UK stock market investors are having a difficult time. Many high-quality shares are very expensively valued while many cheap shares are cheap for very good reasons. Quality at a reasonable price is a scarce commodity, but ten-pin bowling operator Hollywood Bowl (BOWL) looks as though it might just measure up.
The business
Hollywood Bowl is the UK’s largest operator of ten-pin bowling centres. It currently has 60 centres across the UK, with 52 trading under the Hollywood Bowl brand and 8 as AMF. The AMF sites are gradually being rebranded to trade under the Hollywood Bowl name.
In total, these centres have more than 1,400 bowling lanes. The average size of each centre is around 30,000 square feet, with 24 bowling lanes. The company rents all its properties on long-term rental agreements.
The company has four sources of revenue, which made up its £120m of sales in 2018:
- Bowling (50%)
- Drinks (18%)
- Food (10%)
- Amusements (22%)
Sales are fairly stable across the year, with peaks coinciding with the timing of school holidays. Wet weather tends to help increase sales, with hot weather doing the opposite. The hot summer of 2018 contributed to a slowdown in the underlying growth rate of the company’s bowling centres.
Strategy
The company is not pursuing an aggressive growth strategy by trying to open up lots of new bowling centres. It is very much focused on improving the performance of its existing centres and is taking a cautious approach to expansion. This can be best summed up as a quality over quantity approach.
Around two-thirds of the company’s centres have been refurbished or rebranded. By refurbishing them, it is looking to make them more family friendly so that people stay longer and spend more money. The company is upgrading its bar and dining facilities, replacing carpets, adding new lighting, creating more space for amusements and introducing new VIP bowling lanes to enhance the customer experience.
The refurbishments seem to be having a positive impact on the company’s performance. This has also been helped by the fact that the UK bowling market has been growing for the past five years and is expected to keep on doing so.
According to the company, the money spent on refurbishment is earning very attractive returns. I have not seen a definition of these returns, but my guess is that it is referring to the profit uplift (probably measured by Ebitda) from the refurbishment as a percentage of the money spent refurbishing the centre. The company targets an average return of 33 per cent, with its last 13 refurbishments or rebrands producing returns of 46.5 per cent.
This should not be interpreted as the bowling centres as a whole making returns on investment of 46 per cent, which would represent exceptional levels of profitability. As we shall see shortly, the company is making very good levels of profit.
Spend per game
Year | Spend per game | LFL (%) |
2013 | £7.13 | |
2014 | £7.54 | 8.1 |
2015 | £8.12 | 9.1 |
2016 | £8.63 | 6.5 |
2017 | £8.70 | 3.5 |
2018 | £9.22 | 1.8 |
H1 19 | £9.79 | 4.4 |
Source: Hollywood Bowl
The effectiveness of the refurbishment strategy is shown in increases in customer spend per game. This is the key driver of like-for-like (LFL) sales growth, which has been impressive in recent years. This growth rate slowed in 2017 and 2018 (due to hot weather and the football World Cup football, but is still a good performance given the tough comparatives it was up against. LFL sales growth has accelerated again in the first half of 2019.
The company has a very sensible and structured approach to opening new sites, which is paying off. I like this disciplined approach and the fact that the company will not chase growth for the sake of it by sacrificing the quality of the estate. The key criteria for a new Hollywood Bowl site are:
- Plenty of available parking space.
- Located next to the leading cinema in the area.
- Little existing competition nearby.
- Strong local demographic.
- Plenty of footfall.
Hollywood Bowl has a very good relationship with landlords such as Intu Properties (INTU), which are looking to mitigate a tough retailing environment by expanding the amount of leisure space in shopping centres. This type of relationship can pay off handsomely as evidenced by two of the company’s recent new sites being offered to it by landlords at nil cost (before fitting-out costs).
The company currently has agreements for seven new bowling centres out to 2023 and is looking to open two new ones per year.
The UK bowling market has become increasingly polarised in recent years, with growth being driven by the bigger operators such as Hollywood Bowl and Tenpin. Many independents have closed and those in poor locations have struggled to make money. Hollywood Bowl’s 60 sites currently give it a 25 per cent market share by bowling lanes. The next biggest competitor is Ten Entertainment Group (TEG), which trades under the Tenpin brand and currently has 44 sites.
Elsewhere, among the smaller players there has been some buying and selling of bowling centres. Disco Bowl – a nightclub operator – has entered the market after buying eight centres from MFA.
As well as trading in the right locations and spending a lot of time on maintaining and improving the customer experience – with initiatives such as priority lanes and lane food ordering – communicating the value for money of a trip to a bowling centre is key to driving growth in revenue and profit.
Apart from new entrant Disco Bowl, Hollywood Bowl has the lowest prices of all the main bowling operators. The company makes extensive use of dynamic pricing policies and tailors its pricing depending on how busy a centre is likely to be. Customers can get some great deals by booking online in advance. It is still possible for a family of four to have a game for less than £20, which means that bowling remains very competitively priced compared with other leisure activities such as going to the cinema.
This value for money element is crucial in my view to protecting the company’s revenues and profits in an economic downturn. The relative cheapness of bowling should give Hollywood Bowl some resilience. This is vital given that the business has lots of fixed costs and therefore a lot of operational gearing – a fall in revenues could lead to a big fall in profits.
Given its high-quality locations and its customer-focused strategy, the company looks to be in a good competitive position. The sensible approach to new centre opening means that it is unlikely to trash the profits and returns of its existing centres.
Competition from its rivals, while not to be discounted, is protected to an extent by its location in primary leisure and shopping centres in towns and cities. Throw in the effectiveness of its refurbishment strategies and the investment case for this business looks more than reasonable.
Financial performance
The effectiveness of the company’s business strategy is feeding through into some very impressive financial performance numbers. Consequently, Hollywood Bowl looks to have many of the financial characteristics of a high-quality business.
The company has been growing its revenues, profits and cash flows in recent years due to a combination of adding new sites and the boost from its refurbishment and rebranding strategy.
Performance
Year | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | TTM |
Turnover | 70.2 | 78.7 | 86.0 | 106.6 | 114.0 | 120.5 | 123.9 |
Ebitda | 11.2 | 15.9 | 21.6 | 28.8 | 33.4 | 36.2 | 36.6 |
Operating profit | 1.9 | 6.5 | 13.3 | 19.0 | 22.2 | 25.0 | 26.8 |
Post-tax profit | 7.9 | 14.0 | 18.3 | 18.9 | 20.1 | ||
Capital employed | 51.2 | 95.6 | 105.7 | 116.5 | 129.5 | 134.1 | 134.1 |
Cash capital employed | 74.9 | 96.3 | 113.5 | 131.6 | 150.8 | 163.8 | 165.4 |
Capex | 8.5 | 9.6 | 7.3 | 10.5 | 13.7 | 11.0 | 13.3 |
Operating cash flow | 13.7 | 12.2 | 22.4 | 29.3 | 32.8 | 36.2 | 37.0 |
Free cash flow | 4.9 | 2.5 | 11.0 | 14.4 | 15.2 | 19.6 | 18.1 |
Source: Annual reports
It is a very profitable business. Gross profit margins are extremely high at just under 86 per cent. The directors consider the bowling segment to have a gross margin of 100 per cent due to the absence of direct selling costs (surely there is some direct labour cost?).
Trading profit margins have also seen a nice improvement in recent years. This has been helped by improved gross margins, refurbishments and some operational gearing as the bowling centres have quite a high level of fixed costs (rents, depreciation, utilities, staff).
This was a business that was barely profitable back in 2013, but is now achieving operating profit margins of nearly 22 per cent. Its return on capital employed (ROCE) and cash return on cash capital invested (CROCCI) are more than 20 per cent. ROCE when adjusted for rented sites is also at a very good level. Last, but not least, the company is very good at converting its post-tax profits into free cash flow (FCF). Its FCF margins – free cash flow as a percentage of sales – are also very high.
These numbers are very impressive and indicate that Hollywood Bowl is a very high-quality business in my opinion.
Ratios
Ratios: | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | TTM |
Sales growth | 12.2% | 9.3% | 23.9% | 6.9% | 5.7% | 2.8% | |
Ebitda margin | 16.0% | 20.2% | 25.1% | 27.0% | 29.3% | 30.0% | 29.5% |
Ebit margin | 2.70% | 8.28% | 15.50% | 17.84% | 19.48% | 20.75% | 21.63% |
Lease adjusted ROCE | 5.7% | 6.9% | 10.2% | 12.2% | 12.8% | 13.7% | 14.4% |
ROCE | 3.7% | 6.8% | 12.6% | 16.3% | 17.1% | 18.6% | 20.0% |
CROCCI | 15.0% | 16.5% | 19.0% | 21.9% | 22.1% | 22.1% | 22.1% |
FCF margin | 7.0% | 3.1% | 12.7% | 13.5% | 13.3% | 16.3% | 14.6% |
Operating cash conversion | 723% | 187% | 168% | 154% | 148% | 145% | 138% |
FCF conversion | N/A | N/A | 139% | 103% | 83% | 104% | 90% |
Source: Investors Chronicle
One of the best ways to look at how well a company is performing is to look at its incremental returns – how changes are being made over time, such as the amount of extra sales, profits or cash flows that come from additional investment spending. Hollywood Bowl scores well on this type of analysis.
Changes
Changes (£m) | 2014 | 2015 | 2016 | 2017 | 2018 | TTM | Cumulative |
Turnover | 8.6 | 7.3 | 20.6 | 7.3 | 6.5 | 3.4 | 53.7 |
Ebitda | 4.6 | 5.7 | 7.2 | 4.6 | 2.8 | 0.4 | 25.4 |
Operating profit | 4.6 | 6.8 | 5.7 | 3.2 | 2.8 | 1.8 | 24.9 |
Capital employed | 44.4 | 10.1 | 10.8 | 13.0 | 0.6 | 1.2 | 82.9 |
Cash capital employed | 21.4 | 17.2 | 18.1 | 19.2 | 4.6 | 0.0 | 90.5 |
Operating cash flow | -1.5 | 10.2 | 6.9 | 3.4 | 13.0 | 1.6 | 4.8 |
FCF | -2.4 | 8.5 | 3.4 | 0.8 | -2.7 | 2.3 | 23.3 |
Incremental: | |||||||
Ebit margin | 54.0% | 93.1% | 27.6% | 43.3% | 42.9% | 52.9% | 46.3% |
ROCE | 10.4% | 67.4% | 52.8% | 24.4% | 433.4% | 150.0% | 30.0% |
CROCCI | 21.6% | 33.3% | 39.9% | 23.8% | 60.8% | N/a | 28.0% |
FCF margin | -28.3% | 115.9% | 16.6% | 10.7% | -42.1% | 68.8% | 43.4% |
Source: Investors Chronicle
Since 2013, Hollywood Bowl has added £53.7m of additional turnover, £24.9m of additional operating profit and £23.2m of additional FCF for additional investment of £82.9m. This adds up to incremental operating margins, ROCE and FCF margins of 46.3 per cent, 30 per cent and 43.4 per cent, respectively – impressive stuff.
Hollywood Bowl also stacks up well against Ten Entertainment Group, its main competitor in terms of financial performance. The performance of TenPin is also very impressive and underpins the quality of well-run bowling businesses.
Hollywood Bowl versus Ten Entertainment
Ratios: | BOWL | TEG |
Ebitda margin | 29.5% | 26.9% |
Operating margin | 21.6% | 18.5% |
ROCE | 20.0% | 20.1% |
Lease Adjusted ROCE | 14.4% | 16.2% |
CROCCI | 22.1% | 23.7% |
FCF margin | 14.6% | 11.6% |
Source: Annual reports/Investors Chronicle
Why is the valuation multiple so undemanding relative to companies with similar financial performance?
Hollywood Bowl’s recent half-year results confirmed that the company is performing well and that its strategy continues to bear fruit. The outlook seems set fair for a period of steady growth backed by a business model that has been proved to work.
Yet, despite being able to grow while posting very impressive financial performance on a selection of respected measures, the shares are still relatively lowly rated. At 225p, the shares trade on a one-year forecast rolling price/earnings (PE) ratio of 15.9 times. Ten Entertainment Group seems very unloved, trading on under 10 times at a share price of 210p.
Excellent companies such as Halma (HLMA) and Spirax-Sarco (SPX) have similar levels of financial performance and growth rates, but trade on double this multiple. You can make a case for saying they are overvalued, but is there a good case for arguing that Hollywood Bowl and Ten Entertainment are cheap? I think there is.
Hollywood Bowl forecasts
Year (£m) | 2019 | 2020 | 2021 |
Turnover | 128.5 | 135.1 | 141.4 |
Ebitda | 37.3 | 39.6 | 41.3 |
Ebit | 27 | 28.5 | 30 |
Pre-tax profit | 25.9 | 27.4 | 29.1 |
Post-tax profit | 20.9 | 22 | 23.7 |
EPS (p) | 13.8 | 14.7 | 15.6 |
Dividend (p) | 8.2 | 8.1 | 8.6 |
Capex | 14 | 15.4 | 15.6 |
Free cash flow | 17.8 | 19.1 | 21 |
Net borrowing | 4 | -4.1 | -11.8 |
Source: SharePad
I can only think that the investors are put off by its exposure to the UK economy; a lack of overseas growth and the risks that come with its high operational gearing. There could also be a view that the effect of the refurbishments will wear off.
I think it’s fair to think that their effect will diminish, but if sales levels are maintained then FCF generation will increase as the company is spending around £6m on revenue-generating capex.
It’s also the case that the company has not run out of ideas to woo customers to its centres. The venture into mini-golf centres is interesting and while it is early days, this initiative could produce very decent returns on investment.
The UK bowling market is also continuing to grow and has very attractive value-for-money characteristics. This following wind is set to benefit the company and help it to continue to generate profits and FCF growth.
The income attraction of the shares should also not be understated as they offer a prospective yield of 3.6 per cent. The company has paid special dividends and its strong financial position suggests that further payouts should not be ruled out.
Finally, I like the way this company is managed. Both the chief executive and finance director have significant equity stakes in the company and clearly eat their own cooking. The communication with investors is clear and informative and the accounting is clean – they rightly state that share-based payments are real costs, for example.
In a market where high-quality businesses are very richly priced, Hollywood Bowl looks to be an overlooked share at an attractive price that has the potential to reward long-term investors.
