Stobart Group — Update 10 November 2016

Stobart Group

Disposal-driven returns plus underlying growth

Post-results update

Alternative energy

10 November 2016

Price	153p
Market cap	£527m

Net debt (£m) at H117		47.7

Shares in issue	344.2m
Free float	100%
Code	STOB

Primary exchange	LSE
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(7.7)	(14.6)	41.4
Rel (local)	(5.9)	(51.1)	30.4

52-week high/low

178.00p

96.25p

Business description

Stobart Group owns and operates London Southend Airport, biomass processing and supply assets, a rail engineering business, a property portfolio and non-controlling equity investments in logistics and aircraft leasing businesses.

Next events

Trading update

March 2017

Analysts

Jamie Aitkenhead	+44 (0)20 3077 5746
Roger Johnston	+44 (0)20 3077 5722

industrials@edisongroup.com

Edison profile page

Stobart Group is a research client of Edison Investment Research Limited

We were, on balance, reassured by Stobart’s interim results. The 7.8% yield, supported by the continuing disposal plan, gives equity holders more than enough compensation before operations in Energy and Aviation fully ramp up to their FY19e/CY18 objectives. We adjust our near-term forecasts upwards slightly to reflect the observed H117 margin expansion, but leave our FY19 target year estimates largely unchanged. We believe in the deliverability of Stobart’s FY19e growth targets but, in the case of the Aviation business, we would be further reassured by concrete evidence of passenger growth.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
02/15	116.6	9.6	2.2	6.0	69.5	3.9
02/16	126.7	20.6	5.9	6.0	25.9	3.9
02/17e	147.8	22.8	5.5	12.0	25.8	7.8
02/18e	207.5	33.1	8.1	12.0	18.9	7.8

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Core: Better profitability, but Aviation not ‘in the bag’

We increase our core EBITDA forecasts by 0.5% and 2.6% for FY17 and FY18 to reflect better than forecast profitability in Energy and Aviation. We are encouraged in particular by the outlook in both the Rail and Energy businesses. However, in Aviation, while we welcome the addition of CityJet as a partner at Southend Airport, we believe management has yet to demonstrate the concrete progress in passenger growth to reassure the market on its FY19e targets.

Non-core: Dividends financed by disposal plan

The headline group-level ‘beat’ in H117 was driven by the gain on disposal of the Speke asset on Merseyside. The doubling in dividend payout and shift to quarterly payments was announced in June and requires £40m of cash flow to finance it. Stobart expects to close a further two transactions – in Chelford (£7.4m) and Hull (£8.6m) this month, which will bring the book value of assets for disposal below £100m, or another 2.5 years of dividend payments assuming no premiums achieved. We are convinced of management’s ability to execute on the disposal plan, to achieve premia to book values in the process and to at least meet dividend commitments during the non-core disposal programme to FY19.

Valuation: All about returns, for now

Our sum-of-the-parts valuation for Stobart implies a FY19e fair value per share of 210p (FY18e 160p; both include forecast dividend/share). However, the main story, until non-core assets are disposed and core businesses meet their targets, is shareholder returns. The 7.8% yield does not take into account potential premia to book values on disposal, nor does it take any account of the proceeds from the proposed sale of the 49% equity stake in Eddie Stobart Logistics (book value £55m/16p share, Edison FV £100m/30p/share). In our view, there is significant upside to the planned £120m dividends we project for FY17-FY19 inclusive.

Interims: Strong operating performance, work remains

Stobart reported a near 20% increase in its underlying Support Services EBITDA, driven by growth across each of its three operating units: Energy, Aviation and Rail. The standout performer at group level was the Infrastructure unit, which contributed £12m of EBITDA due to a well-flagged profit on the disposal of the Speke property asset during the half. This was the main driver of Stobart’s headline reported EBITDA doubling for the half year.

Exhibit 1: Stobart interim results (H117)

£m	H116	H117	% y-o-y
Total revenue	57.6	65.3	13.3
Energy	4.2	4.9	16.6
Aviation	0.4	0.7	78.4
Rail	0.9	1.0	9.9
Support Services EBITDA	5.5	6.6	19.5
Investments	6.4	5.5
Infrastructure	0.7	12.0
Eliminations	-2.7	-3.8
Total EBITDA	10.0	20.2	102.1
Underlying Profit Before Tax	4.6	16.2	252.1
EPS	1.58	4.03	158.3
DPS	2.00	6.00	200.0

Source: Stobart Group, Edison Investment Research

Disposals drive returns for now

We believe that doubling its dividend in June caused a re-rating of Stobart’s stock. The change in payment schedule to quarterly from half-yearly, and from FY16’s 6p per share to FY17’s expected 12p per share, was the main driver of the stock’s strong performance over the summer. Superficially, the required £40m per year to finance the dividend, coupled with Stobart’s £109m book value of assets to dispose of, will sustain almost three years of dividends. In reality, however (and using the recent Speke disposal as a guide), it is likely that management will continue to achieve disposal values well in excess of book value. In addition, there is likely to be a further one-off windfall from the potential Eddie Stobart Logistics (ESL) disposal in the next few years. It is difficult to predict a specific timetable for these disposals and we do not explicitly forecast the resulting cash flows. However, it is possible that up to FY19, Stobart shareholders will receive more than the scheduled £120m in dividend payments.

Divisional update: Energy and Rail strong, Aviation slower

■

Energy: at the interim presentation, recently appointed Energy CEO Ben Whawell was positive on the outlook for the biomass business. We slightly increase our forecasts for the unit based on the solid 16.5% EBITDA per tonne increase to £10.44 during H117, bolstered by a number of efficiency measures. We continue to believe management is at least on track to deliver its 2018 targets of 2m tonnes delivered at £10 per tonne EBITDA. Management reassured investors by communicating that 2m tonnes of annual biomass supply is already contracted for 2018 (FY19e) and that 2.4m tonnes pa of virgin wood supply has been secured.

■

Aviation: we welcome CityJet’s intention to start flying to 18 destinations from Southend, starting in spring 2017. Stobart management said CityJet could bring “up to 600,000 passengers” per year. However, it should be noted that this would account for only 40% of the required passenger uplift to reach Stobart’s 2018 target of 2.5 million passengers (FY17e 0.95m). On the positive side, we increase EBITDA per passenger slightly as margins are outperforming expectations. Also, management said that, easyJet is performing well at Southend and we note that one more easyJet plane based at Southend would add another 250,000 passengers annually. However, on the whole there are grounds for caution on the outlook for the Aviation unit. Stobart said it was having fewer conversations with airlines interested in slots at Southend in comparison with the 12 it mentioned at the FY16 results. This is probably partly a short-term consequence of Brexit. However, to reassure investors of its ability to meet its passenger targets, Stobart must start providing concrete evidence of delivery. We reduce slightly our current year passenger forecasts in line with flat year-on-year guidance from management, but retain our FY19 estimates of 2.5m passengers at £8 EBITDA per passenger.

■

Rail: we maintain our strong (+20%) revenue and EBITDA growth forecasts for the Rail unit. Management sounded upbeat, quoting a £61m order book and highlighting several noteworthy projects: the £12m Gospel Oak to Barking electrification, £2m pa Far North Plain Line plus other ‘internal’ projects. In the half, Stobart signed a Major Incident Response contract with the Environment Agency to assist with flood defences 24/7.

■

Infrastructure: we update our FY17e forecast to reflect the capital gain on the Speke disposal (included in the infrastructure EBITDA). We do not explicitly forecast the planned further disposals in this unit. At the half year, management said there was a book value of £109.5m of assets left in the Infrastructure unit and that in November the company would complete £16m of disposals comprising sites at Chelford and Hull. We expect most of the rest of the 16 assets to be disposed of by year-end FY19.

■

Investments: ESL continues to perform well with the Tesco contract renewed for another three years and a new contract signed with Aggregate Industries worth £30m over five years. EBIT growth has averaged 15% and management believes its 49% equity stake is worth well above the £55m current book value. We adjust the valuation upwards in our sum-of-the-parts to reflect this. During H117, Stobart also increased its stake in Propius, the aircraft leasing business, to 66.6% by acquiring Invesco’s 33.3% stake in the business for £12m. Finally, we expect newsflow soon on the disposal of Stobart Air. Management stated that it is in discussions with CityJet about the sale.

Financials and forecasts

Stobart’s balance remains conservative at 11.7% net debt to equity (H117). Capex, at £7.7m for the half, was invested mainly in processing sites for the energy business. We estimate FY17 capex at £12.7m, but forecast that net debt levels will remain manageable in comparison to both EBITDA and equity in FY17 (3.3x core EBITDA and 14.6% equity).

We tweak our earnings forecasts to reflect interim numbers. Our base operating assumption that both the Aviation and Energy units meet their FY19e targets remains unchanged. We increase our core EBITDA (only the Support Services segments: Aviation, Energy and Rail) estimates by 0.5% and 2.6% for FY17 and FY18 to reflect the strengthening margin performance in Aviation and Energy. Our net debt forecasts are materially increased as we incorporate Stobart’s significantly increased dividend payout plus increased capex forecasts.

Exhibit 2: Stobart forecast change table

	EPS (p)			PBT (£m)			EBITDA (£m)
	Old	New	% chg.	Old	New	% chg.	Old	New	% chg.
2016	5.9	5.9	0.0	20.6	20.6	0.0	30.0	30.0	0.0
2017e	5.2	5.5	5.7	20.4	22.8	11.4	31.3	33.8	7.9
2018e	8.1	8.1	0.0	31.6	33.1	4.7	42.3	42.9	1.4

Source: Stobart Group, Edison Investment Research

Valuation

We roll forward our sum-of-the-parts valuation as the company is well into FY17. Despite the stock’s outperformance, provided management meets its objectives for FY19e (Aviation: 2.5m passengers returning £8 EBITDA per passenger, Energy: 2.0m tonnes of biomass supplied, returning £10 per tonne EBITDA, both by CY18, which is two months before FY19e), there is 29% upside to our FY19e fair value per share of 210p (FY18e 160p; both include forecast dividend per share). We have kept each of Stobart’s operating segments on the same EBITDA multiple and increased our premium to book value for the Investments unit to reflect the strong performance of ESL, which is still 49% owned by Stobart Group. Management guided to ESL growing operating profit at around 15% per year since it was bought by DBAY in 2014 for £196m and that debt had been paid down considerably since the acquisition.

Exhibit 3: Stobart sum-of-the-parts valuation

SUM OF THE PARTS	FY18	FY19
Current price (p/sh)	153.0	153.0
Fair Value Per Share (p/sh)	147.6	198.8
Upside/(downside) to FV (%)	-3.5%	29.9%
Dividend yield (%)	7.8%	7.8%
Total return (%)	4%	38%
Current number of shares (n)	342.3	342.3
Operating Segments			FY18 EBITDA (£m)	FY19 EBITDA (£m)	Multiple (x)	FY18 Value (£m)	FY19 Value (£m)	Basis
Energy			16.7	23.3	9.0	150	210	No peers - but high growth, visible contracted earnings
Aviation			9.0	20.0	10.0	90	200	London City (44x EBITDA), Fraport, Flughafen Wien
Rail			4.8	5.6	8.0	39	45	Amec, Balfour, Serco, Babcock, Carillion
Investments			H117 Book Value (£m)
Investments			55.0		1.90	105	105	ESL Performing well, recent sales in Propius high premia
Infrastructure			121.0		1.10	133	133	Based on previous capital gains
Other
Brands (£m)						39.0	39.0	FY16 - Book Value
GROUP ENTERPRISE VALUE (£m)						556	731
Net debt (£m)						(48)	(48)	FY16
Pensions and other (£m)						(3)	(3)	FY16
Minorities (£m)						0	0	FY16
SOP VALUATION (£m)						505	680

Source: Stobart Group, Edison Investment Research

Based on our calculations, Stobart’s current market price implies core EV/EBITDA multiples of 9.7x and 6.1x for FY18e and FY19e. Based on these numbers, despite being a little over two years away, it is fair to say that the stock is not pricing in Stobart meeting its FY19e targets. We therefore believe that, even disregarding the exceptional shareholder returns in the intervening period, there is upside in Stobart’s share price based on EBITDA growth in its core businesses. The 7.8% dividend yield belies the potential for significantly higher returns in the form of special dividends or buybacks on the back of exceeding disposal targets. While investors need to keep one eye on the medium-term operating performance, disposal-led returns offer shareholders an exceptionally attractive story over the coming years.

Exhibit 4: Financial summary

	£m	2015	2016	2017e	2018e	2019e
Year-end February		IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		116.6	126.7	147.8	207.5	257.3
EBITDA (underlying)		18.0	30.0	33.8	42.9	58.8
Operating Profit (before except.)		11.3	21.5	25.0	35.7	51.5
Exceptionals		(18.7)	0.0	0.0	0.0	0.0
Other		0.0	0.0	0.0	0.0	0.0
Operating Profit		(7.7)	21.5	25.0	35.7	51.5
Net Interest		(1.7)	(1.0)	(2.2)	(2.5)	(3.4)
Profit Before Tax (norm)		9.6	20.6	22.8	33.1	48.0
Profit Before Tax (FRS 3)		(9.4)	20.6	22.8	33.1	48.0
Tax		1.4	(1.2)	(3.9)	(5.5)	(8.0)
Discontinued businesses profit/(loss) underlying, post tax		(3.7)	0.0	0.0	0.0	0.0
Discontinued businesses profit/(loss) non underlying, post tax		10.6	0.0	0.0	0.0	0.0
Profit After Tax (norm)		7.3	19.4	18.9	27.6	40.1
Profit After Tax (FRS 3)		(1.2)	19.4	18.9	27.6	40.1

Average Number of Shares Outstanding (m)		329.9	328.1	342.3	342.3	342.3
EPS - normalised (c)		2.2	5.9	5.5	8.1	11.7
EPS - normalised and fully diluted (c)		2.2	5.9	5.5	8.1	11.7
EPS - (IFRS) (c)		(0.4)	5.9	5.5	8.1	11.7
Dividend per share (c)		6.0	6.0	12.0	12.0	12.0

EBITDA Margin (%)		15.5	23.6	22.8	20.7	22.9
Operating Margin (before GW and except.) (%)		9.7	17.0	16.9	17.2	20.0

BALANCE SHEET
Fixed Assets		427.7	453.3	400.2	399.0	397.7
Intangible Assets		116.2	112.3	108.4	104.4	100.5
Tangible Assets		221.9	218.0	180.7	183.5	186.2
Investments		78.8	109.7	97.7	97.7	97.7
Other		10.8	13.4	13.4	13.4	13.4
Current Assets		101.7	109.2	145.1	135.5	132.4
Stocks		46.2	45.1	46.4	48.5	45.7
Debtors		42.4	49.0	52.7	51.2	49.3
Cash		5.7	9.9	40.7	30.5	32.0
Other		7.4	5.4	5.4	5.4	5.4
Current Liabilities		(52.3)	(54.5)	(55.6)	(55.1)	(53.4)
Creditors		(43.9)	(38.2)	(39.3)	(38.8)	(37.1)
Short term borrowings		(7.3)	(9.0)	(9.0)	(9.0)	(9.0)
Other		(1.2)	(7.3)	(7.3)	(7.3)	(7.3)
Long Term Liabilities		(70.8)	(94.4)	(94.4)	(104.4)	(109.4)
Long term borrowings		(17.5)	(48.9)	(48.9)	(58.9)	(63.9)
Other long term liabilities		(53.3)	(45.5)	(45.5)	(45.5)	(45.5)
Net Assets		406.2	413.7	395.3	375.1	367.3

CASH FLOW
Operating Cash Flow		(11.0)	3.4	14.8	26.4	43.1
Net Interest		9.8	1.0	(4.8)	(4.5)	(4.4)
Tax		(0.0)	0.0	(3.9)	(5.5)	(8.0)
Capex		(10.1)	(45.3)	(12.7)	(10.0)	(10.0)
Acquisitions/disposals		204.4	14.7	53.0	0.0	0.0
Financing		0.0	0.0	0.0	0.0	0.0
Dividends		(19.8)	(19.7)	(41.1)	(41.1)	(41.1)
Other		(0.2)	8.9	12.0	0.0	0.0
Net Cash Flow		173.1	(37.0)	17.3	(34.7)	(20.3)
Opening net debt/(cash)		196.0	19.1	48.0	17.2	37.3
HP finance leases initiated		0.0	0.0	0.0	0.0	0.0
Other		3.9	8.1	13.5	14.5	16.9
Closing net debt/(cash)		19.1	48.0	17.2	37.3	40.8

Source: Stobart Group, Edison Investment Research. Note: Capital gains included in EBITDA.

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