Endeavour Navigating Choppy Seas

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Endeavour Group posted a resilient FY24 result, but faces ongoing challenges in FY25.

-Resilient FY24 from Endeavour Group
-Technology costs a drag
-Property portfolio offers promise
-Debate over valuation

By Greg Peel

Endeavour Group ((EDV)) has been facing a tough consumer environment. Already dealing with a more general consumer shift towards a healthier lifestyle, and a guilty rethink of the amount of alcohol consumed during covid lockdowns, the retailer has been hit with the cost of living crisis.

In bottle shops, consumers have responded by switching back to lower margin, well-known brands from higher margin, and higher price, boutique brands, while also taking advantage of cheaper deals on larger pack sizes (eg, -10% off when buying six bottles of wine).

In pubs, as well as eschewing craft beers, diners are shying away from higher priced steaks, for example, preferring cheaper burgers and schnitzels.

The resultant drag on revenues has come at a time Endeavour is unshackling itself from the IT systems it inherited after being spun-off from Woolworths Group ((WOW)) back in 2021, investing in its own purpose-built technology at not inconsiderable cost.

Still, Endeavour managed minor growth in earnings in FY24, in line with broker forecasts, and also managed to declare a fully-franked dividend slightly ahead of forecasts. It was a resilient effort in the tough climate, brokers agree.

Not so impressive were Endeavour’s numbers for the first seven trading weeks of FY25, which saw retail and hotel sales up 0.6% and 0.2% respectively, below market expectations. The market took this as a sign of things to come in the rest of the year, and promptly sold the stock down -7% on the day.

Management was at pains to point out the same time last year saw a bit of a binge as Australians were all swept up in Women’s World Cup fever, so the numbers were always going to be weaker this year. It didn’t help the share price, which has since failed to recover.

The issue is that not much has changed as we look ahead in FY25.

More Headwinds Ahead

While inflation remains stubborn and interest rates remain elevated, there is little chance of a change in consumer behaviour in the immediate future. In the meantime, management has guided to -$60-80m of FY25 operating expense for its One Endeavour technology development, up from -$45m in FY24, along with -$310-325m in lease interest expense, up from -$305m.

In the longer term, Endeavour may also face a significant increase in rents for the 78 hotels it sold off to Charter Hall Long WALE REIT ((CLW)). Citi notes at the time of acquisition, rents were some -37% below market levels.

In FY24, the company managed to offset -$100m of One Endeavour costs through its EndeavourGo cost-program, exceeding $35m of One Endeavour costs over the period. However, guidance for both reveals One spending will exceed Go cost-outs as FY25 progresses. The reversal offsets the lower rate of cost of doing business in FY25.

Currently, as UBS notes, the new technology is costing more than the current payment to Woolworths for the old technology, but over time it is expected to be lower as it will be fit-for-purpose, enabling process savings and better data insights.

On the subject of data, Citi notes AI appears to be driving a gross margin benefit in retail, but the broker questions whether Endeavour will be able to drive further expansion while cost of living pressures persist and the market becomes increasingly promotional in order to lure customers. Here, Dan Murphy’s “we’ll beat any price” policy may end up hurting gross margins.

In the longer term, Citi would like to understand how the company will navigate risks from ongoing declines in per capita alcohol consumption and online gaming which could cannibalise earnings generated by pokies.

Endeavour is, after all, Australia’s largest poker machine operator.

Despite having executed a sale-and-lease-back with the aforementioned REIT, Endeavour still boasts a large portfolio of freehold property, and an FY24 review provided management with further confidence of the capacity to unlock more than $1bn in market value.

The company has several assets at the DA lodgement stage and is seeking capital partners. FY24 renewals delivered a return on investment in excess of the 15% target, and three leasehold divestments have improved portfolio quality, Morgan Stanley notes.

Hotel food & beverage gross margins improved in FY24 driven by menu optimisation and procurement savings.

Jarden sees an emerging catalyst in the crystallisation of the $1bn-plus freehold property portfolio, which is considered the key piece of new news outside of the trading update at the FY24 results.

If Endeavour is able to monetise this successfully and lift return on invested capital, Jarden sees scope for a multiple re-rate, along with positive earnings risk.

A Matter of Valuation

The great hope for all retailers looking ahead is the beginning of a long-awaited RBA cutting phase, as inflation abates. The jury’s out on when this might begin in the first half of 2025 or the second but, suffice to say, hopes are looking up for FY26.

That said, Macquarie has long maintained consumer staple retailers, which includes alcohol, are resilient to economic cycles, and both Endeavour’s on-premises (hotels) and off-premises (bottle shops) business are naturally hedged against changes in consumer behaviour.

Macquarie continues to see long term upside from a refresh program for Endeavour’s hotels division, but sticks with Neutral for now.

Morgans believes Endeavour is fundamentally a good business with well-known brands (eg, Dan Murphy’s and BWS), number one market positions in both retail and hotels, and an experienced management team. However, while the company continues to deliver good cost-out benefits and progress its strategy to streamline operations, the consumer environment remains subdued and variable, the broker warns.

This will put pressure on sales growth with operating costs (eg, labour) still elevated and Woolworths separation costs (One Endeavour) ramping up. Morgans retains Hold.

While Endeavour has a number of levers to drive growth and is executing reasonably well in a tough market, Citi sees a risk of growth falling short of expectations due to operating deleverage as cost inflation exceeds top line growth in a competitive market, increasing One Endeavour costs, the prospect of a longer-term rent reset, and potential future gaming regulatory changes.

Citi retains Neutral.

Endeavour has successfully managed margins and costs to deal with the top-line issues, Ord Minnett notes, and another -$100m more in savings is expected in the next two years, but without growth in the market, the broker struggles to see how Endeavour can justify its elevated PE multiple.

On that basis, Ord Minnett downgrades to Hold from Accumulate.

Not everyone agrees with Ord Minnett’s “elevated multiple” call.

Morgan Stanley retains Overweight, premised on a defendable pathway to delivering ahead of consensus earnings uplift in hotels, an undemanding valuation and dominance in liquor retail.

UBS retains Buy due to the strong liquor industry position, cost management, hotels growth optionality, capital discipline and you guessed it — valuation.

The six above-mentioned brokers monitored daily by FNArena are split two Buy or equivalent ratings and four Hold on Endeavour Group. The consensus target is $5.47, ranging from $5.10 (Ord Minnett) to $6.20 (Morgan Stanley).

Outside of daily monitoring, Jarden leaves its Overweight rating unchanged, with improving industry top-line sales and/or positive news on property the key catalysts nearer term. Jarden cuts its target to $6.00 from $6.30.

Goldman Sachs reiterates its Buy rating given improving business quality and attractive valuation despite the challenging operating backdrop, cutting its target to $6.20 from $6.30.

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