PM Bolt-On: Exclusively Majestic Wine (MJW) - you may need coffee.

Good Evening,

Majestic Wines trading update came in better than expected - fear not, it’s still not great but with the 'strategic review completed' the market has bought into the story. Despite Majestic Wines stating the obvious:

This transformation will take time and require significant investment, so we expect profits to fall before they grow again. However, we are certain that it is the right thing to do for shareholders, customers, staff and suppliers.

The structure of Majestic's pre-Naked Wines meant MJW should have been able to develop a Business to Business (B2B) and an e-offering without having to acquire Naked Wines. Majestic had an established network and logistics already in place – it did not have to spend £70M.  

Majestic's web-based expansion plans are putting shareholder returns at risk (dividends), with the majority of free cashflow likely to go towards customer acquisition - why is the market buying into this? With the company guiding to no dividend until July 2018 at the earliest, there's no urgency to put equity at risks unless you are a true believer in the story. 

The mainstream  ran with, ‘Investors may raise their glasses to toast Majestic Wine’s new boss Rowan Gormley today if he can deliver a much-needed three-year strategy that can deliver on upturn to the group’s finances’ (Telegraph – with apologies). 

EMC's believes in the short-to-mid-term that online wine, text for wine and all web-type-wine-entities offer limited upside. The method of acquisition and enticements do little to promote customer loyalty; resulting in higher costs and ironic reduced loyalty rates. The market appears to subscribe to the "hope value in this being a profitable web based offering", we do not.  

These types of marketing strategies are a bet on a customer relationship lasting long enough to recover the initial outlay and make a profit. Examples of enticements being ‘a free case of wine, ‘£40 off a case', or ‘sign up to paying a monthly fee for discounts’. Has the market not seen this before - including offering rewards for recommending friends? 

The best of the results are normally in the summary, we'll handover to MJW (bold, italics and underlining are additions) and cover some of the balance sheet later:

• Underlying H1 trading encouraging at Majestic Wine whilst strong growth continued at Naked Wines.

• Thorough strategic review now completed, challenging medium term target announced today along with key new initiatives and updated short term cost guidance.

• New management structure and team in place and working well. 

Are Majestic management losing sight of the value of Majestic retail by chasing revenue with Naked Wines? The challenging medium term target implies there's going to be a revolution in online wine sales and the Business to Business (B2B) arena. Established players are very adept at dealing with challenges. We believe there is a good argument for a Majestic (brand specific) web offerin - where customer acquisition costs could be cheaper than if the Naked Trader brand or format was used and with brand loyalty.  

There's undoubtedly value in expanding the B2B offering, but the question remains, why expand within an already competitive online market place? What is Naked Wine's edge in the market place? 

If Majestic asserts that Naked Wine's will be the go to ‘virtual’ shop for online wine, one has to consider the competition - Laithwaites and Virgin Wines (This is Money). In an already competitive market, we now question whether growth will be profitable enough to warrant the investment and the suggested valuations (we have avoided stating shareholder returns at this stage).

Analysts with rose tinted spectacles might like to consider the following: Googled for you -search wine (Search 1) and Googled for you - online wine (Search 2). Please note the positioning of "Majestic's" in Search 1 compared to Naked Wines in Search 2. More so Laithwaites, Virgin Wines  and Tesco all come in above Naked Wines in Search 2. The very position of Majestic in search two (online) questions why there was a need to pay £70M for Naked Wines. EMC ignored the advertisers as well, albeit these are as poignant. 

We note the change in director’s responsibilities and some amusing KPI's with a challenging set of three year targets up to 2019 (see further down). 

Over to Majestic with their Three year transformation plan highlights (ECM's additions are italics, bold and underlined):

• Underlying H1 trading encouraging at Majestic Wine whilst strong growth continued at Naked Wines.

• Thorough strategic review now completed, challenging medium term target announced today along with key new initiatives and updated short term cost guidance.

• New management structure and team in place and working well.

• Announcing today a new strategy to deliver sustainable, volume led earnings growth and improved return on capital

• Targeting over £500m sales by 2019. Key performance indicators to demonstrate progress are also published today

• Good progress made on structure, team and key initiatives
• Key elements of the plan include:

• Absolute focus on disciplined investment to generate returns on investment - measured as annual recurring EBIT generated as a % of investment outlay - above our target of 25%

• Change of emphasis from opening new stores to new customer recruitment to drive higher returns from the current level of investment spend

•  Total UK store target reduced from 330 to 230, currently 211

• Reviewing the existing store network for opportunities to unlock value

• Reinvigorating sales growth in mature Majestic Retail stores with a new and simplified pricing policy (including no minimum purchase) and improved customer experience in store and on-line

• Continuing to expand the fast growing and successful Majestic B2B business by winning additional accounts

• Continuing to expand the fast growing and successful Naked Wines businesses in the UK, USA and Australia

We concur with B2B focus and customer relationships managers (CRMs) that have perhaps been underutilised to date. In essence, Majestic will be making the current estate work harder and this is always a positive for shareholders. However, these positives may be offset by Naked Wines that has to acquire customers at a cost - one cannot help but wonder if all the key metrics and words utilised sound a little "Hello Fresh" like in the KPI format (below)

Likewise, reducing store footprint and/or limiting expansion when growing the B2B is somewhat of a contradiction. The ability to deliver and compete would surely be a benefit of further expansion. There is also a marketing opportunity within the B2B that would cost significantly less than the Naked Wine concept that entices customers with a free case of wine or similar etc.

Majestic's KPI's     

Segment	KPI	Current level	Significant improvement by:
Majestic	Customer retention	45%	H2 FY17
Retail	Product availability	67%	H2 FY18
	Store manager retention	77%	H1 FY18
	Wine quality	TBC	H2 FY18
	Proportion of 5-star service ratings	85%	H1 FY17
Naked	Number of Mature Angels	269k
Wines	Net Growth in Mature Angels	+29k
	Retention rate of Mature Angels	66%
	Growth investment in Mature Angels	£1.2m
	Return on Investment in New Mature Angels	112%

Note: Wine quality at Majestic Retail will be measured in future by customer ratings. No current data is available.

Questions;

1. How does Majestic's measure customer retention? 
2. What is the retention measured against - Active Customers? Does it mean incentives are offered to customers to stay? 
3. With a 45% Retention Rate - does one assume then that it is a 55% churn rate? 
4. Will all these retention numbers be stripped out per operating divisions? 
5. How does one check in a shop-based business if someone is a returning customer – store customers are notorious for forgetting to bring their loyalty cards.
6. Product availability? Does this mean Majestic's has to carry sufficient stocks to not be out of stock? Or simply have wine for sale? Being out of stock is only a bad thing if it means a lost profitable sale – what is customer behaviour – do they substitute; or return; or have deliveries to their home? 
7. Are the Majestic stores out of stock because the model relies on limited volumes of attractively priced wine to bring the punters in? Without explanation and analysis ensuring ‘sufficient’ stock could be a Majestic own goal.
8. Store Manager retention - is the limited opportunistic research we've conducted correct, that Majestic are haemorrhaging their talent at significant cost to training?
9. 5 star customer service based on what platform for reviews?
10. Are Mature Angel customers who leave kept on the books for a period of time "just in case they re-join?" Or is their no motivation for Angels to return.
11. Retention of Mature Angels – as per the KPI table - in the cycle of achieving the status of a Mature Angel, does this mean 55% churn/exit before becoming an Angel. Once qualifying, is there an expectation of 35% of Mature Angels exiting. What is the cost to the company for a customer to attain the status of Mature Angel? Or for that matter, the cost to customer?
12. Growth Investment in Mature Angel? Is the KPI the amount the customers have paid in or the amount the company has spent?
13. What's the difference between Naked Wine and any other offering? 
14. Do supermarket models offer less value? We disagree and consider Naked Wines model to funding and monthly payment a hindrance to customer on-boarding and choice. Supermarkets including the discounters challenge the model not just on price and margin but more importantly convenience. 
15. Is the Naked Wine's "customer monthly payment/crowd funding" model the way forward rather than a hindrance? The customers shall decide over time - perhaps it gives some sales outlook and reliability in forecasting
16. Comparatives are hard to find in LFL wine offerings but there are remarkably similar themes. The main benefit being, one doesn't have to pay monthly or become an Angel "to obtain a discounted price" at a supermarket or off-licence. We feel this type of offering / marketing gimmickry may work, in the short term. 
17. A KPI of "average revenue per customer" or "average basket price"- like Majestic used to report would be beneficial. 

We should at least loosely consider Majestic’s results:

• Net debt and liabilities are currently near £25M – with the aspirations of expansion there is a real likelihood this will increase as marketing/customer acquisitions continue apace.

• All is not lost though - debt is sufficiently serviceable if operational performance remains stable and/or improves in 2 of the four divisions.

• We rate Majestic Wine retail division and consider the commercial division B2B to be of significant future value as it has yet to be fully developed. We can draw possible similarities in the B2B space between Conviviality (CVR) and Majestic's in the future and the potential of such an offerings - perhaps even M&A to command better margins. 

• Ley and Wheeler (L&W)– we acknowledge that L&W could be developed further with the possibility of added to other divisions with the bolt on of specialist fine wine business.

• We have already mentioned the reduction in new store roll out (CAPEX) - one suspects will be directed towards marketing.

Today confirmed the belief that dividends are toast for the foreseeable future – Majestic suggests they intend to return the dividend in July 2018. This validates our belief that Naked Wines does not fit the Majestic model and will be a drain on profitability longer-term.

The hype of the 'internet of things' is not a model we invest upon within the wine space. Retail clothing yes (BooHoo etc…), but wine has so many other competing factors including supermarkets and their discounting cousins. Simply, why add another 'point of sale item' to your weekly/monthly shopping - hobbyists perhaps but the average consumer........? 

Businesses should be viable and as such, Naked Wines needs to prove itself significantly more to warrant us buying in Majestic. If investors feel there are rewards in buying the stock based on two divisions and hopes of an web-based wannabe Goliath (Naked Wines) + specialist fine wine business – then today will no doubt present as an opportunity over the longer-term. 

We do not deny the webcast was well received by the market – however we remain unconvinced. We feel the strategic review was unchallenging and has not gone far enough improve the outlook for Majestic Wine on many levels. Validated in part by the Majestic statement:

We are excited and confident about the future, but I must emphasise that these plans will take time and require investment, which means that we expect profits to fall before they return to growth from a low point in FY16.  We anticipate that our strong cash flow will enable us to invest as needed while continuing to deleverage and restoring the dividend in full by 2018.

In our view, they have not answered how they will manage the supermarket threat to margins (conventional or discounters); or how they will shift consumer perception of their offerings and how the value of Naked Wines is justified. The outlook for Majestic may be changing, but currently there are insufficient indicators to warrant us being a buyer; we have been negative since the acquisition of Naked Wines. 

The benefits of the economic moat Majestic previously had have been eroded - this we felt insulated Majestic's offering with the 6 bottles minimum purchase. This helped establish Majestic’s brand and offering over years and was devalued in an instant; other options were available and should have been explored.

We believed the two models do not fit together for investors. A good percentage of shareholders would have invested on the basis of a very different concept. Expect those in Majestic 1.0 (dividends and modest growth) to sell into any strength of Majestic 2.0 (web-based hopes and expansion). 

Atb Fraser

Morning Mumble: Direlight (DIA), Chemring (CHG), Kenmare Resource (KMR) and Majestic Wine (MJW) their economic moat!

Good Morning,

Dialight have given strategic review & trading update. Over to Dialight (see additions by EMC in bold):

Trading Update

Trading in the three month period to 30 September 2015 was characterised by continued weakness in the oil and gas sector and reduced levels of industrial capital expenditure, particularly in North America. As a result, reported lighting revenue growth for this period was 5%. The cost reduction actions announced on 7 August are on track to deliver their targeted reduction in operating costs and we are encouraged by the strength of our order book. However, with market conditions having become more challenging during the third quarter, and Dialight's financial performance weighted as usual to the seasonally-strong fourth quarter, the Group faces an increased level of uncertainty in the remainder of the current financial year.

But...By the end of 2018, Dialight is targeting to achieve:

• Over 25% annual revenue growth
• Over 40% gross margin
• Over 15% EBIT margin
• Over 80% cash conversion

The market is wising up to the realities. See: EMC: Direlight (DIA) June 2015.

Chemring (CHG) trading update that isn't good news with a "potential" delay in the 40mm contract. The concern being, this is yet another company flag waving a rights issue so far in advance it raises significant questions about any understanding of the market. 

Admittedly, with a bit of good fortune, Chemring could turn the situation around by gain the necessary permits and export approvals associated with this contract, although one senses the board find this highly unlikely. Over to Chemring, additions in bold. 

Key points

• Despite significant progress having been made, there is potential for delay to revenues from the 40mm ammunition contract announced on 14 September 2015

• As a result of this and other issues, there is now a realistic prospect that year ending 31 October 2015 ("FY15") underlying operating profit1 could be reduced by approximately £16 million to approximately £33 million

• Order book at 30 September 2015 of £606.3 million; £344.6 million for delivery in FY16, representing more than 75% of expected FY16 revenue of £450 million

• Discussions will be held with debt providers to negotiate amendments to the operation of covenants and the waiver of any event of default that may result from the 40mm contract delay

• Proposed rights issue (the "Rights Issue") of up to £90 million in Q1 2016; fully underwritten on a standby basis by Investec and J.P. Morgan Cazenove

• Resultant medium term target capital structure of 1.0x - 1.5x net debt to EBITDA

The company's debt levels have been a concern and impeded them for some time, so Chemring elect to kitchen sink their issues today with:

"The recent progress of the Group has been impeded by its high levels of debt and associated interest costs. Significant time has been spent managing this debt, at the expense of further operational improvement and fully capturing the longer term growth opportunities open to the Group. We have therefore announced today that the Group proposes to launch a fully underwritten rights issue to raise up to £90 million, the proceeds of which will be used to fundamentally address the high levels of debt and to provide a competitive capital structure."

It begs the questions of why the rights issue isn't now...shareholder value? The cash advance whether recognised in this year or next is immaterial to the overall issues the company are facing. Target price now likely to be near 87 pence. If it quacks like a...This company has a momentual task just to maintain existing shareholder value, 

Kenmare Resources (KMR) forgot to mention some key ingredients within their  Q3 trading update. Namely the pricing environment over and above anything Kenmare can do will remain challenging. Iluka Resources is fully aware of the KMR financial position when such terms as "Super Senior Facility" are utilised it rather suggests who has the stronger hand.

A question: exactly how much time have the "board / management" spent out at Moma? More so, what is the purpose of the board if an external consultant has to be appointed to support and extend this ongoing cost control and efficiency programme? We'll ignore the stock levels and the like for now, as all the cards are in China's and Iluka's hands at the moment. 

In the current environment, Iluka Resources have no need to save Kenmare and there is a real risk of downward pressure on any offer price. For a perhaps more open outlook, please read Iluka's Q3 (see the market conditions section). 

The market is waking up to the realities of Iron Ore, scrap prices are falling quicker, steel prices down. More so, there's now evidence Steel Mills are bringing forward larger maintenance works and/or shutting capacity due to the limited demand. We acknowledge the likelihood of a larger sized steel mill default. 

With two significant events currently under way the 18th CPC and the Fed, there are likely to be considerable trading events. We have Aluminium production in China yet again on the increase, the average operating rates of Chinese copper processors is steady but nothing to shout home about, Zinc inventories in Shanghai, Tianjin and Guangdong are on the up and finally, scrap prices in China fell through the floor evidencing the realities/contradictions of the alleged balance in supply and demand.

Finally, it would be unfair not to consider Majestic Wine (MJW) whom pulled the proverbial plug out of their economic moat of six bottles or more. Apparently, MJW trialled no minimum bottle requirements at 23 stores for 5 months. Its allegedly had no impact of volumes, really?? 

The question is, did the removal of the 6 bottles or more criteria improve sales? Or just increase the cost per sale? Is this a flag waving event where they firmly placed themselves within the supermarket sector where such benefits of 6 or more bottles may have insulated them to a degree. Surely if one is an off-license location is key!

If someone could be so kind as to point out where Majestic announced to the market that they were trialling the no minimum bottle purchase, it would be appreciated. As in yesterday's announcement of a new pricing strategy stated, "follows the previously announced successful trial in selected Majestic stores since Spring 2015 proving popular with both new and existing customers." Perhaps one is just being tardy, a quick email to Majestic's IR might assist. 

With the results out on the 16th, and one has a suspicion there's been a leak to the supermarkets! Quite why Majestic Wine's didn't merely launch their own online offering of wines via post/text is a very pertinent question

Atb Fraser

Apologies for grammar a quick one!