A Portfolio of AIM Shares (2): Majestic Wine PLC and Abbey Protection PLC

AIM Stock: Majestic Wine PLC

Image courtesy Majestic Wine

 

After the demise of First Quench (Threshers, Wine Rack and others) in 2009 and Oddbins in 2011, Majestic Wine is, with Bargain Booze, the only national wine retailer left standing. Majestic Wine was listed on AIM in 1996. The company has a good record of earnings growth, it currently yields 3%, holds net cash and it has carved out a niche, as a well-priced retailer with a large wine selection, in the wine trade. These are desirable elements for an investment in AIM, where companies tend to be small and volatile and where they often find it hard to borrow at a reasonable cost.   

Shares in Majestic Wine are currently eligible for 100% business relief for Inheritance Tax, the company has a 'free float' of 98% of its shares and the bid to offer spread for its shares is just 0.8%. It is valued by the stock market at 333 million pounds. 

The UK market for wines has been static, in volume terms, for the past five years. And yet Majestic's revenues have grown by 36% over this period and its shares (in blue) have been an excellent investment, far superior to other food and drink related retailers such as J Sainsbury (in green).

Graph courtesy Yahoo, click to enlarge

 

In the 2013 Annual Report, Majestic's CEO explained its growth strategy:

"Majestic has a clearly defined growth strategy which has four key components; the continuing growth of sales through our core estate coupled with its expansion, growing sales to business customers, increasing ecommerce traffic and developing sales of fine wine."

So, how have the four key growth components developed over the last 5 years (2009-13)? 

1a. Sales per UK store have declined by 8% these past 5 years. The average price per bottle has increased by 19% in this period. The average drop in volumes per retail outlet would seem to be 23%. (Note: included in these figures are business to business sales amounting to 50 million pounds in 2013 and not segregated in 2009. So the figures are indicative).

1b. The number of UK stores has increased from 149 to 193, or by 30%. The company has identified a further 140 sites as suitable for new stores.

2. Sales to business customers declined by 20% in 2013, compared to 2012. This followed Majestic's decision to exit the wholesale wine trade. 

3. Ecommerce sales have increased by 59% in the past five years and now account for 11% of Majestic's retail sales. These are serviced from the nearest Majestic branch.

4. Lay and Wheeler, the fine wine merchants purchased in 2009, recorded sales of 18 million pounds and operating profits of 1.7 million in 2013, both slight declines on 2012. This is seen by Majestic as a blip.  

Not everything is going to plan. 

However, Wine Report 2011 by Neilson includes some favourable comments from wine producers about Majestic. One winemaker remarks, “Majestic is going from strength to strength – a good, well-funded company selling keenly-priced, excellent wines with knowledgeable staff will always find a place in the market.” 

But there is also a caveat from the UK Managing Director of Cordoniu, the premier producer of Spanish cava: “Majestic has a very successful model, both commercially and with the right people in the business who know and understand it, to make it work. Looking more widely at this channel, overheads are one of the key issues, so independent shops and small regional chains, where costs can be controlled, are the sustainable way forward. Driving consumers through the door is ultimately what makes a business work, so marketing, range, pricing, margins, supplier relationships, store location and people are all key ingredients.” 

A visit to a Majestic Wine store is a much more rewarding experience than visiting a supermarket, in terms of wine selection and description, service and even price. But the supermarkets take 84% of the wine business, by volume, in the UK. 

Majestic has keenly controlled administrative expenses, which in 2013 are below 2009's level. And the company has a good training programme for its employees. In the 2013 Annual Report, the CEO writes:

   "We have built a team of personable, articulate and knowledgeable individuals who take great pride in exceeding our customers’ high expectations. . ." and, "We have an extensive training programme designed and delivered in-house that is widely recognised as amongst the best in the industry."  

Turning to trading results and financials, Majestic has weathered the adverse retail environment well:

1. Earnings per share have increased by almost 8% p.a. cumulatively in the last ten years.

2. The historical return on equity is a healthy 20%, and a similar 19% on retained earnings.

3. Net margins are a healthy 8-9%.

4. The company has net cash of 3 million pounds at April 2013.

5. Operating cash flow, after deducting capital expenditure, has covered dividend payments 1.2 times on average these past 5 years.

6. Majestic has no defined benefit pension scheme obligations. 

At the current offer price of 508p, Majestic is on an historical PE ratio of 19 and yields 3.1%. My valuation model values the company's shares at about 460p.* At this price Majestic shares would be on a prospective PER of 16 and yield a prospective 3.7%. Majestic shares reached a 12-month high in August 2013, at 535p and a 12-month low of 397p in April. *Assumptions: eps growth of 7.7% p.a.; equity per share growth of 10% p.a.; ROE 19%; average PER 17.5; 60% eps paid out as dividends and 40% retained; discount rate of 11.8% (3.8% investment grade corporate bond + 3% operational risk + 5% margin of safety).  

The cautious investor will note: 

1. The overall wine market in the UK is static and dominated by the supermarkets. Majestic can only grow by gaining market share by opening new stores and outwitting the competition.

2. Tesco claims to have the largest online sales of wine in the UK, at 200 million pounds a year.

3. Majestic faces competition from the supermarkets, regional chains, independent vintners and online wine clubs. It may have received a temporary boost from the demise of First Quench and Oddbins that flatter the growth figures between 2009 and 2011.

4. The company's main reason for listing on AIM may have disappeared. One founder owned 15% of the company's stock, but he has been liquidating his holding. Majestic might move to the main list. Good for the shares but bad for investors seeking AIM stocks to reduce inheritance tax.

5. Recent shareholder transactions have all been sales. Three directors sold 386,000 shares in July and August at prices ranging from 501p to 510p a share.

6. The company's share price has increased by 28% in only 5 months. This positive sentiment could easily fade.

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AIM stock: Abbey Protection PLC

NOTE: ABBEY PROTECTION HAS AGREED A RECOMMENDED OFFER FOR THE COMPANY AFTER THIS PUBLICATION DATE

 

Civil Law Notary, by Quentin Massys, Flemish 16th Century, courtesy Wikipedia 

Abbey Protection claims to be the leading insurer of legal, tax accounting and professional fees for small and medium sized enterprises (SMEs) in the UK. Abbey has a large consultancy/advisory business and a properties facilities business. With the acquisition of a firm of solicitors, it will begin to offer legal services to its SMEs in 2013. Abbey derives 67% of its revenues from consultancy/advisory and 31% from writing insurance premiums.  

In the 2012 Annual Report the CEO writes, "Our objective is to achieve strong, sustainable earnings and a progressive dividend yield through a strategy of driving organic growth, developing opportunities for the Group’s consulting divisions and making selective and complementary acquisitions." 

Floated on AIM near the peak of the stock market (November 2007), Abbey's shares have proved to be an excellent investment:

 

Graph, courtesy Yahoo, click to enlarge 

Abbey Protection shares are currently eligible for 100% business relief for inheritance tax, and it has a free float of 43% of its outstanding shares, well in excess of the 25% minimum that gives outside shareholders a genuine say in company affairs. Five directors and senior managers hold 52% of Abbey's shares.  

Abbey's development since floatation has been smooth and the company is well financed. Consider:

1. Earnings per share have increased by a compound 7% p.a. since 2008 and equity by a compound 14%.

2. Cash and financial investments totalled 43 million pounds at the end of 2012. The company is valued on AIM at 119 million pounds.

3. At end 2012, Abbey had twenty-two times the minimum required eligible assets available to support its UK intermediation activities and over five times the minimum required eligible assets available to support its Guernsey based reinsurance activities. 

4. Since floatation, net operating cash flow covered the generous dividend 1.9 times. 

However, as note 24 of the Balance Sheet states: "The nature of insurance business makes it very difficult to predict with certainty the likely outcome of any particular claim and the ultimate cost of notified claims." At the end of 2012, outstanding claims were estimated at 9.7 million pounds by the company. Essentially, claims estimates are based on historical data. While Abbey follows the established method for estimating claims, there have been horrible surprises that, in some instances, have bankrupted the insurer. Investors, recognizing the nature of the risk, award low PE ratios to insurers even when premiums account, as here, for less than one-third of the business. Otherwise, the balance sheet is clean of defined benefit pension scheme liabilities and derivative assets and liabilities. 

At the current price of 121p, Abbey shares trade on an historical PE ratio of 15 and yield 4%. The current share price, according to my valuation model, is about right.*

*Eps  growth 7%, equity per share growth 14%, return on equity 25%, average PE ratio of 12.5, 40% of eps retained and 60% paid out as a dividend, discounted at 10.8% (3.8% SLXX + 2% operating risk + 5% margin of safety). 

Prospective investors will note:

1.  The current share price is at an all-time high and 34% higher than last year.

2.  The new legal services business is an unknown.

3. The first half of 2013 ended with the same pre-tax profit as the first half of 2012. A decline in underwriting profits was compensated elsewhere. However, Abbey raised its interim dividend by 14% and paid out a 5p per share special dividend in the period.

4.  5 directors and senior managers have large stakes in Abbey, with far more to lose, if things go wrong, than outside investors.

5. The only investment analyst to follow Abbey has moved his recommendation from Buy to Hold.