Cheap room rates get budget travellers through Premier Inn’s doors, but will the extension of that trait to shares in Whitbread, the hotel chain’s parent, bring bidders to the check-in desk?
The numbers suggest that might be the case. An enterprise value of 12 times forecast adjusted profit before tax and other charges is below a post-Brexit referendum average multiple of 15; and the 17 per cent slide in Whitbread’s shares over the past year could tempt potential suitors.
There is some justification for the market’s reticence. Bookings of 40 per cent of available rooms for the second quarter give grounds for confidence in strong half-year numbers, but beyond that there is little visibility over future revenue. True, an even split between leisure and corporate business provides some insulation against a downturn in demand from holidaymakers, while the return of business travel helped UK occupancy to recover to almost 83 per cent over the first quarter of the financial year, easily ahead of pre-pandemic levels.
Inflation of 8 per cent to 9 per cent for Whitbread’s cost base means that short-sightedness sits more uneasily. Consumers and businesses with less cash to spend might think more carefully about the number of nights they, or their employees, need to stay away from home, too. Rising demand means that Premier Inn can charge more for rooms, but if that eases up, the scope to lift prices to offset rising costs becomes more limited.
Moreover, avoiding supply chain havoc puts added pressure on the company’s wallet. Disruption caused by staff shortages at the country’s airports has been galling — Whitbread wants to avoid angry customers. It has brought forward plans to invest £20 million to £30 million this year, split roughly 50-50 between increasing wages and upgrading the reservation system and hotel rooms. Without a big acceleration in sales, it is doubtful that margins will recover to pre-pandemic levels this year.
Yet there is still enough to convince potential bidders to take a tilt at Whitbread, even putting aside an undemanding price tag. Owning roughly 56 per cent of its estate gives the group a property portfolio valued at £3.4 billion at the start of March. A sale-and-leaseback of just a slice of those hotels and land could be one way to unlock value for a potential bidder. There is also the temptation to lever up to boost returns, which could get private equity fingers twitching. In March the group had £141 million in net cash on the balance sheet, comfortably below a banking covenant ceiling of building net debt — excluding lease liabilities — to 3.5 times adjusted profit.
Paucity value might play a part for any private equity bidder, with the scale of Premier Inn’s hotel estate in the UK matched by few and giving more ground to search for cost savings. Faster gains are up for grabs in Germany, a market where coronavirus restrictions have been lifted more recently and occupied roughly 70 per cent by independent hotels, versus the 50 per cent share they have in Britain. Premier Inn has ten times the hotels it entered the pandemic with in Germany and the financial clout to expand further.
Whitbread’s underperformance of the banking and commodity-heavy FTSE 100 over the past 12 months is understandable, but it also has been weaker than the more domestic FTSE 250, an index that has proven fertile ground for private bidders looking to capitalise on a weaker UK economic outlook.
Likely upgrades by analysts to earnings forecasts this year make the shares look even cheaper. Shore Capital has mooted an increase in pre-tax profit this year by a punchy £50 million to £60 million from the £200 million it had pencilled in.
ADVICE Buy
WHY Takeover potential and a further recovery in occupancy could lift the shares higher
Paragon Banking Group
Domestic lenders are caught in a tug of war when it comes to stock market sentiment, with investors attracted by the margin-boosting benefit of rising interest rates but hesitant about what higher debt costs might do to loan defaults. The former should trump the risks surrounding the latter for Paragon Banking Group.
A delay in passing on the benefit of rising interest rates to the alternative lender’s growing deposit base means that the net interest margin is expected to grow by 0.2 percentage points this year, ahead of the 0.05-point rise previously suggested by its management. Neither the prospect of a cooling housing market nor a darker economic outlook have dimmed demand for mortgages from buy-to-let landlords or for business loans. New lending on both is expected to be about £100 million higher this year than had been anticipated previously.
Yet Paragon has other margin-inflating prospects. The roll-off of less profitable owner-occupied mortgages from the loan book is one; so, too, is higher growth in the commercial lending business, which attracts margins of between 4 per cent and 8 per cent compared with 2 per cent on mortgages.
The group also has sold the last of its unsecured lending business. New impairment charges declined to only £1.3 million over the six months to March, or 0.02 per cent of average loan balances.
To what extent will bad debts remain low? The bank’s mortgage borrowers, which account for 86 per cent of the loan book, start from a comfortable position. The rental income that Paragon’s landlord borrowers receive covers the cost of their repayments by an average 212 per cent, the lender estimates.
Shore Capital raised earnings forecasts for the next three years by 10 per cent, 11 per cent and 16 per cent, respectively. Assuming a payout ratio of 40 per cent of adjusted earnings, the broker reckons the dividend will total 26.8p this year, which at the present share price equates to a potential yield of 5.3 per cent. Not bad, even if rising yields on fixed-income assets mean that equities need to work harder to prove their income potential.
ADVICE Buy
WHY Shares offer a generous yield and are valued at a lower premium to book value
