Description

Description:

C&C Group is a company that has been posted on VIC before, so going to keep the company description brief and focus most of the attention on why the investment is attractive today.

C&C Group plc (“C&C”) is a leading, vertically integrated premium drinks company which manufactures, markets and distributes branded beer, cider, wine, spirits, and soft drinks across the UK and Ireland. C&C Group’s portfolio of owned/exclusive brands include: Bulmers, the leading Irish cider brand; Tennent’s, the leading Scottish beer brand; Magners the premium international cider brand; as well as a range of fast-growing, premium and craft ciders and beers, such as Heverlee, Menabrea, Five Lamps and Orchard Pig. C&C exports its Magners and Tennent’s brands to over 40 countries worldwide. C&C owns brand and contract manufacturing/packing operations in Ireland and Scotland. Following the Company’s acquisition of Matthew Clark and Bibendum (“MCB”) in 2018, C&C established itself as the No.1 drinks distributor to the UK and Ireland hospitality sectors.

Why does this opportunity exist – The set-up:

The last few years have been particularly difficult for the UK hospitality sector. During this time, C&C has endured a string of non-stop macro issues (e.g., covid lockdowns, labor constraints, material cost inflation, recent rail strikes in the UK), all of which have obstructed the Company’s ability to display its financial strength and true earnings power driven by its strong core brands and unrivalled distribution network. These headwinds along with fears of a recession have caused analysts to keep pushing out their timelines for when C&C will be able to return to normalized EBITDA and FCF generation. In our view, this has resulted in shareholder fatigue and a lack of enthusiasm from potential investors in the C&C story. Recently, (On May 19, 2023), C&C announced challenges implementing an ERP system upgrade in the MCB business in Great Britain, resulting in a one-off impact to the company’s FY 2024 (ending February 2024) financials and adding to the list of reasons to reduce earnings forecasts and delay C&C’s timeline of getting back to pre-covid / normalized levels. As if investors didn’t have enough disappointing news, it was also announced that David Forde, C&C’s CEO, will be replaced by the current CFO.

It is our sense from talking to the Company that David Forde was fired following his poor handling of the ERP system debacle and the board felt the need to hold him accountable.

While the macro-outlook remains uncertain in the near term, we believe the share price embeds far too much pessimism for a well-positioned business over the long-term. Therefore, we believe the stock is set up for a compelling risk/reward for the long-term investor due to the company’s low valuation levels.

Investment Thesis:

The distribution channel is becoming increasingly more important in the industry:

From an industry standpoint, alcohol regulation in the UK is intensifying, making it more difficult for brands to sponsor events and market their brands effectively. Additionally, the beverage industry has become more saturated, giving consumers more options than ever before to choose from when selecting beer, wine, or spirits. For instance, 10 years ago there was 1 red and 1 white at the bar. Today there’s more like 20 reds and 20 whites. There used to be 7 or 8 beers at the bar, but today there’s more like 20 beers. Since consumers are demanding more choices at the point of retail, we believe the companies who can get their beverages on the bar, behind the bar, and visible for consumers are going to win, giving more power to the distributors and making their service increasingly important within the industry.

This is why we believe C&C’s strategic acquisition of MCB in 2018 was so important and transformational. By establishing itself as the No.1 drinks distributor to the UK and Ireland hospitality sectors, we believe C&C is well positioned to further expand their own brands, by simply pushing them through their broader and more powerful distribution network.

The benefits of combining distribution with C&C’s own brands was explained in further detail in the company’s 2022 investor day presentation (which we encourage you to go through). The company’s strategy is focused on 1) expanding their customer base, 2) taking greater share of the customer wallet and 3) deepening the penetration of their own brands and agency brands – a formula we think makes plenty of sense and would enhance the company’s margin profile long-term (*this is not needed for the stock to work or included in our valuation assumptions).

During H1 2023 and the Company’s FY 2023 earnings calls, management highlighted progress in this growth strategy. For example, the company displayed positive results growing their agency and equity brands, driving growth in their premium beer brands and winning new distribution customers (e.g., Redhat), all of which gives us more confidence that C&C has the access, brands and capability required to execute on their strategic plan.

To further support our view in the power of C&C’s distribution channel, it’s worth nothing that in 2021 C&C received an 8% equity stake in Innis & Gunn, a Scottish craft brewer, in exchange for assisting the company’s growth profile. A long-term incentive scheme was also put in place which will make a number of additional shares available to C&C (up to 20% equity ownership) based on performance targets being met. Under the new partnership, as Innis & Gunn starts to significantly increase brand presence and investment in England, C&C will use its position as the largest independent beverage-alcohol distributor in the UK and Ireland to increase the distribution and availability of Innis & Gunn beers. Innis & Gunn will continue to be responsible for all brand marketing and for sales and distribution to national pub chains, the off-trade and current international markets. We find this sort of partnership interesting and think that C&C will likely attract more brands and partnerships in exchange for “sweat equity” (no capital investment made) overtime, which could offer incremental upside to equity holders’ down the road (not included in our valuation).

C&C is competitively well positioned and is likely to take market share during a tough macro backdrop:

Today C&C’s distribution network delivers to ~30K outlets in the UK and Ireland and our diligence, suggests that MCB is massively advantaged because they have the widest offering and biggest scale, which creates a fly-wheel effect. For instance, because MCB distributes to large nationals and big hospitality accounts, massive brands (e.g., Diageo) want to do business with MCB and because more brands get put on their platform, more pubs and restaurants want to do business with MCB and hence the fly-wheel spins. This fly-wheel further benefits C&C from a scale perspective, MCB gets better procurement deals with brands it supplies than smaller or regional competitors. This offers the company a competitive advantage on the cost side, which we view as important in what is typically an industry that operates at low profit margins. Additionally, the establishment of an inhouse data and insight product called PROOF, which pools all of C&C’s sales data together to offer real-time consumer trends is another way for the business to differentiate itself. This data can then be used to help C&C better service their distribution partners and customers, which we believe will increase customer switching costs and better position the company to win more business vs. less scaled players (not to mention give C&C greater insight into driving sales for their own brands). Balance sheet strength is another important competitive advantage since an important aspect of the distribution business is often extending credit to customers. Our diligence suggests that this tends to help differentiate larger and well capitalized distributors like C&C who are able to step in when it becomes difficult for smaller players who are less willing to work with customers during times of stress.

To be clear, a recession would not be good for the business by any means. However, we believe C&C should weather the storm should macro headwinds worsen and come out the other side stronger.

For reference, during covid Britvic decided to exit the distribution wholesale business in the Irish on-trade market, bringing 3 national distributors down to only 2. Also, during that time, C&C disclosed several customer wins on the distribution side (e.g., St. Austell pub company, Robinsons pub company, Ei Group). We also think it is important to note that the latest ERP debacle will and has impacted customer service levels near-term, but we are confident the business will recover and gain share overtime. In our view, Covid helped highlight the strength of C&C’s franchise, especially during tough times, and we believe it’s well positioned competitively in the future.

Negative revisions over the last few years have tempered expectations:

As mentioned above, since 2020, the company has faced one headwind after the other causing the company’s eventual return to normalized earnings to be delayed. We show this chart simply to showcase the frustration C&C shareholders have experienced over the last few years as investors and analysts alike have had to consistently revise their projections downward due to macro headwinds (e.g., covid, inflation, rail strikes, weakening consumer) and now ERP challenges facing the company heading into FY 2024. We think there is plenty of fatigue in this name and believe the lack of enthusiasm help set the company up for a compelling risk/reward on the long side.

Current valuation levels are unsustainable over the long-term:

In terms of valuation, this business has historically traded at ~9-11x EV/ EBITDA (pre-covid, pre and post-acquisition of MCB). Precedent transactions for branded beer businesses support EV/ EBITDA M&A multiples in the double digits. Furthermore, we believe the industry dynamics increase the importance of the distribution channel going forward and therefore we believe the addition of MCB increases the value of C&C’s franchise.

Taking a step back, in 2020 (pre-covid) Adj. EBITDA (Pre-IFRS) was 132M. Following the MCB acquisition, mgmt. took out ~18M of costs in the business, which implies that the new run-rate pre-covid EBITDA for the business is ~150M. With an Enterprise Value today of ~635M GBP shares trade at <5x Pre-covid EBITDA & ~4x Pre-covid EBITDA including the 18M cost cuts.

To be fair, this business has experienced material cost inflation (like many other UK companies), so we aren’t expecting the Company to get back to these pre-covid levels, but C&C continues to raise pricing in order to help offset some of these cost headwinds. We anticipate FY 2024 to be a challenging year as the company is experiencing ERP headwinds, more input cost inflation and consumers face cost of living pressure, which may dampen demand at the pub. We also suspect margins should start to recover around FY 2025 as input cost inflation subsides and branded business margins benefit from price increases. With that said, assuming the company can do ~100M of Pre-IFRS EBITDA by FY 2026 @ an 8x multiple it implies ~1.90 share price or ~35%+ upside and at a 10x multiple, it implies ~2.45 per share or ~70%+ upside (including free cash flow during the interim).

We think 100M Pre-IFRS EBITDA is fairly conservative given we assume the business grows 3% from FY 2023 – FY 2026 (basically just pricing the company will likely pass off per year offset by slight volume declines) and ~5% EBIT margins. For reference, the business did ~7% EBIT margins pre-covid before taking the 18M costs into account and did ~6% EBIT margins in H1 2023 before experiencing disruption in H2 from nonrecurring rail strikes around Christmas and ERP system headwinds, which are also one-time / nonrecurring.

Our bull case financials scenario: If the company can do ~16% branded EBIT (it did ~25% EBIT margins pre-covid) and 4% distribution margins by FY 2026, it would imply ~6% EBIT margins and ~118M of Pre-IFRS EBITDA. At 10x this ~118M number by FY 2026 it implies ~2.90 per share or ~100%+ upside (including free cash flow during the interim).

While the near-term fundamentals can get worse, we believe the risk-reward is compelling at these levels since you’re paying a low multiple on already depressed earnings. A full-blown recession would obviously be a risk to the shares, but we believe C&C’s business is here to stay through the cycle, will come back stronger vs. industry peers and we don’t view drinking with friends at the pub or restaurant to be going out of style. At <6.5x our conservatively projected FY 2026E EV/ Pre-IFRS EBITDA, we believe there is a lot to like in C&C with leading brands and a distribution-led model.

Insiders also think the shares are mispriced. Following the May 19, 2023 announcement regarding the ERP system and new CEO change, Patrick McMahon (new CEO) and Ralph Findlay (Executive Chairman) purchased shares in the open market.

Lastly, because of the company’s strong competitive positioning and historically proven free cash flow generation, we believe C&C presents private equity funds with a compelling take-private opportunity and therefore would not be surprised if this business were to be sold in the next few years.

Catalysts:

Business normalization and execution, increasing dividend payments, share repurchases, take-private

Risks:

Recession / cost of living crisis and inflation worsens, reduction in on-trade sales and branded business margin profile, inability to raise prices further to offset inflation, timeline to normalized earnings gets pushed out well beyond FY 2026.

Catalyst

Business normalization and execution, increasing dividend payments, share repurchases, take-private