Fuller's An Excellent Business But Returns Are Just Too Low
Long Only, Long-Term Horizon, Value
Seeking Alpha Analyst Since 2017
- British pub operator with 90% freehold estate, held at cost on balance sheet.
- Company insists on owning buildings where its pubs are based and therefore returns on investments are small.
- Freehold ownership reduces business risks but it also limits growth potential. Current reinvestment RoE of c10-11%.
- Should buy at no more than 10x PE.
Fullers @550 Jul 2020
Earnings do not record estate value growth in the short term, on the other hand estate value growth should boost the earnings power in the long term. Freehold ownership also reduced the risk profile of the business. What they don’t spend on rents can be invested in refurbishments or promotions. Having said it efficient management of labour force is probably more important, kudos to JDW here.
Fullers return on capital is not impressive, strong financial position make it resilient. The 8-10% RoCE is not that attractive, though this business would be crazy to operate debt free, so we should rather pay attention to RoE.
Seems that the business was able to generate 10-11% RoE over the last decade, which is also not inspiring, can they improve upon it? Shouldn’t levering up of 9% RoCE give larger RoE’s?
Under 10-11% RoE assumption, company can only grow up to 7.7% if it pays out 30% of earnings. This just happens to define the last decade of Fullers quite accurately.
Growth at above this rate is only possible if RoE goes up. Now RoE can rise with increasing margins or growing leverage. Given the industry background the former seems unlikely, but leverage could be adjusted, provided that there is willingness from the management.
Fullers Debt to Capital Invested, or essentially the LTV (Loan-to-value) was around 40%. This is conservative especially given that the estate is varied at historic coasts and has been in companies possession for a long time. After the Fullers Brewing disposal, debt to Capital went further down to c30%.
Now how much leverage is management willing to tolerate and what are their existing debt covenants? Covenants are not disclosed, but they mainly relate to EBITDA and they were breached on FY2020 balance sheet date as Net Debt to EBITDA reached 4.1x. So we have to assume that Fullers will stay at the 3-3.5X level, or in line with historic average, even though an argument could be made that more leverage could be tolerated. So unlikely to increase leverage.
To sum it up, Fullers should continue earning c10% on equity, paying out a third of earnings and investing in new pubs and acquisition. We would like to purchase the stock at a lower price given the low return profile. We have set a target price at GBP 4.00.
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