A weak share price at leading UK food wholesaler Booker (BOK) presents a buying opportunity for seekers of a secure and rising income stream.

Though a subdued underlying sales performance of late has caused alarm, confirmation of another year of profit growth could trigger a share price rebound. We believe the market is also underestimating the turnaround potential of Booker’s £40 million acquisition (14 Sep 2015) of Budgens and Londis in Great Britain.

Delivering the goods

Booker is the UK’s leading food wholesaler, supplying groceries, alcohol and tobacco predominantly to independent retailers and caterers. An omni-channel operator, Booker’s businesses include cash and carry operators Booker Wholesale and Makro, as well as delivered wholesale arm Booker Direct, restaurant speciality food supplier Ritter Courivaud as well as Chef Direct.

Under the leadership of chief executive Charles Wilson, Booker has spoiled investors with top line growth and margin improvements over the years. The current year’s focus is more about margin than chasing turnover amid increased price competition in the UK grocery and discount sectors.

The £2.94 billion cap’s third quarter update (14 Jan) showed a 3.1% decline in total like-for-like sales, largely reflecting the impact of a ban on small stores displaying tobacco products.

Non-tobacco like-for-like sales were 1.3% lower, reflecting food price deflation as well as lower footfall from reduced tobacco trade. Market backcloth notwithstanding, Booker appears increasingly strong. Profit remains on an upwards trajectory and the wholesaler sits on a net cash pile, even after acquisitions and returns to shareholders.

Growth: Medium

Challenging UK growth market near-term but Budgens-Londis should boost sales and profit in time.

Risk: Low

High-quality concern with a proven track record, though slower-than-expected progress with the Budgens-Londis turnaround would disappoint.

Quality: High

Veritable cash machine delivering rising profit in mellow market conditions by improving choice, prices and service for customers.

Strategic allure

Third quarter group sales, including the Budgens-Londis acquisition, rose 10.5%. Wilson is working on enhancements to the recently-acquired businesses. They rebalance the business back towards retail in part and provide capacity to expand in the growing convenience market.

Booker has upgraded its fresh and chilled prepared foods capabilities through the Budgens brand and supply chain, while the Londis fascia extends the reach of its retail brands, which already included Premier and Family Shopper.

Significantly, the transaction also delivers greater geographic reach, boosting Booker’s presence in the more affluent south and east of England. While the deal will drag on earnings this year, Budgens-Londis is expected to make at least a £5 million contribution in the year to March 2017, and there is scope for a positive surprise.

Cash machine

Investec Securities analyst Nicola Mallard notes that margins have been increasing despite like-for-like sales struggling to improve this year.

After reversing the impact of deflation out of revenue, volumes are ahead. By dropping low margin revenue from Makro and adding volume in higher margin categories, Booker is enjoying some sales mix benefits.

Mallard has a ‘buy’ rating and 210p price target, implying nearly 40% share price upside. For the financial year ending 31 March 2016, Investec forecasts pre-tax profit of £151.9 million (2015: £138.8 million) for earnings per share of 7p (2015: 6.6p), rising to £171.3 million and 8p respectively by March 2017.

Though Booker’s valuation appears optically demanding on a PE basis, the premium is more than merited given a secure income stream supported by strong free cash flow, with forecast year-end net cash of £97 million set to build to £102.1 million by March 2017.

Booker’s ‘normal’ dividend of 3.9p is expected to grow to 4.3p by March 2017, though Booker has paid 3.5p special dividends in the past two summers and plans to do so again in 2016, so the true yield is even higher.

Booker (BOK) 153.4p

Stop loss: 122.72p

Market value: £2.94 billion

Prospective PE Mar 2016: 21.9

Prospective PE Mar 2017: 19.2

Prospective dividend yield Mar 2016: 2.5%

Bid/offer spread: 0.13%

Analyst price target: 210p*
Investec Securities, 14 Jan 2016