and 16 million bottles of cider in the fiscal year 2015.

Conviviality also bought Bibendum PLB Group in 2016. This allows CVR to leverage, sales, agency, marketing and event capabilities. Bibendum Wine is an on trade business, 65% London & SE and has almost no overlap with Matthew Clark, so the combination is very synergistic (only 3% of accounts overlap).

Both Matthew Clark and Bibendum have seen solid growth since being acquired, and we expect this growth to continue. Matthew Clark has obtained 235 new accounts since the CVR acquisition and Bibendum 110 new accounts. 

2) Conviviality Retail: This is the off-trade, legacy part of the business (buy at a store and drink it at home) -- old CVR, mostly focused on lower income clients purchasing value products at a discount to the supermarket chains. Conviviality Retail owns a large UK’s franchised off-licence and convenience chain, offering good ROEs to franchisors, very low prices to retail clients, range of products. Conviviality Retail operates 624 stores (as at 26 April 2015) predominantly trading under the Bargain Booze, Bargain Booze Select Convenience and Wine Rack brands.

While same store sales (LFL) have disappointed lately, the company has invested capex in refurbishment over the last two years and consider the process close to complete now. The newer stores are performing better with pre 2004 stores like-for-like (LFL) comps -3.6%, 2005-2011 flat, and 2012+ at +3.6%.

3) Conviviality Trading: Smaller business line focusing on providing services for larger customers (events, etc.). This includes the PLB business.

Management

The Management Team has a good reputation in the industry. They have brought in new directors to oversee the three business lines, and the CEO Diana Hunter is quite capable and focused on making future acquisitions.

CEO Diana Hunter: With over 20 years’ senior level experience in the Retail sector, Dianca joined CVR in Feb 2013, and has since successfully floated Conviviality in July 2013, and overseen the acquisitions of Wine Rack in September 2013, 31 Rhythm and Booze stores in 2014 and GT News and Matthew Clark in 2015 and Bibendum in 2016. Prior to joining Conviviality, Diana held senior roles in the John Lewis Partnership from 2004 as Director of Store Development, overseeing the creation of new formats and was instrumental in the significant growth of selling space. Latterly as Convenience Director she was responsible for leading the drive of Waitrose into the Convenience market. Diana began her career with 13 years at J Sainsbury plc where she held a number of senior roles. 

CFO Andrew Humphreys: With 20 years in senior level Financial roles, Andrew joined Conviviality in June 2014 from Direct Wines where he was CFO. Andrew was instrumental in a driving their international sales growth through a combination of acquisitions, JV’s and organic growth. Prior to Direct Wines, Andrew was Finance Director at Shop Direct Group, where he oversaw financial and other aspects of the merger of Littlewoods and GUS and the successful integration of the financial services business.

Risks

There are two main risks:

GBPEUR lower will increase the price of alcohol to the UK end buyer. This is mitigated because only a minority of what they sell is produced in the Continental Europe (eg Old World wines vs. UK beer). In addition, there is little FX risk, as only £70m of their buying is done in euros, and the currencies are hedged to March 2017.

UK recession post Brexit hurts the on-trade sector as people spend less at pubs, restaurants and hotels. However, we examined Matthew Clarke’s revenues over the 2007-2010 period, and they still grew every year. In addition, CVR has a balanced outlet portfolio across on-, off-trade, premium and mainstream parts of the market that makes their business resilient to broad changes in consumer spending.

Valuation

We model 26p of cash eps in FY 2018 (April 2018; adding back amortization) and 29p in FY 2019. The company is trading at 10x FY 2018 and 9x FY 2019.

We model 70m of EBITDA in FY 2018 and 77m in FY 2019. The company is trading at 8.6x EV/EBITDA on 2018 and 7.9x on 2019.

We believe that the CVR is absolute cheap. Moreover, the valuation is at a significant discount to its peers because the integration of acquisitions is not yet modeled properly by the analyst community.

Catalyst

The management recently stated that the integration is running ahead of plan and that a relatively short period between Matthew Clark and Bibendum acquisitions simplifies the integration.

Buying Synergies in COGS: Matthew Clark, Bidendum & Conviviality Retail have significant overlapping product ranges therefore there are many buying synergies that will reduce COGS by leveraging best terms and increasing scale. CVR has already executed some synergies and renegotiated for Matthew Clark and Conviviality Retail with spirits suppliers. They are also in the process of developing strategic partnerships with selected brewers and have created a single team to buy wine for the CVR group. We believe CVR’s scale will help them to significantly control and reduce costs going forward. Management mostly identified COGS synergies so far, and estimates are about £6m for FY2017 and £12m for 2018. In addition, the gross margins will almost certainly increase, even in the event of a post-Brexit recession, as Matthew Clark has a significantly higher margin than the legacy business.

Distribution Synergies in Opex: Matthew Clark, Bidendum & Conviviality Retail also have overlapping networks, with 18 depots in total which will allow for an opportunity to reduce costs and improve service by establishing a single supply chain to serve customers. CVR has created a new central logistics team to optimize operations and routes to reduce. CVR expects total savings to be between £1.0m to £1.5m in FY18. They are also working on cross-selling initiatives to leverage the category expertise of Bibendum in wine and Matthew Clark in spirits.

Dividends: Management increased dividends substantially already, showing high confidence in the realization of identified synergies. Management is aiming to continue increasing dividends gradually to 2x dividend cover in FY 2020