by Will Ashworth | April 26, 2013 6:47 am
Fortune magazine recently highlighted America’s beloved motorcycle manufacturer, Harley-Davidson (NYSE:HOG) — saying that after numerous ups and downs in its 110-year history, not only is Harley growing again, but it’s considered by many investment analysts to be a dividend growth stock.
Whether that’s true or not remains to be seen, but it did get my brain churning about leisure stocks as a whole.
Somebody once said (and I’ll be damned if I can remember the exact reference) that the sporting goods industry is a great business because it methodically grows at 2% per year. Nothing spectacular — just consistent growth. However, while certain leisure stocks (like those sporting goods companies, or movie theaters) do well in all kinds of economic conditions, the recession of 2008 wasn’t as kind to others like hotels and resorts.
Nonetheless, one thing most leisure stocks have in common is that they’ve outperformed the S&P 500 over the long-term.
Can they continue to do so? I think so — and I have three specific targets in mind:
My first pick is something of a cop-out, in that I want you to make a bunch of picks simultaneously.
That is, investors interested in leisure-related investments should snap up the PowerShares Dynamic Leisure and Entertainment Portfolio (NYSE:PEJ) exchange-traded fund. You get significant weightings (5% or more) in Disney (NYSE:DIS), Time Warner (NYSE:TWX), Discovery Communications (NASDAQ:DISCA) and Starbucks (NASDAQ:SBUX), as well as other strong leisure stocks such as Madison Square Garden (NASDAQ:MSG) and Regal Entertainment Group (NYSE:RGC).
This bundle of 30 related stocks has collectively beaten the broader market by 9 percentage points in the past year, and charges just 0.63% in expenses.
I’ve admired Steiner Leisure (NASDAQ:STNR) for a long time. Its main business is operating spas on cruise ships, currently serving 152 cruise ships around the world — including 33 for Royal Caribbean (NYSE:RCL) — by providing cruise-goers with a few hours of peace and relaxation along their journey.
However, over the years it has expanded into land-based spas, skincare products, laser hair removal and the operation of post-secondary schools related to its various businesses.
Following the Sept. 11, 2001, terrorist attacks, the cruise business went through a difficult period of adjustment as vacationers opted to stay closer to home. Steiner, in its position as spa service provider, was caught in the middle. It didn’t matter how good its services were if the ships weren’t full to capacity. Yet despite doing business with one hand tied behind its back, STNR managed to muddle through the crisis and today is a stronger company as a result.
In the past decade, Steiner’s revenues have grown in nine out of 10 years through a combination of acquisitions and organic growth. While it always has generated more service revenue than product revenue, its current diversification into laser hair removal facilities has reduced its reliance on its spa operations. In the future, it will likely seek out complimentary businesses to acquire that further its diversification efforts.
Steiner always finds a way to make money regardless of the economic headwinds. Its free cash flow generation is very consistent; its current cash return — free cash flow plus interest expense divided into enterprise value — of 9.5% is higher than most, suggesting its stock is undervalued at the moment. Since the beginning of 2011, STNR’s average annual total return has averaged -1.7% at a time when the S&P 500 has delivered an annual total return of 21%.
Long-term, I think Steiner is a winner.
One of the metrics I use to get a quick fix on a stock is EV/EBITDA; when comparing companies in a similar industry, it’s a great way to see how the valuations stack up side-by-side.
In the wine, beer and spirits business, the stock with the lowest multiple at the current time is none other than Diageo (NYSE:DEO), the world’s biggest liquor company. Its enterprise value at the moment is 14.9 times EBITDA. That compares to 17.6 times for Brown-Forman (NYSE:BF.B) and 17 times for Beam (NYSE:BEAM), its two nearest publicly traded rivals. In fact, about the only company that has a lower multiple of all the major players in the alcoholic beverage industry is Anheuser-Busch InBev (NYSE:BUD) with a multiple of 12.3.
So why Diageo is valued this way?
I truly don’t know.
In the first nine months of fiscal 2013, organic net sales increased 5%, with a 1% improvement in volume. Four of Diageo’s five regions saw organic net sales increase by at least 4%, with North America reporting a 6% increase. Approximately 42% of its business is in high-growth markets like Latin America and Africa, its operating margin is as high as it’s ever been at 30%, and its balance sheet is remarkably unleveraged for a company of its size. And DEO owns more than a quarter of the 100 biggest premium liquor brands in the world.
Diageo’s performance year-to-date has been mediocre, up just 3% year-to-date — lower than its winery and distillery peers, as well as the S&P 500. However, its returns are much more favorable over the past couple years, and long-term, I think DEO will return to its outperforming ways. Sustainable earnings are the key to growth, and Diageo does that better than most.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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