Buy Enterprise Inns at 107p

Says cautious, long-term blue chip investor Robert Sutherland Smith of UK350.com.

I have history with today's free share tip which was not that long ago - in a funny sort of way - a penny share. In June 2005 I tipped Enterprise Inns (ETI) for a buy at 788p and then, a year or two later, as a sell at 1248p for a 58% capital gain. So I have had this pub company on my watch list for a long time. Given the state of the UK economy I saw no urgency to tip a UK pub company again. However, I almost tipped it several weeks ago when the share price was below 100p but I held back. The share price is now 107p after the trading statement for the sixteen weeks to 16 January 2010. So what prompts me to tip the share now? Crucially, we have had a trading statement demonstrating that there were no unexpected skeletons to fall out of the trading cupboard. In the event, the statement was on balance positive; positive enough to prompt some volume buying of the shares. Well below earlier peaks, the share price has been up to 192p in the last twelve months, bottoming out at 41p. At the recent price of 107p the equity is capitalised at GBP541 million.

Although Enterprise Inns is massively geared both financially and operationally, it has balance sheet assets well in excess of the current market capitalisation of its equity. At the last balance sheet date on 30 September 2009, it employed total assets (its enterprise value) of just under GBP6 billion, supported by equity capital of just under GBP1.4 billion; largely comprising tangible assets. Balance sheet assets attributable to ordinary shareholders were valued as worth 268p a share, in contrast to the recent 107p (last seen) share price. In other words the share price is at a 66% discount to its attributable balance sheet asset value. As another measure of the underlying commercial value of the business sales annual revenue in the last financial year was GBP818 million; or 37% more than the recent value of the shares and market capitalisation of GBP541 million.

The company shared in the good Christmas for retailers; in part due to the weeding out of outlets with insufficient profit or prospect of profit. In the period, 103 pubs were sold off at an average value of GBP310,000 each, bringing in useful if not enormous GBP32 million pounds into the business. In the sixteen week trading period to 16 January 2010, there was a further 4% decline in average net income from pubs. But in more than four fifths of the pub estate estate, that decline was limited to 2% only. Moreover, the overall 4% figure of decline in average sales is to be contrasted with the 8% decline in the previous period as evidence of a significant improvement in the affairs of the business. Having been through an appalling period, the company has improved its position by management action which continues.

So what of the future? First, consensus analyst estimates are based on continuing but lessening falls in sales revenue and earnings out to and including the year to 30 September 2011. That suggests that those analysts who follow the company are being in principle realistic about its prospects in the next couple of years when UK demand and consumption will be reigned in by the next British government. Second, it invites the comment that the shares are reflecting future deterioration in trading conditions and that the current valuation is not dependent on any expectation of growth.

Sales of GBP818 million last year are estimated to fall by a further 8.5% this year followed by another estimated annual fall of 2% next year to a forecast figure of GBP733 million. Earnings per share, which fell 22% last year to 30.7p, are estimated to fall a further 10% this year and a further estimated 8% the year after to a forecast 25.3p. In short, estimated sales in the year to 30 September 2011 are 17% below those of the year ended September 2008 and earnings 33% lower than those three years earlier. Even maintenance of the dividend ceases to be a cause of bearish uncertainty because it has already been cut out as part of the emergency measures taken by the managers; there is no dividend.

In these bearish estimates of earnings, despite the recent strong rise in the price, the shares are selling on estimated price to earnings per share ratio of 4 times for the current year and 4.3 times for next year to 30 September 2011. General economic expectations are universally bearish for the coming two years and the outlook for the drinks sector looks specifically poor. But the ratings on subsequently reduced earnings expectations suggest that the risk reward position for those who buy the equity at this stage are biased more towards reward than risk. The outlook for the British economy over the next two years is foggy with uncertainty. We do not know which party will form the government, whether there may be a ‘hung’ parliament and what the nature of economic policies will be. However, even a wide margin of residual uncertainty is underwritten by the massive asset backing for the shares at this stage. Perversely, because of the high degree of uncertainty is already in the forward income estimates and given a low market valuation of those estimates, the shares for the first time in a long time, strike me as looking attractive. In that, I am as usual taking a longer term view and not a short term trading view. At 107p the shares, in my opinion, are a BUY.

Key Data

EPIC: ETI
Market: Full
Spread: 106.75p - 107.25p (.47%)

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