Conviviality (LON:CVR): Is the Dividend Safe?

Wednesday, Sep 27 2017 by
31
Conviviality LONCVR Is the Dividend Safe

Conviviality (LON:CVR), one of Britain’s largest wholesalers, has gone from strength to strength since it floated on AIM back in August 2013. The share price has risen by more than 270% while earnings have grown each year without fail. Dividend hunters may be particularly interested in Conviviality because the firm paid its maiden dividend in February 2014 and the forward looking yield is now 3.5% - above the market median of 3%.

The elephant in the room is that the company has also gone on a spending spree. It acquired Matthew Clark, the alcohol supplier for its hotel division in 2015. Then in 2016 it bought Bidendum Group, one of the largest alcohol distributors in the UK. In his commentary to The Intelligent Investor, Jason Zweig said that if a ‘company itself would rather buy the stock of another business than invest in its own, shouldn’t you take the hint and look elsewhere too?’ This is an interesting question because Conviviality’s acquisition programme does raise questions about the company’s capacity to sustain dividends. Let’s take a closer look...

Have acquisitions improved Conviviality’s balance sheet?

59cb7b256d552ConvivialityLeverage1.png59cb7b882da46ConvivialityLeverage2.pngA 2010 paper titled To Cut or Not to Cut by Laarni T. Bulan identified several red flags which were apparent in the years preceding a dividend cut. The chart on the top-right has been taken from Bulan’s paper. Dividend cutters (red) are firms that reduced their dividend by 10% or more in a fiscal year. Control firms (blue) are firms that did not reduce their dividend. 

Bulan found that firms with ‘poor financial flexibility (low cash holdings and high leverage) are more likely to cut their dividend’. Clearly, if a company is highly leveraged, and is having trouble meeting its liabilities, then this is going to be a big red flag for the dividend.

Notice on Bulan's chart that book leverage increased during the three years preceding a dividend cut. We can also see from the second chart above that Conviviality has likewise increased book leverage over the last three years. Conviviality’s acquisition programme has been an important factor driving this trend. Let’s explore this further...

Bulan defined leverage as the ratio of book debt to total assets, where book debt is equal to total liabilities plus…

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Conviviality Plc is a United Kingdom-based distributor of drinks and impulse products serving consumers through its franchised retail outlets or through hospitality and food service. The Company's activities consist of the wholesale and retail distribution of beers, wines, spirits, tobacco, grocery and confectionery within the United Kingdom to the on-trade and off-trade market. Its Conviviality Direct is an independent wholesaler to the on-trade, serving over 23,000 outlets from hotel chains to food-led pubs. Its Conviviality Direct brand includes Walker & Wodehouse, Catalyst PLB, Peppermint Events and Elastic. Walker & Wodehouse focuses on supplying wine merchants and regional wholesalers with products and producers as part of wine portfolio. Catalyst PLB brand is the agency brand and supply solutions division. Peppermint Events delivers event concepts and bars at outdoor events. Elastic is a brand activation agency that provides support and insight to the Company's supply base. more »

LSE Price
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19 Comments on this Article show/hide all

Allan Collins 27th Sep '17 1 of 19
3

Hi Alex and thank you for this great piece of research.

Conviviality makes it through one of my tough screening processes which takes in a whole range of criteria including sales growth, good ROCE and cash flow.

I almost bought when the shares flashed up on one of my oversold screens earlier this month with the price around 370p. But I stepped back because the share price still looked a bit rich to me - there was still a big gap between the price and the 200-day moving average.

The broking community are still keen on the shares and I see the consensus is for modest dividend growth over the next two years whilst rebuilding the dividend cover at the same time..

This is going to be an interesting one to watch and to see if brokers are being too optimistic.

Allan Collins.

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Tony John 27th Sep '17 2 of 19

Excellent article at the present I have know interest in the stock but will keep the report on file for future reference as it is very educational to use on other interests

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anfitrion 27th Sep '17 This post is under review
1

This may sound a bit harsh, but this research is the closest thing to what computers already do automatically.

I suggest you start paying less attention to theoretical papers and standardised questions (does anyone ever make acquisitions to improve their balance sheet?") and start asking specific questions about whatever makes the specific business tic.

For Conviviality it would be things like:

-What do suppliers like Diageo or Pernod Ricard think about working with Conviviality vs using their own distribution networks or the smaller independent distributors like LWC, Amathus or Halewood? Does Conviviality have any power to get better pricing terms for them? In which way are they special to be able to get more business?

-Similar, where do customers like Wetherspoons or The Restaurant Group stand? Are they likely to give more volumes or less volumes to Conviviality vs competitors? Are they mainly focusing on getting better prices from distributors or do they actually favour convenience and range of SKUs instead?

Asking these real business questions will lead you to very good indications on what the barriers to entry are for this business, what the top line growth is going to look like over the coming years, whether margins are going to increase or shrink and, as a result, how much free cash flow is going to be available for the company to pay dividends.

By the way, dividend payments is purely a capital allocation decision that's doesn't generate any value on its own - in fact the companies which can get attractive returns on marginal capital employed should pay no dividends whatsoever-. In the case of Conviviality, because it's a mid-low ROCE business operating in a mature industry, they use a 65% pay-out ratio.

Given that consensus expects CVR earnings to increases 60% from 25 to 40m on the back of current growth trends and delivered synergies, there is a very minimum chance (and I'm talking about fraud, war or massive UK natural disaster) that they will cut the dividend. But nobody cares about that, anyway. It's the stock price movement that matters to most investors.

Again, sorry to be "that guy", but in the era of 20 automatic reports generated per stock per day, we only need additional research if it adds value. You have done a lot of work here, obviously, but I think if you could focus these efforts to this other type of research we would all appreciate it even more. :)

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Alex Naamani 27th Sep '17 4 of 19
4

Hey guys,

Thanks for the feedback. It is quite a long article so it's nice to see that some people actually read the whole thing ; -) I hope it provides food for thought.

anfitrion - I do understand where you are coming from, but a tonne of insight can be gained from reading academic papers and answering simple, standardised, quantitative questions like 'is the balance sheet getting stronger? and so on.

Bulan's study is not theoretical. He analysed 901 dividend cuts over a 39 year period (1965-2004) so his study is informed by solid empirical evidence. Bulan found that during the 39 year period, dividend cutting companies were more likely to have declining cashflows, lower profitability, lower sales growth and quantifiable traits which are outlined here http://people.brandeis.edu/~lbulan/divcuts.pdf. I guess the point I would like to make is that an investor could be betting against the 'base rates' of the stock market by investing in a company that had these quantifiable characteristics, even if the investor had qualitative insights into the way a company ticked (eg. insights into relations with suppliers).

William O'Shaughnessy goes into this in quite some detail in What Works on Wall Street. The 'Base Rates are Boring' section of Chapter 2 is well worth a read. In the stock market, base rates could refer to the probability that a particular class of stock (eg. low PE stocks) will outperform the market. O'Shaughnessy explains that people in general are more likely to ignore these base rates when presented with descriptive data. For example, there could be a town where 70% of people are lawyers and 30% are engineers. Clearly Dave, a citizen selected at random is more likely to be a lawyer. However, academic studies suggest that we are more likely to assume Dave is an engineer when we are presented with descriptive data - eg. Dave's hobbies include carpentry, lego and maths. Obviously, we have a higher probability of guessing Dave's profession if we pay more attention to the base rates (eg. 70% of people are lawyers) and less attention to descriptive data (eg. Dave enjoys carpentry).

The advantage of reading empirical academic studies like Bulan's paper is that they help us understand the base rates of the stock market. His findings suggest that companies with high leverage etc. were more likely to cut their dividend, at least between 1965 and 2004. To ignore this base rate and pay more attention to descriptive data (eg. relations with customers) would be like assuming that Dave is an engineer because he is interested in maths, despite the fact that 70% of people in his town are lawyers. O'Shaughnessy said that 'the best way to predict the future is to bet with the base rate that is derived from a large sample'. If there are any other criteria we could use to establish the base rates for dividend cutters, do please feel free to share any insights.

I paid attention to the simple quantitative characteristics that Bulan outlines because they help investors understand what the financial statements of a typical dividend cutter might look like. I am not making any predictions regarding Conviviality's dividend. Investors should do their own research and not take what I say as advice. 


Cheers,

Alex

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Allan Collins 28th Sep '17 5 of 19
2

In reply to post #223143

I think you are right about additional research -which is what analysts and tipsters recommend us to do anyway. If I am moving towards making a significant investment in a company I will try and talk to people in and close to the sector, read trade and sector new sheets, and so on. All to try and get a better understanding of the underlying business.

I think it is wrong however if we dismiss the importance of dividends. You may be right when you say the movement of the share price is all that matters to most investors, but there is an army of long term investors out there to whom dividend is important.

We do go through periods of time when the concerns/hopes over a company's dividend policy are the driver of the share price. And it is clear from many studies over the years that dividends (and especially if they are reinvested) make up a large proportion of total return.

Allan Collins

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Redrichmond 29th Sep '17 6 of 19
2

Amazing work , very heavy reading that academic paper..

Thanks for Summarising, trawling through that paper and cross checking with a large company statement is hard work . Don't stop what your good at :)

Having Read the following books:-- ( and I continue to learn (and make mistakes) I will never have enough to learn...) some are super heavy to read - Easiest/nicest to read is the Naked Trader,The Little Book that builds wealth and The Mark Minivini book )

Read:-
What Works on Wall Street by William O'Shaughnessy
The Little Book that builds wealth by Pat Dorsey
The Intelligent Investor by Benjamin Graham
The Naked Trader by Robbie Burns
The Battle for Investment Survival:How to make Profits by G .M Loeb
Trade like a stock market Wizard:How to Achieve Super Performance in Stocks in Any market by Mark Minivini
How I made $2,000,000 in Stock by Nicolas Darvas


Currently Reading:-
Contrarian Investment Strategies - David Dreman
How to lie with Statistics by Darrell Huff (recommended by Ed)

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harrymunro 30th Sep '17 7 of 19
1

In reply to post #224028

Best investment book I've read this year has been (by far) Investing Through the Looking Glass by Tim Price.

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peterclothier 8th Mar 8 of 19
5

In reply to post #223143

Well after that profit warning, Alex's report raising questions looks right.

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Mark Carter 14th Mar 9 of 19

Good call! Well done.

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Andrew L 15th Mar 10 of 19

Alex - could Stockopedia introduce this as a "dividend cutter" risk metric. Also maybe worth doing a postscript on Conviviality and whether Stockopedia's system picked up on the risks. I won't always do so and when it doesn't it is interesting to see why. Not sure Stockopedia identified Dignity's risks, for example, but it did highlight the risks of Carillion.

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Andrew L 15th Mar 11 of 19

Would be good if Stockopedia or someone could do a CVR postscript. It is currently rated as 71 in terms of quality on Stockopeida. The F Score is high at 7 and earnings manipulation risk is described as low. On the magic formula it was rated as A*. The only metric that picks up potential issues is the bankruptcy risk. This was 0.42 which indicates "a serious risk of financial distress in the next two years."

I have to admit that I haven't looked at how Stockopedia rates quality. But it is hard to see how a company at serious risk of financial distress in the medium-term can be relatively high on the quality metric. Can that make sense from a rational point of view? i.e. this is a high quality business but could have financial issues soon. High magic formula score is because, I think, Stockopedia doesn't include lease adjusted ROCE. This would be much lower than the normal ROCE for CVR I think due to the nature of retail businesses.

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davidispruce 15th Mar 12 of 19
3

I’m not sure that Stockoedia’s measures can take into account basic incompetence in a financial team. Spreadsheet errors, forgotten accruals. The CFO cannot survive this, nor the financial controller assuming they have one. At very least, the financial controls over such basic items are non-existant.

I haven’t held the shares for some time so missed this one but do own Sporttech which was 80+ rated which seems to have been hit by the same ineptitude bug.

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Nicowilson 15th Mar 13 of 19

In reply to post #338883

Agreed. There's an assumption that financial statements are correct.

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Andrew L 15th Mar 14 of 19

In reply to post #338883

Not really. Surely Stockopedia's system should pick up weak cashflow, leverage etc. My point was that Stockopedia's system did pick it up with respect to bankruptcy risk however, this didn't seriously drag down the quality rating.

I do accept your point if the accounts are falsified with regards to cash which is possible. The Chinese companies that listed on AIM sometime back had dodgy accounts with regard to cash. I also accept that an unexpected charge won't be picked up by Stockopedia's system (for example a legal liability that becomes apparent).

However, risks relating to things such as financial leverage should be picked up by Stockopedia's system and would highlight the relative resilience of a business.

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davidispruce 15th Mar 15 of 19
2

This isn’t about weak cash flow though. The company claim they have a £30m tax obligation. They haven’t said what for but given it dwarfs their profits presumably it’s related to VAT/import duties? First off they should have explained what it’s for and second how on earth do you miss an obligation that is bigger than your entire cash position? I’ve been a CFO in listed and unlisted environments and it is impossible without almost impossible incompetence. If an accrual was missed, the controller would soot it, then the CFO, then the CEO. Barring that, my auditors and analysts always had their own models.

It’s too big to just be missed. To my mind the explanation doesn’t add up (pardon the pun!)

I don’t see any accounting/analytical measure that can account for an ‘error’ where numbers are not in any publicly released statements.

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Andrew L 16th Mar 16 of 19

In reply to post #339313

Davidispruce - yes I agree on the unexpected tax charge and how this won't be picked up. I was referring to a reduction in the resilience of the business generally due to higher debt following acquisitions.

Bad things can happen to any company. The key question is whether a company has become more or less resilient. That is what I was referring to. Stockopedia's system did pick up CVR to some extent with it highlighting a high probability of financial stress in the next two years. My argument is only that this should be incorporated into the quality rating that Stockopedia uses.  Or if it is currently included in the quality rating its importance should increase.

Hope that makes sense.

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xcity 17th Mar 17 of 19
2

In reply to post #339313

Agreed.

The big question for me is 'what are the odds of two completely separate and unrelated major errors in a company's books emerging in two days, if there are not also other errors?'

Apart from anything else, I'm surprised that all the books appeared to add up despite these errors.

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Orangetree 1st Apr 18 of 19
1

Great article! Wish Paul Scott read it before relying on information from a broker!

Blog: Walbrock Research
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