New ASX share on our Global Equity Best Ideas
This undervalued share provides the opportunity for both income and capital growth.
Mentioned: Endeavour Group Ltd (EDV)
Finding quality stocks trading at a cheap price can be a challenging and time-consuming task. You not only need to identify whether a company has a tangible edge over its peers. You also need to assess whether a stock is over- or under-valued.
The Global Best Ideas list (available for Morningstar Investor subscribers) is compiled by Morningstar’s equity analysts every month. To earn a spot on the list, these stocks have high analyst conviction in their future prospects and are trading at a price significantly below what our analysts calculate them to be worth.
Buying stocks when they are undervalued gives investor’s a higher margin of safety, therefore reducing the risk of an uncertain future.
Additionally, analysts consider the stock’s moat rating. This rating is an indication of the analyst’s expectations for the company to maintain a sustainable competitive advantage. A wide moat rating is awarded to companies that are expected to maintain and grow their earnings for at least the next 20 years, a narrow moat for the next 10 years.
Brian Han, Director of Equity Research, says of the list “These Best Ideas are sourced from all main sectors of the market, to provide a diversity of names across the spectrum. The last thing investors want is a Best Ideas list chock-full of cheap mining stocks when commodity prices tank, or a litany of oversold retail stocks when consumer sentiment slumps.”
New editions to the June list
In the June edition of Global Equity Best idea three new ASX listed shares were added. And two came off the list. One of the new ASX editions was Endeavour Group (ASX: EDV).
Shares in wide-moat Endeavour trade at a material discount to our fair value estimate and offer an attractive fully franked yield.
We think the market is underappreciating the defensive long-term earnings outlook, with consumers currently pulling back on their nonessential spending. However, fiscal stimulus is about to boost household budgets from July 2024.
We forecast Australian liquor retailing sales increasing midsingle digits after barely growing at all in fiscal 2024. Longer term, liquor demand is defensive and underpinned by inflation and population growth. We expect the structural premiumization trend to counterbalance declines in per capita liquor consumption. As Australia’s largest liquor retailer, with its eminent Dan Murphy’s and BWS branded chains, we expect Endeavour’s liquor sales to grow in line with the market.
We believe concerns regarding regulatory risk are overdone. Our relatively cautious forecast accounts for more-stringent gaming restrictions curbing earnings growth in fiscal 2025, but thereafter we see group profit increasing at an average rate of 6%. Management’s aim to materially increase EBIT in the hotels business provides upside to our valuation.
In isolation, such an uplift would boost our valuation by about $1 per share, or 17%. However, it is still too early to credit this potential and forecast earnings before interest and taxes (“EBIT”) from hotels remaining below fiscal 2023 levels until fiscal 2031. In first half fiscal 2024, the hotels segment’s EBIT increased by $4 million versus the previous corresponding period.
More about Endeavour
Business strategy and outlook
Endeavour is Australia's pre-eminent omnichannel liquor retailer, operating the largest network of brick-and-mortar stores throughout the country, with more than 1,600 liquor outlets across the well-known Dan Murphy's and BWS brands.
Endeavour also has substantial interests in hotels and electronic gaming machines, operating more than 12,000 gaming machines across its portfolio of more than 300 hotels, pubs, and clubs. Endeavour is one of Australia's leading employers, with staff of more than 28,000 throughout Australia.
Endeavour's business is divided into two segments. Its retail segment is Australia's leading omnichannel liquor retailer, while its hotels segment provides hospitality services and gambling operations.
Endeavour's retail segment is also vertically integrated, supported by Pinnacle Drinks private-label portfolio, which operates several wineries, as well as bottling and packaging facilities. Products produced are supplied exclusively to Dan Murphy's, BWS, and ALH Group in Australia and provide a source high-margin differentiation while also minimizing supply chain risks in the wine category.
Shifting consumer trends toward online shopping and convenience have led to strategic investments in online shopping platforms and delivery capabilities, such as smartphone applications for each brand and online pure-play retailers Jimmy Brings and Shorty’s Liquor. About 9% of all Endeavour's liquor sales are transacted online.
Endeavour's revenue is highly skewed to the retail segment, which we forecast will contribute approximately 85% of revenue over the next decade, with the balance coming from the hotels segment. The split is more evenly balanced at an EBT level due to the higher margins achieved in the hotels business, with approximately 65% of EBT derived through the retail business and 35% through the hotels business.
We expect consumer demand for alcohol to be relatively steady through the economic cycle, exhibiting attributes of consumer defensives. We estimate the Australian hotels market will predominantly be driven by the same factors as the off-premises retail liquor market, namely population growth and inflation.
Moat rating
Learn more about finding companies with sustainable competitive advantages.
Endeavour Group has a wide economic moat in its core liquor retailing segment emanating from a scale-based cost advantage. Endeavour's hotels business also benefits from intangible assets that support economic profit generation for the segment.
We estimate the total addressable market for Australian off-premises liquor retailing at $20 billion in fiscal 2020, and estimate Endeavour’s retail segment controls 47% of the market through its BWS and Dan Murphy’s brands which collectively have approximately 1,600 outlets throughout Australia. This is significantly larger than Endeavour’s closest integrated retail competitor, Coles Group, which we estimate holds 17%, and wholesaler Metcash’s independent customers which collectively hold 26%.
Endeavour’s dominant scale allows it to fractionalize distribution, administration, and marketing costs in a way that smaller competitors cannot. Stemming from its domineering market position and significant scale advantages, we estimate Endeavour to have a material, maintainable operating margin advantage over all its competitors.
This competitive advantage manifests itself through average EBT margins which Endeavour have consistently held above 6% relative to Coles Group’s liquor EBT margins which have historically been below 4%, a gap of consistently greater than 160 basis points over the past five years. Further, Endeavour has been able to grow liquor sales faster than Coles Group for the last five years and has greater store productivity with sales per square meter of approximately $20,000 relative to Coles Group of around $15,000, owing to Endeavour's brand strength and capital efficient store network optimization.
Amazon's introduction of the liquor category to its Australian product range is unlikely to materially erode Endeavour’s wide economic moat. Liquor isn’t a category Amazon dominates in globally, and establishing ties with local suppliers is a long and tedious process.
We estimate Amazon’s first and third party food and beverage sales represented only 3% of Amazon global gross merchandise value in fiscal 2020, compared with consumer electronics which we estimate at above 40%. Further, we consider it unlikely, Amazon is capable of leveraging its global buying power, as suppliers could risk range reviews if Endeavour is at a pricing disadvantage. Suppliers simply cannot risk potentially losing access to half of the Australian liquor retailing market.
Moreover, the immediacy of alcohol consumption means Endeavour’s extensive brick-and-mortar network provides substantial convenience value and makes Endeavour less susceptible to domestic or foreign online retailers without most immediate delivery options, either click-and-collect or fulfilment from store.
This is illustrated in the high proportion of Endeavour’s click-and-collect sales at around 50% at Dan Murphy’s, compared with supermarket chains Coles and Woolworths at around a quarter of click-and-collect online sales. We understand, the majority of all wine is consumed within 24 hours of purchase, further pointing to consumers’ relatively high immediacy of need of liquor purchases.
We estimate the total addressable online liquor retail market at AUD 2 billion in fiscal 2022 with online penetration sitting at 13% of total sales. Online penetration remains a key tenet of Endeavour’s growth strategy and we estimate that Endeavour’s penetration was 10% in fiscal 2022 increasing, with online sales up 17% versus fiscal 2021. However, it is still slightly lagging online penetration in the broader liquor market.
The hotels segment holds more than 12,000 electronic gaming machine entitlements, as well as its liquor licences. Gaming licences are capped at a state and territory level, ultimately limiting the number of hotels, pubs, and clubs which have the right to operate electronic gaming machines in conjunction with their hospitality services.
State caps are rarely altered, with approximately 200,000 machines operating in Australia since 2001 according to the Queensland Treasury, limiting the supply of slot machines against a growing population, and leading to a legislated and maintainable source of differentiation for the hotels segment and a barrier to entry for competitors. Endeavour’s licences are predominantly indefinite in length. Licences held have been growing gradually over time as with acquisitions of competing venue operations.
Gaming machines are subject to ESG risks. In fiscal 2024, the Victorian government announced extensive reforms intended to reduce gambling-related harm. We expect the government of New South Wales to follow suit. We anticipate the friction introduced by the reforms to significantly curtail gaming revenue by some 25% in the two states from fiscal 2025, but the hotel segment's pretax profit margins to remain lucrative at around 12%.
Further regulator risk limiting the ability of gaming machines to generate economic profits over our forecast horizon is low. Eliminating the profitability of gaming machines would have a flow on impact to the entire sector and would likely face significant opposition from a large portion of the community, industry lobbyists and internally within state governments.
As highlighted by the Labour Market Information Portal, more than 850,000 people are employed in the accommodation and food-service industry, meaning changes to gaming regulation have the potential to impact a significant cohort of the roughly 17 million Australians enrolled to vote. Industry lobbyists, such as ClubsNSW and the Australian Hotels Association, also have a successful track record of lobbying state governments for the benefit of the industry.
More on Endeavour