Cube Midcap Report (13 Aug 2019) – #PLUS #TUI #CARD
Good morning! It’s Roland here with the Midcap report.
Companies on my list for today are:
- Plus500 (PLUS) – interim results and share buyback programme
- TUI (TUI) – Q3 results
- Card Factory (CARD) – H1 trading update
- Share price: 670p (+17%)
- Market cap: £728m
The rollercoaster ride continues for shareholders of this controversial CFD trading platform. The Plus500 share price is up strongly at the time of writing, after the company reiterated full-year expectations and announced another $50m share buyback.
Today’s half-year results suggest that management are pinning their hopes on a strong H2 after a very mixed H1. This isn’t necessarily unrealistic — the second quarter saw a sharp improvement in performance as market volatility increased. At the same time, customer acquisition costs fell.
However, the firm’s half-year figures suggest to me that strong Q2 trading will need to be sustained or exceeded in order meet full-year expectations.
Understanding the numbers: I think it’s worth taking a quick look at Plus500’s numbers to understand the moving parts that lie behind this astonishingly cash-generative business.
Here’s a snapshot from today’s results. I’ve highlighted some figures I believe are worthy of discussion:
(ARPU = Average Revenue per User / AUAC = Average User Acquisition Cost)
Revenue: Unlike rivals such as IG Group (in which I own shares), Plus500 does not fully hedge customer trades. This exposes the firm to what it describes as “market P&L”. In other words, sometimes customers win at the firm’s expense.
In H1, revenue from spreads and charges (fee income) was $175m, but $27m of market P&L losses reduced reported revenue to $148m.
Conversely, in H2 2018, fee income was $193m, but reported revenue was $254.9m. This appears to imply $61.9m of market P&L gains.
From what I understand, this unhedged approach is how casinos and sports bookmakers normally work. They can rely on customers, in aggregate, to always lose money. Personally, I’m not keen on this in a financial trading firm. As a potential client, I would prefer to deal with a company that didn’t have a vested interest in me losing money.
ARPU: Like rival firms, Plus500 was hit by new restrictions on leverage for retail traders introduced in August 2018. So the reduction in revenue vs 2018 is to be expected. However, I think the relationship to AUAC is quite interesting.
AUAC: Plus500 is trumpeting a 42% reduction in average user acquisition costs, which fell to $1,079 during H1 2019. But in H1 2018, this figure was much lower still, at $677 per user.
For a company with a high level of churn, the relationship between ARPU and AUAC is important, in my view. Today’s figures show that 33% of active customers were new users during H1, highlighting the short-term nature of many of Plus500’s client relationships.
On a full-year view, Plus500’s ARPU has been significantly higher than AUAC every year since at least 2015. This wasn’t true during the first half of this year. My reading of today’s numbers is that ARPU rose significantly during Q2, rescuing what could have been a dire set of half-year results.
If I was a shareholder, I’d watch these figures carefully this year.
Dividend & share buyback: Plus500’s cash balance was broadly unchanged at $327m during H1, despite a $50m buyback during the period. The company has now announced another $50m buyback, to be completed by the time the FY19 results are published.
The shareholder return policy has also been tweaked. While Plus500 will still distribute 60% of net profit to shareholders, only 50% of this is guaranteed to be through dividends. Previously, dividends were set at 60% of net profit.
My view: I’ve never been a big fan of Plus500, as its business model appears to rely on constantly attracting new and inexperienced customers. The short lifespan of these relationships seems to imply that many are rapidly cleaned out and then leave.
The Bitcoin boom was fantastic for Plus500, but this is dying away. I note in today’s results the company mentions new markets that it’s introduced for 2019. These include EUA Commodity (EU carbon emissions allowances), Lithium and Battery, Uber and “thematic indices”.
I would respectfully submit that very few of us could trade these markets with insight or success. However, they are fashionable topics that could attract inexperienced traders. I see this as an attempt to pick up the speculative slack from the declining popularity of Bitcoin.
Plus500 shares always look cheap. This hasn’t changed. Consensus forecasts for the year put the stock on a forecast P/E of 6.5 with a yield of about 10%. This may be deliverable, but for me this business remains too speculative and opportunistic to be of any interest as an investment.
TUI AG (TUI)
- Share price: 827p (+2%)
- Market cap: £4.8bn
It’s not been a good year for travel firms. At one end of the spectrum we have Thomas Cook. At the top end are companies such as TUI and FTSE 100 cruise ship giant Carnival, which are coping well but facing headwinds from rising costs and cyclical factors.
TUI has a vertically-integrated model that includes hotels, cruises and its own airline. This year’s performance hasn’t been helped by the grounding of the Boeing 737 MAX fleet. Although the firm has been able to lease replacement planes to fulfil this year’s bookings, the impact is expected to reduce adjusted operating profit by about €300m this year. To put that in context, 2017/18 operating profit was €1,060m.
Fortunately, today’s Q3 results reiterate previous guidance and do not contain any further downgrades.
Revenue for the first nine months of 2019 rose by 2.8% at constant currency, to €11,143m. Like most such firms, TUI relies on the summer season for its annual profits. But operating losses for the nine months have increased significantly, from -€27.4m to -€262.4m.
From what I can tell, most of this increased loss relates to the 737 MAX grounding. But the company is also complaining of weak demand, later booking and the knock-on effects of the 2018 heatwave and Brexit uncertainty.
My view: TUI shares look fairly cheap, on 10x 2019 forecast earnings and with a 6.6% yield.
But consensus forecasts suggest a 20% dividend cut is likely this year and we don’t know when airlines will be allowed to start flying their Boeing 737 MAX aircraft again. This situation could yet trigger more exceptional costs.
I think TUI is generally a decent business, and I’m attracted to its scale and diversity. But I can see plenty of downside risks at the moment, cyclical and otherwise.
At this point in time, my sector pick would be Carnival. I don’t see any rush to buy TUI at the moment.
Card Factory (CARD)
- Share price: 151p (-7%)
- Market cap: £512m
Today’s half-year trading update from this high street retailer seems to have disappointed the market.
I can see a couple of reasons for this.
Q2 sales slowdown: Like-for-like sales growth was 1.5% during the half year. Given that LFL sales rose by 2.3% during the first quarter, today’s update suggests a significant slowdown in Q2. The company says that Q2 was “a little weaker”, due to lower footfall and poor Father’s Day sales.
The low pace of LFL growth has been a background concern here for a while, in my view. Most revenue growth has come from new store openings, of which there were 26 during the first half of the year. Total sales rose by 5.5% during the half year, ahead of the 3.2% increase reported last year.
Rising net debt: Net debt has risen £29m to £170.3m since the end of January. That represents a multiple of 3.3 times trailing net profits, or 1.8 times trailing EBITDA.
Both figures are within my comfort zone (just) and the latter figure is within CARD’s target range of 1.0x to 2.0x. However, I don’t like the firm’s policy on leverage and see it as an unnecessary risk for shareholders.
Card Factory is one of those companies that operates with an artificially high level of debt in order to maintain an efficient balance sheet and boost shareholder returns.
I’m not a big fan of this approach, often seems needlessly risky to me. Card Factory has a track record of very strong free cash flow, and generates a return on capital employed of about 18%. But it is a high street retailer with a network of nearly 1,000 stores.
I think that the balance of risk and reward would be more attractive if the firm maintained net debt at less than 1x EBITDA. In my view, this would reduce the risk of debt-related problems while still supporting attractive dividends.
My view: The market seems to have taken a dim view of today’s half-year update, presumably because of the sharp fall in LFL sales during Q2.
The stock now trades on 9 times forecast earnings with a prospective yield of about 9% (including a special dividend). History suggests this payout should be covered by free cash flow and I remain tempted by this stock as an income buy.
However, with leverage rising and a somewhat uncertain outlook, I think I’ll remain on the sidelines for now.
That’s all for today, thanks for reading.