Good businesses can become bad investments – Hollywood Bowl is a prime example

There is a vast difference between a good business and a good investment. A company may have a solid balance sheet, a strong competitive position within its industry and a sound long-term growth strategy but if its share price fails to offer a margin of safety, the potential for high capital returns may be limited.

One of this column’s previous recommendations, Hollywood Bowl, is a prime example of a good business that now lacks investment appeal.

Shares in the company, Britain’s largest 10-pin bowling operator, have gained 14pc since our original tip in August 2018 and now trade on a forecast price-to-earnings ratio of 15.

In Questor’s view, this valuation fails to account for the company’s near-term challenges. Inflation surged to a 40-year high of 9pc in April and, according to the Bank of England, will not peak until double-digit figures are reached in the latter part of this year.

High inflation is certain to prompt a substantial decline in consumers’ discretionary incomes. This is likely to lead to reduced demand for non-essential services across the leisure sector. Consumer confidence has already fallen to its lowest level since records began in 1974.

While Hollywood Bowl stated in a first-half trading update released last month that cost control remained a key focus and suggested that it had enjoyed considerable success in keeping employee costs down, a combination of reduced consumer demand and rising costs could squeeze margins in future. 

Further details on its recent financial performance will be included in half-year results due to be published on Wednesday.

The company also said in its trading update that it now expected full‑year performance to be ahead of the market’s previous expectations. This view followed a strong recovery in its financial performance after the end of pandemic-related restrictions.

Indeed, it reported record first‑half revenues that were 36pc higher than in the same period of the 2019 financial year as pent-up demand following lockdowns prompted consumers to flock back to leisure activities.

But now that consumers are increasingly concerned about the effects of inflation, and as the novelty of post-lockdown leisure activities wanes, the company’s future financial performance could disappoint.

While its share price has declined by 8pc in the past month, it is still 1pc higher than at the start of the year in spite of a rapidly evolving industry outlook. 

By contrast, a number of other consumer-focused firms have experienced significant declines in their market value this year as investors have factored in an increasingly challenging economic outlook. As a result, there are better value opportunities available elsewhere in the “consumer discretionary” sector.

Hollywood Bowl remains a good business that is in a strong position to survive short-term challenges. It conducted a £30m share sale in March 2021 that strengthened its balance sheet to the extent that, as of the end of March this year, it had a net cash position (excluding lease liabilities) of nearly £50m.

This gives it a high chance of emerging from a prospective leisure industry downturn in a stronger position than its rivals in the sector.

In addition, the company has significant long-term growth prospects. For example, it continues to expand and improve its estate through new openings and refurbishments. It is also moving into mini-golf centres, which provide a promising growth opportunity thanks in part to the fragmented nature of that sector.

However, the current and future challenges that face consumers are not reflected in Hollywood Bowl’s share price. Its market value lacks a margin of safety and could realistically come under pressure should there be a period of economic pain that disproportionately affects the leisure sector.

As a result of its lack of further capital growth potential, now is the right time to take profits on our holding and look elsewhere for better value opportunities. Sell.

Questor says: sell

Ticker: BOWL

Share price at close: 234p

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