Not always a leisurely path

Not always a leisurely path

A company that generates stable cash flows is highly appealing, as it allows management to redistribute capital with a considerable amount of visibility. Yet investors should always value new growth opportunities on a stand-alone basis, and not allow the stability of the core business to influence the perceived risk of new endeavours.

By way of example, Ardent Leisure (ASX: AAD) operates three businesses which generate stable cash flows; Dreamworld on the Gold Coast, Strike Bowling and d’Albora Marinas. But because the divisions have reached mature growth, little value can be generated by internally reinvesting proceeds.

In the pursuit of growth, management has redeployed excess capital into Family Entertainment Centres in the United States (called Main Event), and Fitness Clubs in Australia.

It’s important to keep in mind that both divisions are reasonably risky endeavours. Ardent is growing the number of Main Event centres via greenfield investments, which means it is entering a new market by building and operating sites from scratch. Meanwhile, Ardent Leisure is acquiring growth in the Health Club division, with the recent purchase of Fitness First centres in Western Australia being added to the network of Goodlife Health Clubs.

Leading into the first-half 2015 results, the market was reasonably cautious about the growth in Main Event centres. This is because the portfolio is predominantly located in Texas, and it was considered that a lower oil price would negatively impact energy investment and as a result would reduce discretionary spending. Yet it seems that the market was not applying sufficient conservatism to the growth in health clubs – despite limited visibility from recent acquisitions, a client base that is cyclical and a market place which is highly competitive.

Ardent’s first-half 2015 results revealed that Main Event was performing solidly and the outlook remained positive. Conversely, revenue from Health Clubs declined by 4.1 per cent on a constant centre basis, due to higher than expected member attrition. In an effort to offer a more competitive product, Goodlife will be introducing a 24-hour service. But if management is focused on restructuring the business model, this means that less attention can be afforded to growing the division. It seems that the market has tempered future growth expectations, with the share price of Ardent Leisure falling by 15 per cent on the day of the announcement.

Ben MacNevin is an Analyst with Montgomery Investment Management. To invest with Montgomery, find out more.