Description

Elior (ELIOR FP) (“Elior” or the “Company”) is a €2.5 billion market cap French food service and catering company.  It operates three businesses grouped into two divisions: Contract Catering & Services, (72% of 2017 revenues and 64% of EBITDA) and Areas, the Concession Catering business (28% of revenues, 36% of EBITDA). Contract Catering operates kitchens and meal services, usually on-site in an institutional setting – mostly for healthcare, education and commercial clients - and the services group (estimated 10% of division sales) provides primarily cleaning services, often to the same clients. Though it has lower profit margins than the concessions business, Contract Catering requires little capital as the client often provides the facilities, though in some cases a central company kitchen is used. Concession Catering operates retail food services in airports, motorways, railroads, etc. This business has higher margins but usually requires a greater upfront capital investment. Contracts tend to be longer (typically 10 years) but the business is also more economically sensitive than Contract Catering.

Elior has seen its stock price cut in half over the last year as the company has missed growth and margin expectations due to a combination of internal and external factors.  In addition to depressed valuation, the Company has many of the characteristics that we look for in a turnaround candidate - we believe that the underlying business is still healthy, the external issues should resolve themselves over the next year, and most importantly, a new Management team, including a new CEO with turnaround experience has been hired and has started to execute to a plan to restore profitability.  Management incentives are now clearly aligned with shareholder value.  Despite these developments, investor skepticism following the repeated mistakes of the previous CEO and the conservative guidance given at the recent Capital Markets Day has left the stock trading near its all-time lows and at a significant discount to peers.

Our takeaway from our meetings with the new Management is a focus on the operational basics and a clear plan to reverse the drift of the last few years and restore profit margins. At around 15.5x depressed EPS and 8.6x EV/EBITDA, Elior’s stock doesn’t price in the upside of a likely turnaround.  We believe the stock has 35-50% upside (incl. a 3% dividend yield) over the next twelve months if management can execute on its plan.

History

Elior was founded in 1991, by Francis Markus and Robert Zolade who bought the contract catering subsidiary of Accor, initially operating only in France.  The Company grew through a series of acquisitions into the new business lines of concession catering and cleaning, as well as into new geographies – from its beginnings in France, Elior now operates in 16 countries worldwide with significant European operations in Spain, Italy and the UK, as well as the growth markets of the United States and India.  Elior was taken public in Paris in 2000, taken private in 2006 and IPO’d again in Paris in 2014.  Founder Robert Zolade remains the largest shareholder through BIM, his holding company.

Outsourced catering has historically been a good business, with stable revenues and solid returns on capital.  However, Elior’s European markets are fairly mature, especially France where industry growth is around GDP levels.  Elior augments this with acquisitions and expansion into under-penetrated markets such as the US which have a higher organic growth rate.  Under Elior’s previous CEO, Philippe Salle, the company had issued aggressive goals for growth and margins and pursued a strategy of competing on price to take market share in France.  Given the oligopolistic market structure in France’s contract catering market, the competitive response was exactly what you would expect, and margins and profits declined.  As results deteriorated Mr. Zolade (still the largest shareholder) became critical of the strategy and the board separated the roles of CEO and Chairman in July 2017, leading Mr. Salle to resign as CEO.

In November 2017, Philippe Guillemot was appointed as CEO.  Mr. Guillemot has held a variety of operational roles and was involved in turnarounds at Michelin and Alcatel Lucent (as COO).  He reorganized the management team, bringing in a new CFO focused on cash returns, and shaking up internal management and reporting.  The Company issued profit warnings in November, December and May reflecting the reduced profitability of the French contract catering business, the impact of bad weather and French transportation strikes, and the upfront cost of starting up new concession contracts.  Finally, at its Capital Markets Day in July, Elior provided new mid-term guidance through 2021 which was below consensus.  Analysts, no doubt wearied by the series of disappointments, reacted negatively with a further lowering of earnings estimates and price targets.

The Turnaround

Despite the events of the last year, we believe that there are reasons to be optimistic about Elior’s future.  The missed estimates and resetting of guidance over the last year are the legacy of the unrealistic goals and poor execution of the prior leadership.  By contrast, the new operational targets are the result of a bottoms-up budgeting process by the new team after a thorough review of the business and we believe that they represent a reasonable, conservative view of the company’s prospects. The balance sheet is in reasonable shape, with no major debt maturities until 2023 and a commitment to reduce leverage. Meanwhile the market for outsourced catering is still growing, particularly in the US.

While guidance of organic revenue growth above 3% and EBITA growing at twice the rate of revenue does not sound especially ambitious, we believe that it represents a baseline that is achievable and can be exceeded.  Around a third of the recent margin pressures relate to weather and transport strikes, both of which should normalize over the next year or two.  Another portion relates to startup costs on concession contracts which should pass as the business matures.  Finally, around half of the margin pressures have come from the aforementioned aggressive bidding on contracts - a self-inflicted wound.  Typically, these contracts are re-bid every five years, and Mr. Guillemot is very clear that Elior will be extremely rational on price moving forward.  His consistent public comments on rational bid behavior and pricing are a clear signal to competitors such as Sodexho, and we expect margins on new business to return to historical levels.  That said, it will take around 5 years to fully turn over the book of mis-priced business, so the results will still only be partially reflected by the guidance horizon of 2021 and we expect margin improvement to continue thereafter.

While 2018 and 2019 will show lower margins (7.5-7.8% EBITDA) the effects outlined above should mean a real pickup in 2020 and 2021, with margin upside from contract repricing extending at least a couple of years past that point.  In addition, the Company has begun to focus more deeply on areas like procurement (30% of costs, and Mr. Guillemot’s first major hire) and working capital.  An emphasis on ROIC metrics and a commitment to deleveraging gives us comfort around capital allocation, where we expect most free cash flow to be dedicated to debt paydown or investment in the US business where Elior is growing quickly both organically and through accretive acquisitions. Increasing scale in the US, UK and Italy should help increase margins in future.

Incentives are aligned also: Mr. Guillemot’s short-term bonus is tied to free cash flow generation and his long-term incentive plan is tied 60% to growth in adjusted EPS, and 40% to total shareholder return relative to Elior’s peers.  Other top executives have similar incentive structures.

Valuation

At current prices, Elior trades at 8.6x EBITDA and 15.5x P/E on FY 2018 (September year-end) estimates.  These multiples compare to historical multiples of 10-13x EBITDA and 25x P/E.  Peers such as Sodexho, SSP Group, Compass, Aramark and Sligro are trading at 10-13x EBITDA and 17-25x P/E, and while each company has a different business and geographic mix, we regard the discount as too wide.  Conservatively, we are not underwriting a return to peak multiples but using 9x EV/EBITDA or 18x P/E on FY 2021 estimates (still a significant discount to peers), implies a stock price of over €20.  There’s also the 3% dividend yield and upside potential from faster margin improvement, cost cutting and accretive M&A.

Split-up Potential

Mr. Guillemot is very clear that there is no real synergy between the two main businesses of Elior – concessions and contract catering - “other than best practices”.  This opens the possibility of splitting up and selling part of the group once the base margins are on an improving trajectory.  While we are not relying on a breakup to crystallize value for us, we note that founder Robert Zolade still controls over 20% of the stock and has been active and influential in driving recent management changes.  We believe that if the Company is not turned around, a split-up and a piecemeal sale is not a far-fetched scenario.  On the Concessions side, SSP Group trades for 1.4x EV/Sales and 12.5x EV/EBITDA compared to Elior’s 0.65x and 8.6x. Contract Catering and Services peers include Compass which has similar multiples to SSP, but French peer Sodexho trades for 0.8x EV/Sales and 11.8x EV/EBITDA. Even allowing for mix, geographic and scale differences we think that in a breakup scenario discounted multiples of 1.1x Sales for Concessions and 0.75x for Contract Catering would be reasonable. That would suggest a sum-of-the-parts value for Elior of €22/share. 

Disclaimer: This report is neither a recommendation to purchase or sell any securities mentioned. The author or affiliated funds  presently has a long position in securities of this issuer and may trade in and out of these positions without notice. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. Please do your own work.

Catalyst

Execution on the turnaround - margin improvement

Potential to split up the two divisions for sale