Financial Academy

The move by Fitch to revise the outlook to Negative from Stable shouldn’t be a surprise. It’s logical given the circumstances that Just finds itself in given the uncertainty created by CP13/18. We view the affirming of the A+ Financial Strength rating as a positive. In addition, Fitch also affirmed the rating on Just’s £230m Tier 3 subordinated debt at ‘BBB’.

We think it almost impossible to come up with a valuation given the uncertainty over the amount of additional regulatory capital that might be required post CP13/18. That said, there would have to be a massive hit to IFRS NAV to justify the fall in the share price that now puts it on discounts of 68% to EEV of 230p and 56% to IFRS NTAV of 169p at 30 June 2018.

We think that nothing has been ruled out by the company and this includes the possibility that the best way forward would be for Just to be part of a bigger group which might require lower regulatory capital than if it were to continue independently.

On this basis and the strength of the ongoing business with new business margins north of 10% we believe the shares are a Buy on a 12-month view. Short term the share price will probably be highly volatile, as they have been, until we get clarification of the additional capital requirement.

Just believes it can re-price its products to continued to earn an attractive return even with the increased capital requirements. The company questions the theory behind the increased capital requirements, using equity market type option pricing on an illiquid long term asset class like lifetime mortgages, and also questions why insurers are having to assume very different underlying house price assumptions for its residential mortgages (-1% per annum depreciation), versus banks (+2% house price appreciation). However, the unintended consequence is that the consumer will pay the price for the increased capital requirements, and also likely impact supply of the product (particularly in lifetime mortgages to younger people and couples).

However, Just’s main concern, and what impacts its capital much harder, is if the rules are applied retrospectively to the back book, to business it wrote between 2005 and 2015 (up until the implementation of Solvency 2). The company had assumed the rules would only be applied to new business post Solvency 2 (and hence could be managed through price increases to cover the increased cost of capital, similar to the initial implementation of Solvency 2), and not retrospectively to older business written under different terms and conditions. The company believes a longer transitional period is justified given any potential losses from the no negative guarantee, even in stress house price situations, would occur over 20 to 30 years, and losses over any likely transitional period would be minimal. For example, in their base case, the company expects £2.5bn of lifetime mortgages to mature in the next 10 years, with only £1m cumulative short fall from no negative guarantees. Even in a stress scenario, which they hold Sol 2 capital for (an immediate 28% fall in house prices with no recovery), the losses over the first 10 years are only £69m on £2.5bn of maturities. Even in this stress scenario, the company has received their initial advance back, plus a 5% compound interest rate over time, an attractive return on any asset class.

We previously stated $500mn was the tipping point for the deal becoming value accretive. On our numbers we estimate the deal is EPS neutral post synergies (larger-than-expected rights discount) but should generate 7% FCF yield with a ~10 year payback (assuming ~6% CAGR growth). ND/EBITDA of the consolidated company should fall to 1.75x by end of 2019. We applaud management for listening to shareholder views and for renegotiating a substantial discount on the transaction.

We view the earn-out clause as attractive given it implies $63mn EBITDA in 2020 which is $10mn above our post synergy EBITDA estimate at a cost of $53m – implies ~5x EBITDA on the earn-out.

Currently trading at ~55x our 2020 EV/EBITDA estimate of $80.6M, and ~34x our 2021 estimate of $139.5M, the stock is now valued at a slight discount to industry leader Canopy Growth (CGC), but at a substantial premium to the group.

By accepting lower margins (but higher volumes), JDW has consistently outperformed the wider pub market over a number of years, with lfl growth averaging over 4% since 2012. We think its position is now firmly cemented, with a cult brand, well over one million downloads of its order-and-pay mobile app, and competitors exiting the value segment of the market. We assume lfl growth of 3% can be delivered over the coming years, which may prove conservative. All else being equal, for every 1% increase in lfl forecast, EPS would increase by c10%.

Compared with its peers, JDW has a remarkably “clean”
cash flow statement, with few “exceptionals”, and one of the highest levels of cash conversion in our entire UK mid-cap consumer and leisure coverage. In our view, the company runs a particularly conservative P&L, with GBP66m of “repairs and maintenance” equivalent to c50% of group EBIT last year. We suspect many peers would have capitalised or simply not undertaken at least a proportion of that expenditure, and believe that higher-quality earnings deserve a higher multiple. At current levels, investors can buy JDW at a c6% FCF yield for sector leading growth.

Management has a clear medium-term leverage target of 3.5x net debt to EBITDA. That level has been maintained since 2015 through share buybacks (reducing the company’s share count by c15% in the last three years alone), and investment in greater freehold ownership (increasing the proportion of freehold pubs from 47% in 2014 to c60% today). If it were to maintain leverage at 3.5x, we believe JDW could spend nearly GBP300m on buybacks in the next three years alone – equivalent to c20% of its outstanding shares at current levels.

We first wrote on Amer back in the summer of 2017, highlighting that Amer could be an attractive target for VF or potentially other private equity suitors. What is clear today is that Amer’s portfolio of brands with a global footprint has made it attractive to ANTA who is seeking to expand its global presence. On top of its global footprint, Amer would also bring ANTA the opportunity to accelerate the growth of Amer’s brands in China, particularly Amer’s jewel in the crown, Arc’teryx. We would normally treat the approach for a European target from a Chinese consortium with some scepticism, but both ANTA and FountainVest are credible parties here. The industrial logic for the acquisition seems sound and so we are loathed to dismiss this out of hand. On top of this, as we identified last year, Amer could make an attractive target for a number of potential acquirers. As such, one cannot rule out the potential of this situation getting competitive, though we note that the most likely counter would come from VF who may well have their hands full completing the spin of their denim business, announced in August 2018.

The indicated value of EUR40 is consistent with trading value ranges boasted by Amer’s peers, albeit peers that boast a greater concentration to trophy brands. The response from Amer reads well and certainly does not yet look like a rejection out of hand. This management team has never demonstrated that it is wedded to any one brand or independence. Implicit in their business model is their recognition that brands may derive better value if sold, an approach that would seem just as applicable to the business as a whole.