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Earnings downgrades and debt fears suggest it needs to rethink dividends
Thursday 20 Oct 2016 Author: Daniel Coatsworth

Fancy getting 11% dividend yield from investing in a Caribbean hotel operator? Elegant Hotels (EHG:AIM) owns plush hotels in Barbados and is expanding into Antigua. Sadly there’s a catch to the investment case which suggests dividends may need to be cut.

Earnings forecasts have been downgraded several times this year and there is a material risk to demand near-term.

EHG - Comparison Line Chart (Rebased to first)

Vacation versus staycation

Approximately 70% of its customers come from the UK. Currency weakness and concerns about economic conditions would suggest people in the UK may think twice about splashing out for a Caribbean holiday at the moment.

The pound has weakened by approximately 17% against the Bajan dollar, making it more expensive for UK customers to go to Barbados. Elegant last week confirmed forward bookings for its current financial year ending 30 September 2017 are weaker than at the same point last year.

Liberum responded by slashing its profit forecasts by a third for 2017 and 2018. The investment bank had already downgraded estimates by circa 14% and 10% respectively four months ago.

Takeover target?

At 62.5p, the company trades at more than 40% discount to net asset value. ‘The disparity to the land value is material and we feel this could result in a bid approach,’ says Liberum.

Nearly half the company is owned by UK fund managers with Vision Capital holding a further 23.8% stake. We doubt these investors would accept an opportunistic takeover bid given the shares trade significantly below last year’s 100p IPO (initial public offering) price.

A typical 40% bid premium on the current share price would only pitch a potential takeout at 87.5p – so original IPO investors would still be losing money.

Debt pressures

The company is forecast to pay 7p (8.8c) per share dividend for the next few years, which equates to an 11% yield. Net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) is forecast to be 3.5 times in the current financial year. That’s danger territory for many companies.

Liberum believes debt covenants won’t be breached, yet we reckon Elegant should avoid any problems by cutting the dividend now.

This stock was originally sold to investors as a dividend story, so cutting the shareholder reward so early into its life as a listed company wouldn’t go down well. (DC)

Value investors may find the stock appealing. We are less enthusiastic, believing the shares will struggle to fight the current negative market trend until there is clear evidence of a recovery in trading. For that reason, avoid.

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