Andrew Peller Limited Report

Andrew Peller Limited

The graph shows modest but steady growth in revenues per share and strong growth in earnings per share.

Andrew Peller Limited
RESEARCH SUMMARY
Report Author(s):  InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold no shares
Based on financials from: March ’16 Y.E. + Q2 ’17
Last updated: 27-Jan-17
Share Price At Date of Last Update: $10.79
Currency: $ Canadian
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): (Lower) Buy rated at $10.79
SUMMARY AND RATING:  The graph of revenues per share (red line) shows  modest but steady growth. Earnings per share growth was stronger at almost 14% annually in the past five years. The Value ratios would indicate only a Weak Buy Hold. Management quality and integrity appears to be strong. The insider trading signal is moderately negative. Executive compensation is not excessive. The outlook is for modest growth. The company has some competitive advantages in terms of brand loyalty but also faces low-cost imported competition. The company should continue to prosper over the years and appears to be a relatively low risk operation. Overall we would rate this as a (lower) Buy. A reasonable strategy might be to take an initial small position with a view to adding to that if the price becomes more attractive.
DESCRIPTION OF BUSINESS: (Based on the year ended in march 2016). Andrew Peller produces wine across the spectrum of prices. Its brands include Peller estates, copper Moon, Skinny grape, Hochtaler, Wayne Gretzky. While it has 10 vineyards it appears that roughly 95% of its grapes are purchased. It has 7 wineries some of which are classified as estate wineries.  96% of sales are in Canada the remainder is primarily to the U.S. although there are modest sales in 20 other countries. The company sells wine-making products across Canada through 170 authorized wineexpert retailers and 600 independent retailers. The company owns and operates 100 wine retail stores under the banners: Wine Shop, Wine Country Venters, and Wine Country Merchants. There are 1,134 employees of whom 476 are in the retail stores.
ECONOMICS OF THE BUSINESS: The economics appear reasonable good in that it sells branded products which do not compete strictly on price. Profits on sales are 6.5%. Sales are 107% as large as the ending asset investment and equity is 53% as large as assets. This results in an attractive 13.2% return on ending equity.
RISKS: We would consider this to be a relatively low risk company in that sales volumes and prices are relatively stable and costs are also relatively stable. Potential risks would include product contaminations and changes in where wine can be sold and possible increases in taxes.
INSIDER TRADING / INSIDER HOLDING: (From June 1, 2016 to January 23, 2017) The controlling Peller family sold about 14% of its non-[voting class A shares at 11.50 in late December. Another large owner sold a small portion of both its a and B shares at about $10 in July and August. An insider sold 9000 A shares at $11.33 in July to hold 93,000. There was one buy in the public market, an insider bought 2500 Class B voting shares at $12.44 in November to hold that same amount. Several insiders were buying regularly “under a plan”. Overall the insider trading signal is at least moderately negative.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (pass), has favorable long-term economics due to cost advantages or superior brand power (at least marginal pass due to established  brand value), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (pass), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass)
MOST RECENT EARNINGS AND SALES TREND: Adjusted earnings per share growth in the past four quarters beginning with the most recent was 7% 25%, minus 78% and 20%, In the same four quarters revenue per share grew 4%, 6%, 8% and 8%. Overall the recent earnings trend is relatively strong.
COMPARABLE STORE SALES  OR INDUSTRY SPECIFIC STATISTICS
Earnings Growth Scenario and Justifiable P/E: The current P/E of 20 can be justified with growth of about 9% in earnings per share over the next five years.
VALUE RATIOS: Analysed at a price of $10.79 and based n the A shares. The price to book value ratio is 2.64. The dividend yield is  modest at 1.5% and represents a payout ratio of 30% of trailing earnings. The trailing adjusted earnings P/E ratio is moderately unattractively high at 20 although it would be perhaps 18 if some unusual expenses were adjusted for. The ROE is strong at 13.7%. Adjusted earnings per share grew a compounded average of 12.8% in the past five fiscal years which is very strong and the growth was steady. In that same 5 year period revenues per share grew at a smaller (and very steady)  rate of 4.9% indicating that earnings were increased through higher margins and cost efficiencies. We calculate an intrinsic value of only $7.81 if earnings per share grow at 5% for five years and the P/E declines to 14 and $11.76 if earnings per share grow at 9% for five years and the P/E declines to 18. Overall, the value ratios indicate a strong company which however is likely about fully valued and therefore indicating only a Weak Buy / Hold rating.
SUPPORTING RESEARCH AND ANALYSIS
Symbol and Exchange: ADW.A, Toronto
Currency: $ Canadian
Contact: info@andrewpeller.com
Web-site: www.andrewpeller.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS
Latest four quarters annual sales $ millions: $342.2
Latest four quarters annual earnings $ millions: $21.7
P/E ratio based on latest four quarters earnings: 20.7
Latest four quarters annual earnings, adjusted, $ millions: $22.4
BASIS OR SOURCE OF ADJUSTED EARNINGS: We used management’s figure for adjusted earnings which in recent quarters excluded unrealized gains and losses on certain financial hedges. In prior years we used earnings from continuing operations or a similar figure provided by management.
Quality of Earnings Measurement and Persistence: The earnings quality is strong. The amortization of the value of purchased customer relations (which are unlikely to be eroding) causes earnings to be understated by perhaps 5%.
P/E ratio based on latest four quarters earnings, adjusted 20.0
Latest fiscal year annual earnings: $19.2
P/E ratio based on latest fiscal year earnings: 23.4
Fiscal earnings adjusted: $20.3
P/E ratio for fiscal earnings adjusted: 22.1
Latest four quarters profit as percent of sales 6.5%
Dividend Yield: 1.5%
Price / Sales Ratio 1.31
BALANCE SHEET ITEMS
Price to (diluted) book value ratio:                                            2.64
Balance Sheet: (As of Q2 fiscal 2017) Assets consist as follows: 38% is wine inventory, 36% property plant and equipment (includes 10 vineyards, 7 wineries and several offices and warehouses), 12% purchased goodwill, 10% accounts receivable and 3% intangibles (mostly the purchased value of brands and customer relationships plus some software). These assets are financed as follows: 53% by owners equity, 25% debt, 13% payables, 5% by deferred income taxes, 2% by a reserve for post-employment benefit obligations and 2% other small items and rounding.
Quality of Net Assets (Book Equity Value)  The book value of the equity in assets is solid as evidenced by the low double digit ROE and by the nature of the assets (see the description of the balance sheet).
Number of Diluted common shares in millions:                                     41.4
Controlling Shareholder: The company is controlled by the Peller family’s holding company called Jalger. Mr. E. J. Kernaghan of Toronto, Ontario owns 10.1% of the voting shares.
Market Equity Capitalization (Value) $ millions: $446.9
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 52.9%
Interest-bearing debt as a percentage of common equity 47%
Current assets / current liabilities: 2.0
Liquidity and capital structure: The liquidity and capital structure are strong with good cash generation and a relatively modest debt level.
RETURN ON EQUITY AND ON MARKET VALUE
Latest four quarters adjusted (if applicable) net income return on average equity: 13.7%
Latest fiscal year adjusted (if applicable) net income return on average equity: 13.3%
Adjusted (if applicable) latest four quarters return on market capitalization: 5.0%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE
X years compounded growth in sales/share 4.9%
Volatility of sales growth per share:  $                                    –
X Years compounded growth in earnings/share 11.5%
X years compounded growth in adjusted earnings per share 12.8%
Volatility of earnings growth:  $                                    –
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? Yes
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 9.3%
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 9.0%
OUTLOOK FOR BUSINESS: The company appears to be projecting only modest earnings growth, if any, in fiscal 2017 although sales are expected to increase.
LONG TERM PREDICTABILITY: The company should continue to grow over the years although earnings growth may slow versus the level of the past five years.
Estimated present value per share: We calculate  $7.81 if adjusted earnings per share grow for 5 years at the more conservative rate of 5% and the shares can then be sold at a P/E of 14 and $11.76 if adjusted earnings per share grow at the more optimistic rate of 9% for 5 years and the shares can then be sold at a P/E of 18. Both estimates use an 6.5% required rate of return.
ADDITIONAL COMMENTS
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (marginal pass as new players face the difficulty of establishing brand recognition). No issues with powerful suppliers (marginal pass as Ontario Grape growers sell through an association and there is only one suitable glass provider in Canada). No issues with dependence on powerful customers (marginal pass at best as provincial liquor agencies are major direct customers), No potential for substitute products (pass) No tendency to compete ruinously on price (marginal pass as some wines are certainly sold at discount prices). Overall this industry appears to be only marginally attractive according to these tests.
COMPETITIVE ADVANTAGE: The company’s established brands and the reputation of those brands provide some competitive advantage. It also operates wine stores which provide some advantage in terms of distribution. However, the company notes that it faces competition from low cost wine imports to Canada. And the company uses Canadian grapes for its premium wines while noting that imported grapes are cheaper.
COMPETITIVE POSITION: The company’s share of the Canadian wine market was 14.4% in 2016
RECENT EVENTS: The company continues to win numerous industry awards including being named Canadian wine producer of the year in December 2015. It is nearing completion of its Wayne Gretzky Estate Winery at Niagara-on-the-Lake. It now has also started selling A Wayne Gretzky branded whiskey getting into the distilled products business for the first time.
ACCOUNTING AND DISCLOSURE ISSUES: There is an unusual feature whereby the earnings per share of the non-voting A shares are different from that of the B shares. As is often the case, the purchased value of brand names and customers is lumped in with software. There is an amortisation of purchased customer relations that could be adjusted for and that would add about 5% to the adjusted earnings. Some modest unusual expenses for a quality problem in 2016 and a failed acquisition bid in fiscal 2017 were not added back which is a conservative approach.
COMMON SHARE STRUCTURE USED: The main trading shares are non-voting A shares. The voting B shares also trade and have a dividend that is only 87% as large as the A shares and are considered to have an earnings per share that is 87% that of the A shares. Note that if there is a takeover offer for the voting B shares the non-voting A shares have “no right to participate” which is a negative factor for the A shares.
MANAGEMENT QUALITY: Management quality appears to be strong. We like the focus on ROE and book value per share and also its conservative approach to financing and to reporting adjusted earnings.
Capital Allocation Skills: The company appears to have a good history of prudent capital investment and financing. In fiscal 2016 it repurchased 100,000 shares from its family holding company at market and the share price has increased substantially since then.
EXECUTIVE COMPENSATION: Compensation for the five named officers is modest at from about 400k to 700k but the CEO is at $1.7 million. This level of compensations is not excessive for a company of this size and success.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. There are three family members on the Board, one of whom is the CEO, Three members represent investment companies, one is a management consultant and one is involved with a foodservice company. Overall this appears to be a  good board with strong representation from the founding family that controls the company.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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