TD Initiates Coverage with a $41 Target Initiating Coverage: COVID-related Weakness a Buying Opportunity
We are initiating coverage of K-Bro Linen Inc. with a BUY recommendation and $41.00 target price. Please see our full report, available later today, for additional details.
TD Investment Conclusion
K-Bro is the largest operator of laundry and linen processing facilities in Canada, and is also the market leader in laundry and textile rental services in Scotland and Northeast England. We have a positive outlook on K-Bro shares, primarily due to the following reasons:
1. K-Bro's hospitality business (45% of revenue) has been negatively affected by COVID-19 and, in light of elevated near-term uncertainty, we attempt to incorporate conservatism into our forecasts. Even after taking this tempered view, we believe that K-Bro shares offer compelling value at current levels, trading at a discount to its historical average valuation (11.9x NTM EBITDA) and to comparables. Our $41.00 target price is based on 10.5x F2022E EBITDA.
2. K-Bro is a market leader (42% market share in both key markets) with highly recurring revenue, what we consider a high-quality customer base, long-term customer contracts (5-10 years in healthcare and 2-5 years in hospitality), strong customer retention (>96% historically), and a long-tenured and financially prudent management team.
3. We believe that its balance sheet is strong enough to weather any potential near-term setbacks, with $70.6mm of available liquidity, financial leverage of 1.5x (excluding IFRS 16), and positive free cash flow expected over our forecast horizon.
4. We see numerous avenues for growth, which we expect will more than offset any lingering COVID-19 impacts on the business in the coming years. K-Bro has averaged approximately 7.5% annual organic revenue growth over the past decade, and we expect a similar level of growth moving forward (in addition to a gradual normalization of hospitality demand), including through additional outsourcing of the linen market, market-share gains, expansion of existing customer relationships, and industry growth, among other sources.
5. We expect K-Bro to opportunistically pursue M&A, offering potential upside to our forecasts and target price. We believe that M&A will consist of tuck-in acquisitions that strengthen K-Bro's presence in existing markets, as well as opportunistic acquisitions that expand its footprint in Canada and the U.K.