Initial thoughts from a Fund Manager on the Endeavour Group demerger from Woolworths

In Opinion
June 25, 2021
Zach Riaz

Given Woolworths Group (WOW) is a well owned stock, many clients may be asking what to do with the Endeavour Group (EDV) shares. We provide some initial thoughts below.

Thoughts upfront – we would suggest investors hold their EDV shares as we conduct further due diligence on EDV. We suspect any re-rating in EDV shares will come more from margin expansion expectations rather than significant top line growth potential. Further, given the stability of EDV earnings profile (notwithstanding a Covid-19 type event’s impact on the Hotels business), capital management and shareholder returns could also be very attractive. Of course, investors may take a negative view on Endeavour as it doesn’t qualify under ethical and social screens, which could see the share price come under some selling pressure as some existing WOW shareholders exit the stock and going forward it may be difficult to attract new investors for this very reason. We have provided an estimate of what EDV shares could be worth below – our SoTP valuation comes out at $7.21 per share. We will provide a further update on WOW and EDV post their respective August results update.

Demerger Recap

Eligible WOW shareholders will receive one EDV share for every share they own in WOW. Post the demerger, WOW will still own 14.6% of EDV, with the other major shareholder being Bruce Mathieson Group (BMG) (also owns 14.6% of EDV). Post demerger, Woolworths will be predominantly a food business (Aus & NZ), whilst Endeavour will be a leading retail drinks (Dan Murphy + BWS) and hospitality operator in Australia. The size of the business means EDV will be counted among the ASX50 stocks (by market capitalisation).

Source: Woolworths

Source: Woolworths

Rationale
– As an independently listed company, EDV’s management team will have more control over the strategic direction, capital allocation and capital management, with greater access to capital markets. We expect top line growth for the overall business to be GDP+ type (3% to 4% p.a.). Further, we expect some EBIT margin expansion, both from a recovery in hotels (from Covid-19 impacts) and improved operating efficiency with a more focused management team.

– WOW becomes a very focused supermarket business (which can also be viewed as a negative!), with a strong balance sheet post the demerger. It will be interesting to see what WOW’s management does with the Big W business. We appreciate the business is seeing a turnaround, however we still consider it non-core for WOW and Big W’s end markets remain challenging and competitive. Post the EDV demerger and a cleaner business model, management is likely to focus on shareholder returns with an improved FCF profile and less capital expenditure requirements. Beyond this, WOW could very easily consider other strategic opportunities to chase (via acquisitions potentially).

– It has been reported WOW sought to exit EDV in order to increase its appeal to ESG investment mandates. However, WOW has retained a 14.6% stake in EDV. If the target is ESG investors for WOW, then we should assume over time WOW will divest its holding in EDV. This may represent some overhang on the EDV’s shares, however there are plenty of institutional mandates who could easily acquire WOW’s EDV stake in a large trade block sale without too much disruption.

What are EDV shares worth?

We have provided our back of the envelope sum-of-the-parts valuation for EDV below to give investors a framework on how to perhaps think about EDV’s valuation and what the shares could be worth. We have provided our FY21 estimates and multiples applied using relevant peer groups (one could argue we could expand this peer group to include international players as well) in the table below.