McColl's still a winner

The disruption caused by P&H was evident in the 11 weeks to 11 February, with reduced availability causing a 3.6 per cent like-for-like drop in sales at the stores the wholesaler supplied, and a 2.2 per cent overall like-for-like drop. In response, broker Liberum cut its EPS forecasts for 2018 and 2019 by 11 per cent and 6 per cent, respectively. However, the broker sees more scope for upgrades, as opposed to downgrades, in the future based on its belief that McColl's could raise gross margins to 27 per cent by 2020 rather than the 26.5 per cent it currently forecasts. That would result in EPS upgrades of 15 per cent, which look particularly enticing given the broker already forecasts a compound annual earnings growth rate (CAGR) of 9.1 per cent over the next three years.

There are several reasons to believe McColl's can continue the trend of profitability improvement, which has seen gross margins rise from 24.2 per cent in 2014 to 25.7 per cent last year. For one thing, the new supply contract with Morrison offers far better commercial terms, an improved product line, and a more resilient supply chain. Footfall should also continue to benefit from the installation of Post Office counters, Collect+ and Subway franchises inside shops. McColl's also has scope to continue to boost the sale of higher-margin products and focus on larger convenience stores, which tend to generate higher margins.

The recent step up in the size of the estate to 1,611 stores has come with an increase in net debt, which at the end of November stood at 3.2 times cash profits. Sizable rent commitments associated with a large leasehold estate represent another financial liability, which new accounting rules will require to be recorded on the balance sheet from the start of next year. While such high "financial gearing" represents a noteworthy risk, especially for a company with relatively low operating margins, McColl's has started to sell and leaseback some of the 116 freeholds that came with the Co-op acquisition to reduce borrowings. And Liberum expects cash profits to cover net debt by 2.1 times by 2020. The group's progressive dividend policy should also provide some extra confidence in the attractive income on offer.