Description

We believe Elior Group SA (“Elior”) offers 3-4x potential upside over the next 24 months.

Elior operates a business that is high-quality, resilient, and well-capitalized – making, in our judgment, for an attractive risk/reward.

We see fair value of 20+ Euros/share vs. a current stock price of 5.95 Euros/share.  Liquidity is solid as Elior’s market cap is just over 1 billion Euros.  The Bloomberg ticker is ELIOR FP.

Contract Catering is a High-Quality Business

Elior is a leading global contract food catering and services firm.

We consider contract catering to be an excellent business. 

• Revenue visibility is high with agreements often signed for 5-7 years. 
• Customer retention is strong with the best contract caterers achieving renewal rates above 95%. 
• Customer concentration is low, with Elior’s top-5 customers representing less than 8% of sales. 
• Cash flow is healthy as the business model is generally asset-light; we say “generally” because upon contract renewal, the caterer typically spends a modest amount of cap-ex to freshen up facilities (which is then quickly recouped in the new contract period).

In addition, the contract catering industry has structural attributes that make it attractive.

The first is revenue growth due to customer outsourcing.  Over time, facilities managers are discovering it is a better value proposition to rely on specialists for food catering who can offer higher quality at lower costs – a hospital’s skill is treating patients, not feeding them.  Every year, the pie grows larger for contract caterers as more and more enterprises decide to outsource this function to specialists like Elior.  The ongoing shift to outsourcing is a long-term structural tailwind, especially in markets like the US that are still in the early-innings of the transition.

The second is industry consolidation.  The contract catering industry generally tends towards fewer players.  In France, for example, the top-3 (Elior, Sodexo, Compass Group) together have 68% market share, with Elior the #1.  This leads to a more rational pricing environment and better margins/returns on capital.

The third is scale.  In contract catering, scale matters tremendously.  One of our LP’s sold his contract catering business a few years ago to one of the large players for many tens of millions.  He is a tough-as-nails negotiator – count your fingers after you shake his hand to make sure you got them all back.  His business was acquired for 20x EBITDA.  He stayed on for a transition period, and his jaw dropped when he walked in the day after the sale and looked at the purchasing power of the acquiror…the EBITDA multiple was cut in half on day one just through better procurement.  Scale (i.e., better purchasing power) provides incumbents with healthy moats around their businesses, while keeping valuation multiples elevated for everyone involved as it makes the incumbents more valuable (and gives them M&A roadmaps for value creation) and makes smaller firms extremely attractive as buy-out candidates.

Put it all together – (1) high revenue visibility, (2) strong customer retention, (3) low customer concentration, (4) healthy cash flows, (5) a generally asset-light model, (6) structural revenue growth from outsourcing, (7) a consolidating industry, and (8) the obvious benefits of scale – and it’s no wonder that contract caterers have historically traded at premium multiples of 10-12x EBITDA or more.

Elior’s Turnaround

Pre-Covid, Elior was making significant progress with a blocking-and-tackling turnaround story.  A write-up detailing the thesis was provided in August 2018 by spike945 here that included a target price of 20-22 Euros/share.  The turnaround thesis is worthy of attention.

Under a prior CEO (Phillippe Salle), Elior had pursued an aggressive “growth at any cost” strategy.  This led to a number of fundamental issues.

Elior over-spent on cap-ex to acquire customers.  At the same time, Elior tried to improve retention by competing on price.  In France, a consolidated market in which Elior is and was the market leader, Elior incomprehensibly launched a price war.  The business lacked centralization (as acquisitions were not properly integrated) so there was no single-point-of-truth for a customer (a multi-national client would have different contracts with different Elior subsidiaries, and Elior did not have visibility into the entire relationship).  A multi-national business itself, Elior did not even have a centralized group to handle tax strategy.  Operationally, the business was spinning out of control.

An example from our due diligence.  We learned that Elior set a budget of cap-ex for regions to spend each year on customers.  Sales personnel would try to spend as much as they could to win deals early in the year, because once the bucket was used up, there was no cap-ex available to win customers closer to year-end.  With no controls on spend or return-on-capital, plus an inability to win clients after a certain point in the year, Elior was pushed towards lower returns and lower growth.  It was the definition of lose-lose.

None of this was unfixable.  It simply required discipline and controls.

The CEO was fired, and Elior appointed Phillippe Guillemot as CEO in 2017 to begin the fixing.  Mr. Guillemot had a sterling track record.  His success at Alcatel-Lucent (he was COO from 2012-2016) was one for the record books – he helped take Alcatel-Lucent from the verge of bankruptcy to being sold for billions to Nokia in just a few years.  It’s an amazing case study.

Mr. Guillemot implemented a straightforward, blocking-and-tackling turnaround at Elior.  We think the improvements have been leaps-and-bounds.

Elior’s non-core concessions business (food in travel centers) was fixed up and sold for a full multiple in 2019 (good timing!), which de-levered the balance sheet and improved focus.  Guillemot imposed new controls around capital spending, including a return-on-capital review process.  The best projects would receive capital, no matter the time of year, and the worst projects would receive none.

The price war in France was ended.  Systems were centralized.  A tax group was hired.  Unprofitable contracts were renegotiated or allowed to lapse at end-date.  Capital was re-allocated to higher-potential geographies, like the United States.  Organic growth returned.

Elior Today

As a result, Elior today is in the best shape it’s ever been.  The business is more disciplined, focused, flexible, and sophisticated.

New business wins are strong.  Retention rates are up.  Margins are growing.  Underlying organic growth is back and appears to be accelerating.

Even disclosures have improved.  Elior historically did not provide the same transparency as its more-valuable peers Sodexo and Compass Group, for example detailing the components of organic growth (new business vs. pricing vs. lost contracts, etc.).  Now Elior does so.  We often find that when disclosures get better, it’s usually a sign that good things are happening under the hood.

Covid has masked much of the improvement.  Elior is clearly a Covid-affected business due to shutdowns.  But even through the pandemic, Elior demonstrated resilience – Elior operated at cash flow breakeven throughout lockdowns, and its balance sheet was never at risk.

At its most recent fiscal year results, Elior gave the market exceptionally strong guidance – EBITA margins of 4.6% by FY2024, representing a 100bps increase vs. pre-Covid 2019 as Elior “turned the crisis into an opportunity” by re-setting its cost structure for improved long-term results.  Revenue is expected to match pre-Covid levels by FY2024 and capital returns are on the table starting next year.

From a high-level perspective, Elior currently has 100,000 employees across five main countries and serves 3.6 million customers each day.

Elior has a top market position in each of its territories: #1 in France, #1 in Spain, #1 in Italy, #4 in the United Kingdom, and #5 in the United States.  We estimate the revenue split is approximately 45% France, 15-20% Spain, 10% Italy, 10% United Kingdom, and 15-20% United States.  Summed up, Elior is #1 in over 70% of its geographies and the remaining 30% represent higher-growth markets.

By business segment, Elior is roughly 1/3 education, 1/3 healthcare, and 1/3 business and industry (“B&I” – soccer stadiums, large companies, etc.).  The first 2/3 of the business have been resilient through Covid; it’s just the final 1/3 in the B&I segment that has been Covid-affected.  Recent numbers show this B&I segment coming back strongly in recent months.

Our Double-Barreled Thesis

We have a double-barreled thesis for Elior.

First, many Covid-affected companies in the United States are now trading at or close to pre-Covid levels.  This is not true in Europe.  Elior traded at 12-14 Euros/share pre-Covid.  Today, Elior’s stock is below 6 Euros/share.   Elior’s share price stands to be a tremendous beneficiary as the world normalizes.  The vast majority of Elior’s B&I business has already returned…it’s just the share price that is yet to follow suit.

Second, we think Elior’s fundamental blocking-and-tackling turnaround will become increasingly apparent to the market.  Elior already operates in an outstanding industry – investors will soon discover how its business is much-improved too.  Again, Elior is more disciplined, focused, flexible, and sophisticated than ever before in company history.

Based on Elior’s FY2024 guidance, we see roughly 400M EBITDA by FY2024 (4.6% EBITA margins and 8.0% EBITDA margins).  At 10-12x EBITDA, this represents a valuation of 4.0-4.8 billion Euros.  The current market cap is 1.0 billion Euros and net debt is 750 million Euros (adjusting back a recent change to IFRS accounting that increased headline net debt by 250 million).

The current share price is 5.95 Euros/share.  At a 10x EBITDA multiple on 400M EBITDA, Elior’s share price would be 18.90 Euros/share.  At a 12x EBITDA multiple on 400M EBITDA, Elior’s share price would be 23.50 Euros/share.  Using headline net debt instead of adjusted net debt knocks a bit more than 1 Euro/share off each of those price targets (172.4M shares outstanding).

Risks To Consider

The risks to an Elior investment can be summed up in single words.  Covid.  France.  Europe.

a) Will humanity leave behind ineffective Covid restrictions and move back towards normalcy, with vaccines now widespread and health outcomes vastly improved?

b) Will a French company be able to structurally boost its margins?

c) Will European investors reward a company that has historically been seen as the lesser peer of much-loved Sodexo and Compass Group?

Conclusion

In our view, the answer is “yes” to each question.  

a) Humanity is already moving past Covid, as the vast majority of Elior’s B&I business has already returned and organic growth is expected to be HSD for years to come.

b) Elior “did not let the crisis go to waste” and instead reset its business model to be more flexible and efficient than ever before.

c) As improved margins flow through the P&L, we think investors will sit up and take notice – as they have in the recent past.

Elior traded above 20 Euros/share just 4-5 years ago.  We think Elior’s business today is vastly better than it was then.  The double-barreled investment thesis of Covid-recovery and fundamental business improvement provides, in our view, a clear roadmap for appreciation back to the 20+ Euros/share level.  We find this a compelling risk/reward.

Disclaimer

The author of this posting and related persons or entities ("Author") currently holds a long position in this security.  Author may purchase additional shares, or sell some or all of Author's shares, at any time.  Author has no obligation to inform anyone of any changes to Author's view of ELIOR FP.  Please consult your financial, legal, and/or tax advisors before making any investment decisions.  While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note.  The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in ELIOR FP.  READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE.  As with all investments, caveat emptor.

Catalyst

-Covid recovery

-Fundamental business improvement

-Investor perceptions change as Elior demonstrates organic growth at higher/more-sustainable EBITDA margins