Majestic Wine (GB00B021F836) – Nothing to see or potential UK “Outsider” company ?
As always: this is not investment advise. Please DO YOUR OWN RESEARCH. Never trust any “stock tips” from anyone.
A few weeks ago I already mentioned that I had invested into a UK small cap company. Because of a lack of time I had to delay finishing the write-up but now I happily reveal the “UK mystery stock”:
Majesic Wine Plc is the dominant wine retailer in the UK for “medium to higher priced” wines, from 5 GBP/bottle upwards. They run a retail chain plus a commercial service for restaurants and a “fine wine” subsidiary. They recently purchased online only wine trader “Naked Wine” but we come to that later.
Charly Munger’s mantra is “Invert, always invert”. So let’s start this one with a couple of reasons why you shouldn’t buy Majestic Wine at the moment:
- BREXIT: This has potentially multiple negative impacts on Majestic. With a lower Pound, imports get more expensive plus a general potentially weak consumer climate could make things really difficult and squeeze margins and/or reduce volumes. On top of that, many of the bankers who might need to leave the City might be target customers
- The overall wine market in the UK hasn’t been growing in the last years so any growth needs to come from competitors. If Wine importers need to raise prices there is also the potential of a “substitution effect” towards other, cheaper alcoholic beverages like for instance craft beer which can be made locally.
- Current numbers do not look that good, even if one adjusts for one-offs etc. the stock is not “cheap”. The company cancelled the dividend for the current year.
- Even before the Brexit discussion, the business had weakened. The earnings peek has been the business year 2013/2014
- As everywhere in retail, online is definitely an issue for the wine trade.
So why not just filter out the company at this stage and move on to more interesting stuff ?
Well, first I made the experience that “macro stress” often creates opportunity for the more adventurous investor. The UK Brexit debate could be one of those instances. At them moment it looks that people expect more and more the “Hard Brexit” which in turn could mean that maybe (and that is a big maybe) a lot of risk is already priced in.
That macro stress is not a reason to buy per se but in my experience often justifies to look deeper if there is opportunity (and value).
Secondly, I would recommend anyone who likes to read good annual reports to read the 2015/2016 annual report of Majestic, which in my opinion is one of the best annual reports I have been reading for a long time. Why ? This leads us to the most interesting aspects of Majestic:
The “Naked Wine” acquisition and the new CEO Rowan Gormley
In early 2015, Majestic acquired online Wine retailer Naked Wines for 70 mn GBP. Coincidence or not, the Majestic CEO had just been fired a few weeks before and the CEO of Naked Wine, Rowan Gormley became CEO of Majestic.
Interestingly, Rowan Gormley decided not to receive cash for his personal stake in Naked Wine but opted for Majestic Wine shares instead (for the most part) and is now the second largest shareholder with 6,4% (after the founding Apthorp family).
Normally, if you google a CEO and almost any picture you find shows you the guy either with a glass or a (big) bottle of wine, you might get concerned as he maybe is drinking too much. Of course this is different for someone running (passionately) a wine business.
- born in South-Africa, trained as an accountant, age 54
- started as an accountant
- worked in Private Equity
- Started to work for Richard Branson / Virgin
- Founded Virgin Money
- Founded Virgin Wine which was sold
- Founded Naked Wine which was sold to Majestic
He also seems to possess a healthy dose of humour. This is how he describes his first two jobs in his Linked.in profile:
1995 – 1999 (4 years)
1983 – 1986 (3 years)
Gormley is clearly a good communicator and story-teller. Normally, I am not such a big fan of “CEO story tellers” because telling a story and actually doing things are characteristics which are rarely found in one person. So I think it is quite important to check if the stories that are told are supported by facts. I think there are clear indicators that Gormley is more than a story-teller. According to this article for instance, he was offered a significant long-term incentive plan of around 7 mn GBP which he declined and passed on to his employees.
Another “walking the talk” is capital allocation. Gormley and his CFO speak a lot about capital allocation, but in my opinion the proof that they take this seriously was the decision to cancel the dividend. They could have paid it but in the current situation it was clearly better to preserve the cash and invest in the business. Clearly many investors want to have their cake and eat it at the same time but in reality and for the long-term benefit I think this was a very good decision.
So what is so special about Naked Wine ? There is a very good video from 2010 explaining how Naked Wines work:
My interpretation is the following: Naked Wine could be a very interesting business because it combines elements of a typical “platform business” with a loyal “Amazon Prime” like customer base.
The “platform” is to link (small) producers with customers directly, which up until now was quite difficult for both sides. The “angel” concept is also quite clever marketing and convincing someone to pay 20 GBP per month is clearly only possible if the customer is really interested and satisfied with the product.
The question is of course: How expensive is it to get more “Angels” on the platform and will those expenses pay off in the long run (will the stay long enough). Reading the available material (including the 6 month trading update), it is not easy but Gormley seems to approach this with a very data driven approach which should help them to identify the best ways to expand the customer base. Reading for instance the 2016 trading update we can read the following:
The decision was taken to accelerate a number of initiatives, including testing a significant new direct mail campaign. It is now clear that, whilst most initiatives were successful, the direct mail campaign was not. We have now stopped this investment, but the short term impact will be higher costs in the first half of the year, with fewer new Angels acquired than hoped also impacting profits over the next 12 months. Accordingly, we now anticipate that the Naked Wines business will move back into making a small loss for the current financial year with an EBIT performance also approximately £2m lower than expectations.
Whilst it is disappointing that the direct mail channel has not proved to be as viable as early tests suggested, we are getting very encouraging returns from other channels, and are ready to scale them when we are confident that the returns are sustainable
This pretty much sounds like it was directly taken out of the “Lean Start-up” playbook: Test, measure and then either continue or “pivot”. To me this looks like a very good approach but investors seem to prefer the “smooth” earnings approach.
I do think that Naked Wine also fits into the current big trend that consumers at the higher end of the spectrum want to know more where their food (and beverages) come from and prefer more artisanal products which creates issues for big brand producers.
Wine was always to a large extent artisanal but in a normal supermarket shelf, it is not so easy to create a relationship between vineyard and customer.
The most interesting aspect is of course that potentially this could mean that Majestic could access and grow in the huge US market which would be very difficult through a classic retail concept.
Another interesting aspect (and proof that those guys are still very entrepreneurial) is that they seem to try out if the concept also works for local/craft beer in a new beta version.
I think that is fair to say that the ultimate success of Naked Wine is not yet proven, but they clearly are approaching it in a different way and have come quite far with currently ~100 mn GBP of sales and being more or less break even on a GAAP basis. With regard to the GAAP account one needs to be aware that Naked Wine is fully expensing all new customer acquisition costs.
From what I have heard, if the would stop acquiring new customers and just stabilize the current ones (including churn), the business should already generate 6-7mn GBP profit annually. Insurance companies in comparison for instance are able to capitalize their customer acquisition costs which of course makes GAAP results much better.
The traditional wine retail business
For any intermediary, there are three major forces which influence the potential profitability:
Power of suppliers, power of customers and competition. The wine trade scores well in the first two categories. Suppliers (vineyards) are very fragmented and there are no dominating buyers, most of the business is retail and even in commercial they trade mostly with single restaurants. However competition is clearly an issue, mostly with supermarkets pushing into wine trading.
However I do think that there is space for specialist retailers. Take Germany as an example. Germany has two of the most aggressive discounters in the world (Aldi & Lidl) which pushed hard into wine a few years ago and are offering more and more wine above 10 EUR per bottle. But the listed Wine retailer Hawesko has been going strong for many years and is actually gaining market share in the “premium” segment.
How can this be ? I think this has to do with the fact that the wine market is much more “Bifurcated” than for instance beer or spirits. According for Hawesko for instance, 5 bn EUR of Germany’s 7 bn EUR wine sales are in the low-cost area (below 4 EUR) which is covered by the supermarkets / discounters. That still leaves a significant segment for specialist retailers.
For wine, people in general are prepared to pay much more for something “special” like for beer or “Normal” spirits.
In the past, Majestic easily managed to generate ROE and ROIC of 20% on average with a net margin between 5,5-6,5%, which clearly shows that the business as such is (or has been) pretty Ok.
So now comes the more difficult part. How can we value the business ? Based on the normal multiples, Majestic doesn’t look like a value stock:
Market Cap: 206 mn GBP (at 2,92 GBP/share)
P/E (trailing) 85,6
P/E (2016): 21,9
Div. Yield: n/a
Majestic doesn’t give any profit targets, only a sales target of 500 mn GBP for 2019.
If we assume that Majestic reaches the sales target and manages to return to its old margins of between 5-6%m this would mean an expected net profit of 25-30 mn GBP. Based on today’s 210 mn GBP market cap, one would buy Majestic at an implicit 2019 P/E of 7-8,5. One could then attach a “fair” or “mean reversion” P/E multiple which in my opinion would be in the 12-14x range (Hawesko trades at 19x).
However there is clearly a risk that there are negative surprises as we have already seen in the 6 month trading update. The current market clearly is nervous when expectations are not met which we can clearly see expressed in a -30% share price drop directly afterwards:
Putting an assumption (future margins) on top of another assumption (P/E mean reversion) is clearly not classic value investing.
Another attempt to approach this would be to assume the following. Based on a longer term average for EPS (20 pence per share over the last 10 year), the current market cap more or less should cover the value of the traditional business including the Brexit risk and the leverage from the Naked Wine acquisition. So the Naked Wine business comes for “for free”.
The question now is: How much is Naked Wine worth ? The 70 mn GBP they paid or even more ?Structurally they Naked Wine business could actually lead to higher margins and ROICs than the traditional basis. No retail outlets, prefunding through the “Angels” and low staff requirements could make this a very interesting business and one could argue for significantly higher margins than the traditional business.
Form a value perspective, I do think it is quite interesting to get something at “fair value” plus a significant “option”, especially as the principal “proof of concept” is already there (there is a significant market). There is another “option” there as well: I t will be interesting to see what a guy like Gormley will do when he combines his online asset with the physical stores of Majestic. According to the company, they have already combined the IT systems (Majestic of course uses Naked Wine’s) and you can pick up Naked deliveries at MAjestic. I think this could be a huge competitive advantage against other competitors at least in the UK.
Majestic Wine is a very interesting case. I think the stock offers good long-term value without looking like a typical value stock due to the potential of the “Naked Wine” business and a maybe temporarily depressed price due to Brexit.
It is also an interesting bet on an “Outsider style” CEO whose interest is aligned quite well with shareholders and who seems to know what he is doing.
That is why I bought a in total a 3,5% position (2,5% position back in September and 1% in October) share for my “Outsider bucket” of my portfolio at around 3,13 GBP/Share. In EUR, I am already down -9%, so any reader who will buy now already has a nice advantage…..
The stock will clearly be not a smooth ride, with the “real Brexit” on the horizon, but for me it is a very attractive “Outsider style” situation with a little contrarian aspect.
As always: this is not investment advise. Please DO YOUR OWN RESEARCH: