Investors’ Chronicle: Hollywood Bowl, Pennon, Greencore

BUY: Hollywood Bowl (BOWL)

Demand is still high at the leisure company — but margins are under pressure, writes Jemma Slingo.

Ten-pin bowling was a big hit when pandemic restrictions were lifted. With their cheap, family-friendly offerings, the likes of Hollywood Bowl and Ten Entertainment enjoyed a surge in popularity in 2021 and 2022, which translated into bumper profits. The question for investors was whether this growth was sustainable, or whether demand would wane as the memory of lockdown retreated. 

So far, so good: revenue at Hollywood Bowl increased by 10 per cent in the first half of 2023 to £110mn. It’s important to note that hospitality businesses paid a lower rate of VAT between July 2020 and March 2022, as part of the government’s Covid support package. This means that Hollywood Bowl’s 2022 figures were unusually high. When the VAT benefit is stripped out, year-on-year growth for 2023 is even more impressive at 21 per cent. 

Organic sales growth was slower at 3.5 per cent. Against tough comparators, however, the group still managed to increase game volumes by 0.6 per cent and boost spend-per-game by 2.8 per cent. Management has been reluctant to raise prices too much, though, stressing that it still offers the “best value for money product of all the branded UK bowling operators”, with a family of four able to bowl at peak times for less than £25. 

Management’s fixation on value for money means the group is at the mercy of cost pressures. Administrative expenses jumped by 23 per cent year on year, driven by wages and property. The situation was made worse by the rise of lower-margin amusements, which are growing at a higher rate than bowling. As such, the group’s statutory profit before tax shrank by 20 per cent to £26.7mn. 

Once again, however, the situation is brighter when the impact of the VAT reduction is removed. Meanwhile, the group is making good headway with its expansion strategy: 2023 will be a “record year of investment in the estate” and it is on track to open at least three new venues. 

Investors are still wary of leisure stocks, and Hollywood Bowl is trading on a forward price/earnings ratio of just 13, compared with a five-year average of 18. It has been cheaper, but we believe this still represents an attractive entry point.

BUY: Pennon (PNN)

South West Water owner Pennon has seen its profits fall significantly in the 12 months ending March 31, as power and other operating costs climbed at the same time as a drought hit Dorset and Cornwall. Pennon also runs Bristol Water, which came under the former’s umbrella formally in March. 

Its underlying profit before tax fell 88 per cent to £17mn, with its net interest charge also taking a chunk out of earnings. 

Like others in the water sector, Pennon has also flagged much greater pressure to curb its dumping of sewage and wastewater. Capital spending was largely focused on “water resources investments”, however, in response to very low storage levels after the dry summer. Overall spending climbed by half to £358mn, and the company aims to spend £750mn over the next two years. 

On top of the pressure to stop sewage and wastewater releases, the focus has also increased on leakage in the UK’s water networks. Ofwat has also specifically opened an investigation into Pennon’s reporting of “operational performance data relating to leakage and per capita consumption” for the 2022 financial year. 

Pennon has increased its dividend 11 per cent in line with its inflation-plus-2 per cent policy. Its return on regulated equity, the measure by which utilities measure their use of capital, was 10.5 per cent, up from 8.9 per cent. United Utilities, which runs water monopolies in the North West, managed a jump of 3.3 percentage points in the same period. 

The business model of the private utilities has come under heavy scrutiny, given the combination of heavy spending requirements to get infrastructure up to scratch, and the high dividends being paid. Something has to give.

HOLD: Greencore (GNC)

Positive signs with sales, with volume growth posted in a challenging food market, writes Christopher Akers.

The market liked what it saw in convenience food manufacturer Greencore’s results, with shares marked up by 7 per cent in early trading on results day. A chunky revenue uplift was driven by price increases as the company sought to recover higher costs, in what remains an elevated and volatile food price environment. Last week, the Office for National Statistics confirmed that annual UK food and non-alcoholic drinks inflation was 19.1 per cent in April, down only slightly from 19.2 per cent in March.

Food-to-go and other convenience sales rose by 15.6 per cent and 28.5 per cent respectively in the half on the back of pricing action. There was positive news on volumes, too, with manufactured volumes up by 5 per cent. Packaged sandwiches remain in demand despite changes to working patterns. 

But top-line growth could not stop higher costs tipping Greencore into the red. Finance costs rose by £4mn as higher interest rates increased the cost of debt, and operating profit halved to £3.6mn on the back of what management referred to as “significant” cost inflation, although the board is bullish about cost recovery in the second half. Adjusted operating margin fell by 90 basis points to 1.3 per cent.

Elsewhere, the leverage ratio fell from 2.1 to 1.9 times and an additional £10mn share buyback programme was announced.

House broker Shore Capital “assume a strong bounce back in profitability, with a determination that, hopefully, yields better times thereafter”. That remains to be seen, but Greencore should benefit as commodity prices ease. The shares trade at a notable discount to the five-year average, at eight times forward earnings compared with a historic rating of 12 times according to the FactSet-compiled consensus.