FCF GROWTH AND ATTRACTIVE VALUATION MAKE FOR A COMPELLING SMID-CAP STORY
THE TD COWEN INSIGHT
The record Q2 results reflect continued strong execution and favourable industry fundamentals (high surgical backlog and healthy leisure and business travel demand). The shares are trading only at 8.2x forward consensus EBITDA (versus five-year average of 9.3x), which we do not think fairly represent the stock's attractive risk/reward trade-off.
Impact: SLIGHTLY POSITIVE
KBL delivered ~8% organic revenue growth in Q2 (~1.5% volume / ~6.5% price) stemming from consistent healthcare demand and healthy hospitality volumes (convention and large group travel has returned). Adj. EBITDA margin expanded 160bps y/y thanks to Shortridge's contribution, operating leverage, and stabilizing costs and labour markets.
For the 2H, we see healthy MSD% organic revenue growth (balanced between price/ volume) in both Healthcare (i.e., clearing the high surgical backlogs, conversion to reusable linen products) and Hospitality (i.e., no immediate demand concerns, supported by Airbnb's (ABNB, BUY; current price $111.44; target price $125.00) stable EMEA trend and robust growth outlook — see our colleague's note here). This will be further enhanced by recent M&A (est. 10% total contribution to revenue). Looking ahead and while not in our forecast, we see upside from potential RFP wins (opportunities totaling tens of millions in 2025) and market share gains (strategic Villeray plant location could drive growth in Quebec).
In addition to contributions from Shortridge's structurally higher margin profile (i.e., ~25% EBITDA margin by our estimate > ~15% in KBL's legacy U.K. business), we still see room for further margin expansion stemming from: 1) improved labour availability as labour markets ease over time; 2) moderated energy prices and inflationary pressures; 3) volume-driven efficiencies from market share gains (given KBL's solid service levels), and longer-term 4) M&A -related synergies (mostly by leveraging excess capacity). Together with capex rolling off, we expect strong FCF growth starting in 2H.
Finally, we believe K-Bro's strong balance sheet (<2.5x pre-IFRS 16 leverage, pro-forma acquisitions) leaves the company well-positioned to not only weather an economic slowdown, but also to continue executing on its active M&A pipeline.
We raised our 2024-2026 revenue and EBITDA estimates by ~1-2%, primarily reflecting the Q2 beat, the C.M. acquisition, and restatement of Q1 EBITDA (add back one-time costs). We lowered our EPS estimates for higher depreciation and interests (from M&A). Our $46 target price is unchanged.