Cube Midcap Report (20 June 2019) – DC, DNLM, WTB, BKG
It’s Roland Head here. I’ll be helping Graham out with the Midcap report from time to time.
Here’s what’s on the list for today:
- Dixons Carphone (DC.) – full-year results
- Dunelm (DNLM) – trading update
Time permitting, I may also take a quick look at Wednesday’s updates from Whitbread (WTB) and Berkeley Group Holdings (BKG).
Dixons Carphone (DC)
- Share price: 102p (-17%)
- Market cap: £1.2bn
At the time of writing, I have a long position in DC.
This year’s results from Currys PC World owner Dixons Carphone were never going to be pretty, due to problems in the group’s mobile phone business (formerly Carphone Warehouse).
Today’s numbers appear to be in line with expectations, with revenue down 1% at £10,433m and headline pre-tax profit of £298m (FY18: £382m). On a statutory basis, the figures don’t look quite so good, with £545m of impairments pushing the group to a net loss of £311m.
As expected, the full-year dividend has been cut from 11.25p to 6.75p. However, the underlying business has remained cash generative and year-end net debt remains fairly low at £265m (FY18: 249m).
Share price crash
The trigger for today’s share price crash is that the outlook for 2019/20 has been downgraded significantly. Headline pre-tax profit is now expected to fall by 30% to £210m this year, versus previous expectations for a flat performance.
Market reaction has been fairly severe and the shares were down by 24% at the open. However, they’ve bounced back somewhat and are down by only 17% at pixel time.
What’s gone wrong?
The electrical retail business is performing well and gaining market share in the UK, Nordics and Greece. Like-for-like electrical sales were up in all markets.
But the group’s other main arm, the mobile phone business formerly known as Carphone Warehouse, is suffering. It appears that the mobile phone market is just not as profitable as it used to be.
As the price of mobile phone handsets rise and the pace of technical improvement slows, customers are keeping handsets for longer. Rather than being tied in to 12-18 month contract replacement cycles, many of us are operating phones with cheap rolling SIM-only contracts instead. In today’s results, chief executive Alex Baldock says the pace of this change is accelerating.
Today’s figures reflect this, with a goodwill impairment charge of £225m to the UK and Ireland mobile business, plus a further £122m “impairment of related assets”. This appears to relate to intangible assets, mostly capitalised software development costs.
Can this be fixed?
It’s some relief that these aren’t cash impairments (although of course they represent money previously spent). But there’s no doubt that the company’s performance needs to improve.
Even using the more favourable headline figures, operating margin fell from 3.8% to 3.1% last year, below Mr Baldock’s target of 3.5%.
The 1% fall in revenue is also a potential problem — sales aren’t keeping pace with inflation, so are shrinking in real terms.
Today’s results include details of an accelerated turnaround plan. Most of this is as you’d expect, with £200m of cost savings planned and margin improvements. However, there are two points I’d like to highlight:
- £1bn of cumulative free cash flow generation over the plan, including £500m+ from working capital improvements, “mostly from mobile debtor”.
This seems to suggest that there’s a lot of value locked up in the legacy mobile contract business. Releasing this cash should help to keep net debt low, removing one major potential source of risk. To put these cash flow numbers in context, the market cap after today’s fall is about £1.2bn.
- Headline pre-tax profit expected to be £300m+ by FY22.
This isn’t so great. The firm appears to be saying that it will take another three years for profits to return to the level reported for 2018/19.
Chief executive Alex Baldock’s previous role was at Shop Direct, an online-only retailer whose origins lie in the Littlewoods catalogue business. He also has experience in asset finance.
As expected, he’s bringing some of this expertise to Dixons Carphone. The number of credit customers rose by 50% to 900,000 last year, while credit sales rose by 20% to £420m. These changes should add to profits and increase customer loyalty.
The other main area of growth is online, where Mr Baldock believes the business is underweight for its size. Market share is said to be growing and my view remains that (unlike AO World), Dixons Carphone has the scale needed to compete against the biggest online-only retailers.
After today’s fall, I estimate the stock is trading on around 7.5 times FY20 forecast earnings, with a prospective yield of 6.5%. Although this retailer does carry some risks, I think the stock offers potential upside from this level.
Dunelm Group (DNLM)
- Share price 950p (+5%)
- Market cap £1.9bn
Homewares retailer Dunelm is living proof that at least some high street firms are still making money.
Today’s fourth-quarter trading update was short and sweet. Like-for-like growth is said to have improved since the firm’s last update in April, thanks to “unseasonably favourable weather conditions” and a soft comparator from the same period last year.
I’m not sure if management are referring to the recent wet spell or the warmer weather that preceded it. But in either case, results for the year to 29 June are now expected to be ahead of the board’s previous expectations. The shares are up by 5%, suggesting the market is pricing in a modest earnings beat.
This is a quality business, with a track record of generating very high returns on capital employed (FY18: 30%). However, the shares have performed very strongly over the last year and seem quite fully priced to me at the moment. I’m going to stay on the sidelines for now, but this is a stock I might consider at the right price.
- Share price: 4,549p (-1.6%)
- Market cap: £7.9bn
Since selling the Costa Coffee business to Coca-Cola for £3.9bn at the start of 2019, Whitbread’s only remaining business is the Premier Inn budget hotel chain.
This disposal propelled the shares to record highs earlier this year, but unfortunately it seems to have coincided with softening market conditions for hotel operators. In a first-quarter trading update on Wednesday, Whitbread reported a like-for-like decline of 3.7% in UK sales, together with an absolute UK sales decline of 1.1%.
UK: CEO Alison Brittain blames an uncertain UK business environment, due to “macro uncertainty”. UK occupancy fell by 2.3% to 74.8% during the first quarter, while revenue per available room — an industry-standard measure — fell by 6.3% to £45.98. Cost inflation is also said to be a problem, presumably due to April’s minimum wage increase.
Germany: The firm’s planned rollout in Germany is getting underway. But with only two hotels opened so far, it’s too soon to say how successful Premier Inn will be in this new market.
Shareholder returns: The return to shareholders of £2.5bn from the Costa sale is continuing. £482m has been returned through buybacks and the company is now about to launch a £2bn tender offer.
My view: As a customer and an investor I’m a fan of this business, but we seem to be in a period of softer rates and falling occupancy. The shares have fallen 10% from April’s record high of £51, but are still trading on 20 times current year forecast earnings and yielding just 2%.
I’d quite like to own Whitbread at some point, but for now I plan to let the dust settle on the return of capital and watch how trading develops. My feeling is that there’s no rush to buy at this time.
Berkeley Group Holdings (BKG)
- Share price: 3,573p
- Market cap: £4.6bn
To finish off, I want to take a brief look at housebuilder Berkeley Group Holdings’ final results from Wednesday. The figures were as expected, with pre-tax profit down by 20% to £775m and net cash up by more than 40% to £975m — almost 20% of the group’s market cap. This increase helped support a year-end net asset value of £23.05 per share, up from £19.38 one year ago.
Although I’m wary about housebuilders at the moment, BKG is a possible exception. There are a couple of reasons for this:
- London focus means the group may be ahead of the wider UK market, in cyclical terms. Prime London prices are already said to have fallen by about 20%.
- Ability to handle large regeneration projects means Berkeley can add more value than some builders.
- Management: founder and chairman Tony Pidgley has an excellent record of market timing.
I think it’s instructive to compare the company’s long-term share price history with that of FTSE 100 firm Barratt Developments (BDEV):
Berkeley didn’t suffer anywhere near as much in 2008/9 as most rivals and has delivered much greater returns for long-term holders.
The group’s profitability is expected to return to more normal levels this year, as the benefits of cheap land bought after the financial crisis fall away. But this has been clearly guided by the firm, which has delivered consistently to expectations.
Another bonus is that the mix of product and buyer means that Berkeley’s Help to Buy exposure is much lower than rivals, with less than 10% of homes sold under this scheme last year.
The stock trades at about 1.5 times book value, with a forecast yield of 5.7%. Shareholder returns have been guided at £280m each year (dividends + buybacks) until 2025.
There are still cyclical risks, obviously. There’s also a degree of key man risk — how much does the firm still depend on 71-year old Mr Pidgley’s judgement?
Despite these concerns, I am attracted to this stock as a long-term income investment. It’s on my watch list at the moment.
That’s all for today. Thanks for joining me for what’s turned out to be a mammoth debut at Cube Investments. I hope you’ve found my commentary useful.