SandpiperCI Group — An island of opportunity

Sandpiper is the largest food retailer in the Channel Islands and operates franchise stores for Wm Morrison, Iceland, M&S Jersey and its own chain of convenience stores, fuel forecourts and off-licenses. Its non-food retail business covers franchises for food, non-food and specialist brand retail. Examples include Hotel Chocolat, Card Factory and iQ, the Apple Authorised Premium Reseller. Sandpiper has also been able to leverage its long relationships with major retailers to open their brands in Gibraltar and, more recently, in the Isle of Man. It owns a portfolio of commercial and residential freehold assets in prime locations. This underpins the valuation, renders the cashflow more stable and acts as an effective barrier to entry for any competition.

The company has long-term and successful relationships with its franchise partners, which has led to franchises mostly being renewed. The strategy consists of filling in ‘white spaces’ by introducing target brands to existing territories and leveraging its existing relationships with franchisors to enter new territories. Management has also stated its intention to selectively add to its freehold portfolio to secure strategic locations and acquire businesses that operate in adjacent sectors in the Channel Islands (ie hospitality) to broaden its appeal and complement the retail operations, although we believe this is unlikely in the short term given the ongoing pandemic and unpredictable restrictions on the hospitality segment.

Sandpiper posted sales CAGR of 6.6% between 2017 and 2020, with trading EBITDA CAGR of 16.7% during the same period. During this time, the company has expanded geographically into the Isle of Man and has worked to fill in some of its ‘white spaces’ across its portfolio. The 58,000 sq ft Liberty Wharf shopping centre was acquired in a prime location in Jersey and was refurbished. We expect the pace of expansion to slow down and forecast sales CAGR of 3.6% between 2020 and 2023e, with trading EBITDA CAGR of 3.2%. Sandpiper’s exposure predominantly to food retail has resulted in a strong performance during the COVID-19 pandemic: while the non-food retail operations have suffered due to a reduction in footfall in town centres and temporary store closures, the food retail side has witnessed a material acceleration as consumers had more meals at home. Overall revenues in H121 were up 6%, with trading EBITDA up 7%.

We value Sandpiper primarily on a DCF basis. Our model assumes medium-term sales growth of 3.5%, 1.5% terminal growth rate and broadly flat margins. This results in a fair value of 130p. We also look at peer group analysis. Although there are not many direct peers, Sandpiper trades on a CY21 P/E of 19.4x and EV/EBITDA of 8.5x, a 48% premium and 3% discount respectively to a peer group of food retailers and franchisors. We believe a premium is warranted given Sandpiper’s significant freehold property, and its attractive and well-underpinned dividend yield (3.9% in 2021).

Retail is a discretionary consumer category and therefore the key sensitivity is macroeconomic in nature. GDP and population growth are good predictors of discretionary consumer spend. Raw material cost increases and FX are also a risk to the sector as a whole. In Sandpiper’s case, there is also the risk it loses its franchise partners over the long term, either due to a deterioration in the relationship, or the franchisors ceasing trading or choosing to exit franchise partnerships.

Sandpiper is the leading Channel Island retailer, with a high-quality portfolio of brands covering food, clothing and specialist products. Sandpiper is the largest food retailer in the Channel Islands and operates franchise stores for Wm Morrison, Iceland, M&S Jersey and its own chain of convenience stores, fuel forecourts and off-licenses. Its non-food retail business in the Channel Islands consists of a portfolio of high-quality UK brands covering food, non-food and specialist brand retail, operating under franchise or as an authorised reseller. Examples include Hotel Chocolat, Card Factory and iQ, the Apple Authorised Premium Reseller. Sandpiper owns the freehold at a number of retail locations. It has also been able to leverage its long relationships with major retailers to open their brands in Gibraltar and, more recently, in the Isle of Man.

Sandpiper was formed in 2007 from the buyout of CI Traders, which itself was formed in 2002 but had roots in Channel Island retailing dating back to the 1800s. Following its formation in 2007, Sandpiper signed a number of new franchises such as Costa Coffee, Iceland and Hotel Chocolat and streamlined the business by selling non-core operations including a bottler, a hotel and a wholesale drinks operation. In February 2016, Sandpiper was bought by a consortium of Channel Islands-based investors together with the management team, and was subsequently listed on TISE in 2019.

Sandpiper is the leading Channel Island retailer, with a high-quality portfolio of brands. The business is divided into three areas:

Channel Islands food retail consists of 47 mixed-format food retail operations, including convenience stores, fuel forecourts and off-licenses, in prime locations. The core long-term franchises are with Morrisons and Iceland, which cover both Jersey and Guernsey and Alderney, and with M&S, which is in Jersey only. The retail formats are clearly segmented, thus covering the full range of customers from value to premium, and the franchise brands also fit into this strategy, for example with Iceland at the value end of food retailing, Morrisons in the middle tier and M&S at the premium end. Checkers Express is Sandpiper’s own brand of convenience stores, some of which have forecourts. Wine Warehouse is an alcohol retail sub-brand, and operates across a number of stores.

Channel Islands non-food retail and food service consists of a portfolio of three clothing brands, operated under franchise in two stores each, hence six stores in total: M&S (clothing and general merchandise), Matalan and Crew. Sandpiper operated George stores under franchise until 2020, but Asda George made the decision to pull out of all franchises, hence these stores were franchised to Matalan instead.

In addition, five specialist retail brands operate in 15 stores under either exclusive franchise or as an authorised reseller, with nine of these dedicated to food service, as detailed below.

We provide a summary overview of the territories in which Sandpiper operates in Exhibit 4.

A franchise is the right or licence granted by a company (the franchisor) to an individual or business (the franchisee) to market and/or trade products and services in a specific area or territory, for a defined time. The franchisee must usually comply with rules and guidelines regarding the business, to maintain brand consistency. Typically, an initial franchise fee is payable to the franchisor, together with regular royalties. The franchisor usually provides support with things such as staff training and marketing and branding assistance.

There are two main ways to run and operate a franchise business:

The key consideration for a franchisor looking for a partner tends to be reliability: as discussed above, the franchisee must maintain brand consistency, but an unreliable franchisee can cause lasting damage to the brand well beyond its own territory.

Sandpiper operates a mixture of the models detailed above, depending on the franchisor. Products are sourced from franchisors, but pricing is mostly set by the franchisee.

The Channel Islands present a unique proposition in terms of franchise retailing, with shoppers eager to access the same brands as the UK high street. Logistics and distribution costs are higher than in the UK as most goods are brought to the islands by boat and labour costs tend to be higher than average. There is, however, a VAT/tax differential compared to the UK. The VAT differential does not apply to all food items, as food staples are not subject to VAT in the UK. That said, average food prices are higher on the Channel Islands, as most goods and produce incur higher distribution costs. We illustrate a basic non-food example in Exhibit 5, and we note that while goods in Jersey are subject to a 5% Goods Sales Tax, Guernsey has no such tax.

The Isle of Man does not present the same VAT/tax differential as the Channel Islands, and hence pricing reflects the increased cost of distribution. There is an incumbent operator in the food retail space, and hence Sandpiper sees more scope for expansion in the non-food retail segment.

Gibraltar – like Guernsey – has no GST, and hence there is a tax differential versus the UK mainland. Distribution costs, however, are significantly higher given the distance from the UK. Pricing therefore reflects this and Sandpiper’s business model is to leverage its long-standing relationships with its retail partners to bring their brands to a new market.

Sandpiper’s portfolio of stores consists of some locations that are leased, and some that are owned. Sandpiper owns a selection of freehold properties in prime locations. The property has been independently valued at £60m by Cushman & Wakefield and CBRE in January 2020, and forms a significant barrier to entry. Part of the company’s strategy is to selectively add retail freeholds as high-quality locations become available.

In the Channel Islands, Sandpiper owns the freehold for eight Morrisons stores, one Iceland store, two Checkers Express stores and a Le Cocq store. In addition, among other property, it also owns the Liberty Wharf shopping centre in Jersey, Nelson House in Guernsey, its own headquarters and over 50 residential flats in Jersey and Guernsey associated with the food retail stores. The latter generate £0.7m of annual income.

The Liberty Wharf shopping centre was acquired by Sandpiper in 2018. It is a 58,000 sq ft covered shopping centre set in a historic building, which is next to the new International Finance Centre, and a three-minute walk from the main shopping artery in St Helier, King Street. Current tenants include Marks & Spencer Simply Food, Costa Coffee, Matalan, several independent local retailers, a bar and restaurant and a new 7600 sq ft gym. Sandpiper acquired and redeveloped the shopping centre, upgrading a neglected asset. Ownership of the freehold allows management to control the tenant mix: for example, the introduction of iQ, the Apple Authorised Premium Reseller to the anchor unit in autumn 2019 has driven an over 20% increment in footfall to the shopping centre.

As detailed above, Sandpiper has a mix of food and non-food franchise retail operations and operates a small number of its own convenience stores, fuel forecourts and off-licences. It operates across the Channel Islands, the Isle of Man and Gibraltar and has close and long-term relationships with its franchisors. Sandpiper management knows the markets in which it operates and can leverage its relationships with the franchisors to expand its presence. We illustrate the white spaces in Exhibit 7. We recognise that some white spaces are unlikely to be available, for example Marks & Spencer has a different long-term franchisee in Guernsey, is a loyal franchise partner and hence is unlikely to switch unless there are unforeseen problems with its current partner. Expansion into food retail on the Isle of Man is also unlikely as there is an incumbent and competent food retail operator. Additional brand franchises remain a possibility, although Sandpiper understandably carefully selects its partners. It shies away from high fashion brands as it looks to secure long term agreements, and not all brands are available for franchise.

In addition to filling in white spaces across its existing geographies, there is the potential to bring existing franchises to new territories, or to take these over if they become available. During 2020, Sandpiper opened its first stores in the Isle of Man and now operates both Card Factory and iQ in that territory. We would expect further geographical expansion to be opportunistic.

The other opportunity for meaningful expansion is to enter an adjacent category, such as the leisure and hospitality segment. In January 2020 Sandpiper announced its intention to acquire The Guernsey Pub Company, which operates its own brewery and a network of 20 pubs and hotels. The acquisition fell through due to the effects of COVID-19. Given the ongoing pandemic, the hospitality segment is not immediately attractive, but we believe the company remains interested in expanding into this space over the longer term.

As all retail operators, Sandpiper had to adapt to the COVID-19 pandemic. Trading has been strong in the food segment and across all fascias since the start of the pandemic as consumers have more meals at home, while the non-food portfolio has felt the effect of partial closures and reduced town centre footfall as more people work from home. Trading EBITDA in H121 was ahead of the prior year by 7% on the back of a 6% increase in revenues, demonstrating the resilience of the business. (Adjusted trading EBITDA (more recently termed ‘trading EBITDA’) is defined by the company as EBITDA before any profit or loss on disposal of fixed assets, revaluation of investment property and non-recurring items such as costs associated with converting and rebranding stores.)

Tony was previously CEO of the company (since its buyout in August 2007) and moved to the position of Executive Chairman in November 2019. He spent 13 years at Marks & Spencer, rising to a senior executive position. He subsequently worked for Somerfield, where he held a number of board positions, latterly MD of Somerfield Stores. He then moved to private equity, working on several turnarounds.

Tony was appointed CFO in 2019 following his return from New Zealand. He is a qualified chartered accountant and has experience in management consulting. He has held senior financial positions in UK retail such as Littlewoods, Iceland and Sainsbury’s, where he served as director of corporate finance. He was also CFO for two of New Zealand’s largest retail businesses, Foodstuffs and Farmlands.

Mike was appointed retail managing director for the Channel Islands and Isle of Man in November 2019, having previously held a number of senior executive roles within SandpiperCI over the preceding 12 years, including MD of Marks & Spencer Jersey and MD of the Food Retail division. He previously spent six years at Somerfield holding the positions of supply chain director and business transformation director.

We illustrate below Sandpiper’s track record in terms of revenue and EBITDA progression. As a reminder, Sandpiper’s freehold property portfolio provides a stream of third-party rental income (which was £2.7m in FY20), but also gives long-term security for many of Sandpiper’s retail outlets and is a barrier to entry for the competition.

Sandpiper posted sales CAGR of 6.6% between 2017 and 2020, with adjusted EBITDA CAGR of 16.7% during the same period. During this time, the company expanded geographically into the Isle of Man and worked to fill in some of the ‘white spaces’ across its portfolio. The 58,000 sq ft Liberty Wharf shopping centre was acquired in a prime location in Jersey and was refurbished. In addition, Nelson House was acquired in Guernsey in March 2019.

In Exhibit 9 we show the gross profit and gross margin progression between 2018 and 2020.

We detail our key forecast assumptions below:

Turning to cash flow, we highlight the following:

Sandpiper’s key sensitivities are:

Our primary valuation methodology is DCF, as it effectively captures the potential growth of the business and it can be flexed to illustrate the sensitivity to our assumptions. We outline our key assumptions:

Our DCF valuation with the assumptions detailed above leads to a fair value of 130p. We illustrate how our DCF valuation is sensitive to flexing the cost of capital and terminal growth rate in Exhibit 10, and the terminal growth rate and the terminal EBIT margin in Exhibit 11. Our DCF valuation does not add a standalone value for the property portfolio.

Peer group analysis is not straightforward as there are few direct peers. Domino’s Pizza and DP Eurasia are also franchisors but in an adjacent category. We include the listed franchisors as peers, although we recognise their business models are slightly different and they benefit from greater scale. McColl’s is a convenience store and newsagent operator and Applegreen is a petrol forecourt operator. We illustrate Sandpiper’s metrics versus the peer group in Exhibit 12 below.

We exclude Hotel Chocolat and DP Eurasia from our peer group average as their metrics are out of kilter with the rest of the group. Sandpiper trades at a premium to its peers for CY21 on P/E but at a discount on EV/EBITDA. This is justified by its strong property portfolio and an attractive dividend yield, in our view. The current equity market valuation is £80m, or EV of £99m. With a property portfolio valued at £60m, this implies the franchise operations are valued at just £39m. Of course, for full comparison, an operating company stripped of the property would have to bear rental costs instead of depreciation. The dividend is well covered by free cash flow and Channel Island investors further benefit from a 20% tax credit on any dividends paid after December 2020.