Brait: bread, boets and (exchangeable) bonds

Brait is such an interesting group. They sell bread in one division and offer gym contracts in another, aimed at those who think bread is poison and the low-carb life is everything, boet.

Ok, there are only certain sections of the gym that follow that approach, but you get the idea.

They also sell clothes in the UK and pay incredible fees to Ethos Private Equity for the pleasure of managing this rather disparate portfolio.

Does this portfolio make any strategic sense? No, of course not. Brait is an investment holding company that was built with a private equity mindset, so the portfolio isn’t designed to make sense when viewed overall. Each investment needs to be assessed based on its merits.

The latest update from Brait is the annual results for the year ended March 2022. As a final bit of context, the share price is flat this year.

Premier

The food business is called Premier and Brait intends to list it separately. The business is performing well, bucking the trend in a sector that has tamed certain tigers.

Premier is 49% of Brait’s total assets and the value increased by 22% in this financial year, a really impressive result. The business somehow managed to increase its EBITDA margin from 8.8% to 10.3% in this period, despite the clear pressures being exerted by retailers on food producers.

The Millbake business contributes 82% of Premier’s revenue and grew revenue by 12.5% and adjusted EBITDA by 32%. Volumes grew by 6% and price inflation was 6.5%. It’s quite extraordinary to compare this to the numbers we’ve seen from the likes of Tiger Brands, which has lost a fifth of its value this year.

The Groceries and International division is 18% of group revenue and has been boosted by the acquisition of Mister Sweet, which was included in this result for 10 months.

Capital expenditure of R519 million was slightly higher than R504 million in the prior year. There were big swings between maintenance and expansionary capital expenditure though. Maintenance dropped to R186 million from R244 million and expansionary increased from R260 million to R333 million.

Virgin Active

Virgin Active is 44% of Brait’s total assets.

The gyms went through a torrid time in the pandemic, as governments worldwide felt that the best way to combat a respiratory virus was to create an unfit and unhappy population. Cash flow dried up for the gym group, an issue that can only end in tears for investors.

There’s a renewed sense of purpose at Virgin Active, with the founder of Kauai joining as CEO and shareholders supporting a recapitalisation of the business to the tune of R1.8 billion. Real Foods (the holding company of Kauai and Nu) is going to become part of the group, subject to regulatory approvals.

New Look

New Look is only 4% of Brait’s total assets. This is a UK-based multichannel fashion business which hasn’t been a happy story for Brait over the years.

The business did well for three quarters of the year. Sadly, Omicron turned New Look into New Variant, ruining the trading performance between October and December. Brait highlights strong momentum into the new financial year, which is obviously good news.

Brait Group

In December 2021, Brait raised R3 billion in capital through the issuance of exchangeable bonds by a wholly-owned subsidiary. This helped partially repay Brait’s committed revolving credit facility, which has been extended to June 2024 with a limit of R3 billion. The drawn balance at reporting date was R2.478 billion. In case you’re wondering where the rest went, R1.7 billion was invested in Virgin Active.

Post year end, Brait finally realised the investment in Consol at a 16% premium to the September 2021 valuation.

Brait’s net asset value (NAV) per share of R8.37 is a 5.9% increase year-on-year and a 2.9% increase since the mid-year number. That’s the kind of growth rate that an angry personal trainer would shout at you for.

It’s certainly worth noting that Ethos Private Equity gets paid an absolute fortune as the investment advisor to Brait. The fee was supposed to be R100 million in 2021 and was reduced to just R91 million – such sacrifice. In FY22 it was still R91 million (vs. contracted R105 million) and has increased to R96 million in FY23 (vs. contracted R110 million). The contract has been extended for FY24 at a fee of R65 million.

Best of all, there’s a short-term incentive payable on top of this. A further R30 million was approved for FY22, taking the total fee to R121 million. This works out to around 2% of the market cap of Brait which I’m sure is no coincidence, as this is a typical active management fee. My point is that you can hire a truly impressive team for less than half that number, especially as this is a group-level management fee and doesn’t include anyone working in the underlying businesses.

This is how most investment holding companies work though, which is why they tend to trade at substantial discounts to net asset value.

The share price is R4.58, a discount to NAV of around 45%. That’s on the high side but certainly not unheard of among investment holding companies. To assess whether you want to invest at this level, you need to consider the valuations that create the NAV.

Valuations supporting the NAV

Premier is valued on a valuation multiple of 7.6x maintainable EBITDA, compared to the peer group spot multiple of 7.7x. Although the finer points of this multiple could surely be debated, I think there are other investments that deserve your attention.

Virgin Active is valued using a two-year forward multiple of 9x, which is more ambitious than me attending a double spinning class after two years of no exercise. This is apparently a 10% discount to the peer average two-year forward multiple of 10x. The maintainable EBITDA on which this valuation is based is 23% less than the actual EBITDA achieved in 2019, so there’s at least some conservatism in the earnings if not in the multiple.

Although the market is clearly discounting Brait’s assets and I suspect much of that is being attributed to the gyms, the R1.8 billion recapitalisation of Virgin Active was achieved based on Brait’s methodology. There are some nuances to this, though. The parties who recapitalised the business are friendly parties and the merger with Real Foods (Kauai and Nu) was also done at a juicy valuation for the food business.

My point is that I would have more faith in a multiple supported by an offer from an independent third party to buy the business. I am not convinced that they would offer 9x.

New Look is valued on a forward multiple of 5x, which is a discount of 25% to the 6.7x peer average. This is a tiny part of Brait’s business, so debating this valuation hardly moves the dial.

A “forward multiple” is based on an expectation of future profits. One would take this approach when using “maintainable earnings” – simply, this is like saying to someone “please ignore the current numbers, instead use this number based on what we think the business looks like in a normalised world two years from now.”

The really fascinating thing to watch will be an eventual listing of Premier, leaving Virgin Active behind along with New Look. If the “RemainCo” share price takes enough of a knock, it may become interesting. There are many complexities one would need to consider though, including the dilutionary impact of the exchangeable bonds.