28-Sep-2020: Taylor Collison: Enero Group (EGG): Initiating Coverage - Outperform
TC's Analyst: CAMPBELL RAWSON, crawson@taylorcollison.com.au, +61 415 146 725 - www.taylorcollison.com.au
Our View
We re-initiate coverage following an analyst change with an Outperform recommendation. We view EGG as a high-quality business operating in a congested industry where companies have to continually produce new ideas and reinvent strategies. In contrast to the majority of the marketing services industry, EGG’s earnings through Covid-19 have grown but the share price remains ~25% below January levels. We are attracted to EGG on valuation grounds as it trades on 3.5x our FY21 EV/EBITDA forecast, representing a 42% discount to the average of a group of listed peers. Earnings risks include the reliance on client relationships, economic conditions and competitors pricing pressure however we view EGG as well advanced at mitigating these and believe the level of risk to be more than priced into the current share price. We view EGG as having strong growth prospects over the long-term with no debt and exposure to high-growth industries providing the ability to organically and acquisitively achieve scale and capability in a highly fragmented industry. We expect the multiple gap to peer average to close as further scale is achieved and strong margins are maintained.
Key Long-Term Attractions
- Exposure to high growth sectors such as technology and healthcare
- Hotwire and Orchard have developed category expertise over many years and subsequently earn a large proportion of revenue from Technology and Healthcare clients respectively. Clientele in these industries are experiencing rapid growth which provides EGG the opportunity to grow alongside them. Compared to more mature industries such as FMCG [fast moving consumer goods], Tech and Healthcare clientele are often more inclined to pay higher rates to help foster their growth trajectory. Both industries are largely unaffected by the Covid-19 pandemic and seemingly are beneficiaries of some of the greatest changes to consumer behaviour in recent history. With group clients including Facebook, Zoom, GlaxoSmithKline and Novartis, we see EGG as well positioned to grow revenue and earnings alongside these highgrowth companies who we expect to grow irrespective of economic conditions.
- Further growth ambitions into vast USA market
- EGG’s USA operation has doubled revenue and almost quadrupled operating EBITDA since FY18 (organic and acquisitive growth). A simplified business model coupled with a renewed focus on larger clients set the platform and we understand the momentum is continuing into FY21. Hotwire leads the growth and continues to win clients and tenders, predominantly in the Tech sector. Recently appointed CEO, Brent Scrimshaw, has extensive brand and marketing experience including 18 years at Nike with senior roles as GM East Coast USA and CEO of Western Europe. With Brent’s experience and desire for geographic expansion, we anticipate Hotwire to follow clients into other operating regions. Momentum in this market bodes well for attracting clients and talent and subsequently underpins the bulk of our revenue and EBITDA growth forecasts.
- Conservative debt strategy
- EGG currently carries no true debt with acquisitions funded by cash and contingent consideration not exceeding remaining cash balances. A cash balance of ~$47m is currently offset by contingent consideration of $25.5m which is all payable by September 2021. We are attracted by the prudent debt strategy and believe the capital strength helps to offset any earnings risk associated with annual revenue churn of ~20% and ~2 months earnings visibility.
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Bear77 Notes: I do not hold Enero (EGG) shares directly, but I do hold shares in WMI (WAM Microcap Fund) and FOR (the Forager Australian Shares Fund), and they both hold positions in Enero (EGG). In fact FOR has held EGG pretty much for their (FOR's) entire existence, riding them down to their lows and then through their strong 2019 recovery, then through the massive falls in Feb/March 2020, and the recovery so far since then. There is actually quite a bit of fundie ownership of EGG:
- Forager (FOR) still own 5.17%;
- Perpetual (PPT) now own 13.29%;
- NAOS (in NCC & NSC) own 14.12%;
- Regal Funds Management own 13.07%; and
- Wilson Asset Management Group (in WMI & WAM) own 8.78% of EGG
WAX (WAM Research) may also hold some EGG, however EGG was not in WAX's top 20 at the end of August - but it WAS in WMI's (WAM Microcap's) top 20. WAM (the WAM Capital LIC) holds all the stocks that WAX, WAA (WAM Active) & WMI hold.
Also, we know that NAOS hold EGG in both their NCC & NSC LICs, but they may also hold EGG in NAC - which targets larger companies - their monthly reports say: "NAC generally invests in mid-cap industrial companies with a market cap of $400m-$1b+" while a recent NAOS company presentation had a graphic suggesting that NAC covers a range of market caps from $250m to $6 billion. In reality however, at the end of August, the Weighted Average Market Capitalisation of the Investments in NAC was $332.1 million and they definitely held companies like OCL (Objective Corp) whose market cap is only $118m (even smaller than EGG). We also know that all 3 of the NAOS LICs (NCC, NSC & NAC) are very concentrated (not too many positions), and there is a lot of crossover between the three of them.
In addition to those five fundies, a private investment firm, RG Capital Multimedia (originally set up by the late Reg Grundy, a legend of Australian TV and Radio) remains the largest EGG shareholders, with a 17.69% stake. RG Capital is now run by Susan McIntosh who is a non-executive Director of EGG.
Out of Enero's six member Board, only their CEO & MD, Brent Scrimshaw, does NOT hold shares or options in EGG.
Between the board members, RG Capital and the five fundies mentioned above, around 75% of the company is accounted for, leaving a small free float of around 25% - and Enero are a microcap company with a total market value of only $136 million (at yesterday's $1.57 closing price).
Liquidity can therefore certainly be an issue with EGG, as it can be with many microcap stocks, particularly those with reduced free floats (the shares available to the general public, i.e. not held by institutions or insiders). As I type this, we have 7 bids on the "buy" side, 5 offers on the "sell" side, and the lowest offer (at $1.595) is 11.5% above the highest bid (of $1.43). It is therefore not particularly unusual to see the SP move quite a bit in percentage terms on very low volume. This is par-for-the-course, i.e. comes with the territory with such companies. The five fundies who own stakes in EGG are used to dealing with such issues, and tend to be longer term focussed investors who know they have to be patient when either accumulating shares in such companies, or when reducing their exposure (or exiting their positions), with the possible exception of Wilson Asset Management, who can be in and out in a relatively short period when it suits them. That could be more difficult with EGG though, seeing as they own 8.78% of the company. I view that as a fairly high conviction position for a fundie like WAM (the manager, not the LIC) considering the lack of liquidity that EGG obviously has. Even more so for RG Capital, PPT, NAOS and Regal who each own over 13% of EGG.
Anyway, as I said, I don't hold EGG directly, however I do follow them because of the indirect exposure I have to them through my holdings in FOR and WMI. EGG appear to be one of the better advertising, brand management and promotional groups out there.
I used to own shares (directly) in WLL (Welcom Group) which was taken over at a healthy premium, so I know that there is money to be made in that space, when you pick the right players.
P.S. This is the second time I've typed all this - I first did it yesterday evening and it failed to save because Strawman.com had gone down for a system update. I had become complacent and never saved a back-up copy on my own computer (which I used to always do), so lost the lot...
