Cube Midcap Report (21 Jan 2020) – Consumers keep spending at #DC #EZJ #IGG

Cube Midcap Report (21 Jan 2020) – Consumers keep spending at #DC #EZJ #IGG

Good morning! It’s Roland here with today’s Midcap Report.

On my provisional list for today are:

  • Dixons Carphone (DC) – peak season trading update
  • easyJet (EZJ) – Q1 trading update
  • IG Group Holdings (IGG) – H1 results & CFO resigns
  • IG Design (IGR) – acquisition/placing

This report should be finished by noon. Finished at 1215.

Dixons Carphone (DC)

  • Share price: 150p (+5%)
  • Market cap: £1.74bn

2019/20 Peak Trading Statement

Please note that Roland has a long position in DC

My first ever Midcap report in June 2019 covered Dixon Carphone’s FY18/19 full-year results. It’s fair to say that on that day last summer, the news wasn’t good. There were hefty impairments and a cut to guidance for FY19/20.

I took the view (and continue to do so) that with sales of more than £10bn each year, this group does have the scale to be successful. I continue to believe that there’s a role for showroom retail. And I’d note the ability of large retailers to make money from financial services — this is an area where CEO Alex Baldock has expertise.

Despite all of that, I admit that this is ultimately a low margin box shifter, reliant on scale and market share. As Graham noted in December, it’s possible that “The margins in this business aren’t worth fighting for”.

So far, so good

I remain a shareholder in DC, so I’m pleased to report that the value of the firm’s stock has risen by 50% since my report last June. The shares are up by 5% today after the company’s peak trading statement — which covers the festive period — revealed an improvement in like-for-like sales of electricals*.

DC peak trading FY19-20 LFLs

*I’ve updated this graphic to reflect a correction issued by the company showing group sales -2% reported for the period, not +2%. No other details changed.

UK & Ireland Electricals: Mr Baldock noted strong demand for supersize televisions, with sales of 65″+ models up by 75%. The company also shifted more 8,000 smart speakers per day and “broke records on wearables like Fitbit and Apple Airpods”. In a sign of how stores are shifting to provide experience-based marketing that’s unavailable online, he said that new “Gaming Battlegrounds” drove “strong sales and share gains”.

UK like-for-like growth of 2% seems respectable, as the company says the wider market was down 3%.

Dixons Carphone appears to have gained market share, but the impact on margins is less clear. The company admits to “margin investment” (i.e. price cutting) and now operates a John Lewis-style price promise – You won’t get it cheaper. Full stop.

As with budget airlines (on which more shortly), the firm’s strategy seems to be to offer the principal product at lower prices and support margins with ancillary services. For example, the firm reports increased adoption of setup and protection services, as well as a 40% increase in transactions on credit.

Progress seems promising, but we’ll have to wait for the full-year results to see how this has affected margins.

International: The group’s smaller overseas divisions continued to outperform the UK.

UK & Ireland Mobile: This good news does not include the troubled mobile business, where sales continued to fall. This is in line with expectations and part of the painful but necessary run-off process the company is currently going through on its existing deals with network operators. A new mobile offer is expected to launch later this year.

The reason for this is that as smartphone development slows (and prices rise), we are relying on SIM-only deals and less frequent phone upgrades. That’s proving painful for Dixons Carphone, which had volume-based deals with network operators to sell combined phone+service contracts.

Guidance unchanged

There’s no change to financial guidance in today’s trading statement. The firm’s previous guidance is for adjusted pre-tax profit of £210m and capex of £200m. The equivalent figures last year were £298m and £166m.

Looking further ahead, Mr Baldock is targeting an operating margin of 3.5% by FY23 and more than £1bn of cumulative free cash flow over the five-year period, driven by cost savings and release of working capital from the mobile business.

My view

Although I’m encouraged by progress so far, I’m aware there is still a lot to prove. And even if the group’s turnaround plan delivers as expected, there’s no guarantee that the firm will be able to continue delivering attractive returns in a competitive, low-margin sector.

After today’s gains, Dixons Carphone shares now trade on around 11 times 2020 forecast earnings, with a prospective yield of about 4.5%. I think the price is up with events for now, but I remain happy to hold and believe further gains may be possible.

easyJet (EZJ)

  • Share price: 1,522p (+5%)
  • Market cap: £6.05bn

Q1 trading statement

easyJet has also surprised the market this morning with a stronger-than-expected trading statement. The budget airline’s shares are up by 5% at the time of writing. Shares in the group have rebounded by around 65% from the lows seen last June. As with Dixons Carphone, it seems June 2019 really was a buyers’ market for consumer-facing stocks.

But enough history. Let’s take a look at the news from this popular airline. These figures are for the quarter ending 31 December 2019:

Total Revenue +9.9% to £1,425m: Passenger revenue (from ticket sales) rose by 9.7% to £1,124m, while ancillary revenue rose by 10.8% to £301m. These extras allow the group to generate margin.

Passenger numbers +2.8% to 22.2m: This comprised a capacity increase of 1.0% to 24.3m and an increase in load factor of 1.6%, to 91.3%. So easyJet has added more seats and it’s selling a higher proportion of them.

Revenue per seat +8.8%: This is a key metric and guidance has been upgraded for the first half of the year. H1 revenue per seat is now expected to increase by “mid to high single digits”. Previous guidance was for an increase “by low to mid single digits”.

The company says that Q1 seat revenue was ahead of expectations for several reasons:

  • Improvements in yield (ticket pricing), especially relating to the turnaround of its German network, which was acquired following the failure of Air Berlin
  • Robust demand” and lower capacity growth by both easyJet and its rivals
  • Continued growth in ancillary revenue, including through a new car rental offering
  • Benefit from Thomas Cook administration

Costs: Headline cost per seat excluding fuel at constant currency rose by 4.3% during the quarter. This mostly seems to relate to inflation-linked increases in costs and pay, plus cancellations due to French strikes in December.

Fuel: The full-year fuel bill (y/e 30 Sept 2020) is expected to be between £110m and £170m higher than last year. The total fuel bill will be c.£1.64bn.

Profit guidance: Like most travel firms, easyJet is routinely loss-making in H1. But this loss is expected to reduce this year versus last year, when the company reported an H1 loss of £275m.

Holidays: Management say the group’s package holiday business has got off to a good start and is expected to breakeven this year.

My view

I’ve always viewed easyJet as a well-run business and my view is unchanged after today’s update. It’s also clear that easyJet and its peers have recognised the risk of excess capacity in the short haul sector and are slowing their growth rates accordingly.

As someone who has a cautious view on the economic outlook, I’m not sure whether now is the best time to climb on board here. But so far easyJet appears to be enjoying strong demand while remaining in control of its margins.

On balance, I’d say the shares look fairly priced at current levels. If I owned the shares, I’d be happy to continue doing so.

IG Group Holdings (IGG)

  • Share price: 691p (unch.)
  • Market cap: £2.55bn

H1 results & CFO resigns

Please note that Roland has a long position in IGG.

FTSE 250 spread betting and CFD firm IG Group is another company Graham and I have both commented on before. One aspect of the business that Graham highlighted in December is its changing leadership.

CFO departure

Following the appointment of a new CEO and a new chairman, it’s now the chief financial officer’s turn to depart.

CFO Paul Mainwaring has been in post since July 2016, which doesn’t seem that long. But his departure appears to relate to his age and changing career ambitions, not to any problems with his current role:

IGG CFO departure notice

I don’t think there’s anything sinister about this, although as a shareholder I’m a little disappointed to lose a CFO with a lot of relevant experience. His previous role, for example, was as CFO of interdealer broker Tullett Prebon (now TP ICAP).

Mr Mainwaring will remain in role while the company searches for a replacement.

H1 results

It’s entirely possible that today’s half-year results will be the last to which Mr Mainwaring puts his name as CFO. So what can we learn about the firm’s progress from these numbers?

The IGG share price is unmoved today, which probably tells us that these figures are in line with the expectations set out in December’s trading update, which I covered here.

Net trading revenue for the half year fell to £249.9m (H1 FY19: £251m). Operating profit was down 11% to £100.1m.

However, it’s worth noting that the first half of last year included two months of trading before European (ESMA) restrictions on retail traders’ leverage came into force. If we take the post-restriction performance as a baseline, then revenue appears to be rising. The company has helpfully provided a breakdown of this:

IGG 1H20 ESMA revenue breakdown

Operating expenses rose to £136.3m (H1 FY19: £122.1m), resulting in an operating profit of £100.1m. This gives an operating margin of 40%, a very attractive figure that’s fairly consistent with the group’s historical performance.

FY 20 outlook: Guidance for the full year is unchanged.

  • Return to revenue growth
  • Operating expenses c.£30m higher than FY19
  • Maintain the 43.2p per share dividend until earnings allow a return to dividend growth

Indeed, the core message is that the implementation of CEO June Felix’s updated strategy is “progressing as planned”. Key to this strategy is maintaining incremental growth in core markets, while delivering much bigger gains in new markets, described as “Significant Opportunities”.

Understanding segmental performance

If you’re a shareholder like me, or perhaps a client, you may be interested to learn a little more about where IG’s revenue come from. Today’s results provides some useful additional colour on this, so I thought I’d take a brief diversion in this direction.

OTC leveraged derivatives

This is the main CFD/spread betting business, where clients take leveraged positions to gain long or short exposure to a wide range of asset classes.

OTC leveraged derivative generated 96% of IG’s net trading revenue in H1. This includes both core (mature) markets and growth markets.

Here’s how this revenue was divided among different asset classes:

IGG 1H20 OTC revenue per asset class

It’s worth noting that not all of these trades will have been aimed at generating an outright gain. Some — perhaps especially the index trades — will be used as hedging instruments for equity and other portfolios. But still, it’s clear that index trading remains at the heart of IG’s offering.

My view

IG’s Significant Opportunities growth markets generated £40.4m revenue during H1, an increase of £12.2m on the same period last year.

The group’s Core Markets appear to remain stable and highly profitable.

The shares have performed strongly over the last six months, but I think that today’s results justify continued support for Ms Felix’s strategy. I’m also encouraged by evidence that margins remain strong.

Indeed, with a 40% operating margin and 6.3% dividend yield, I believe the shares remain attractive at current levels.

IG Design Group

  • Share price: 743p (+7.5%)
  • Market cap: £585m (+£120m of new equity)

Acquisition & £120m placing

I’m used to thinking of gift packaging and stationery group IG Design as a small cap. But both the business and its share price have grown considerably over the last few years, to the extent that it now exceeds our £500m mid-cap cutoff.


Growth has been aided by a number of acquisitions, mostly in the US market. These have become successively larger and more richly priced:

The US has been a major growth market for IG Design. Management hope that this deal will increase its share of the sizeable US craft market while cementing its position as “the global industry leader in gift packaging”.

With US stock markets at record highs, it’s not surprising that the CSS deal is more richly valued than previous US acquisitions. I would be inclined to trust management’s judgement, given that previous acquisitions appear to have been successful. Looking ahead, CSS is expected to generate EBITDA of between $22.1m and $24.1m for the year ending March 2020. Taking the mid-point, that would value the acquisition at 5x EBITDA, which doesn’t seem unreasonable.

Rather than borrowing money, IG Design has opted to use a placing to raise funds for the deal.


Investors appear to have a strong appetite for the firm’s stock. In a statement released this morning, the company said that it had raised £120m in a “significantly oversubscribed” placing at 694p per share. According to Google Finance, that’s slightly above yesterday’s closing price of 687p, so the placing appears to have been completed without a discount.

The surplus cash remaining after the CSS acquisition will be used to provide “further balance sheet capital to support our wider growth strategy”.

The shares are now trading significantly ahead of the placing price, up 7.7% at 742p.

My view

IG Design has a good track record, in my view. Patient shareholders have seen the value of their stock rise 10-fold over the last five years.

The shares now trade on about 22 times forecast earnings (pre-acquisition). I’d argue that this is probably up with events, especially given the challenges of integrating ever-larger acquisitions. In 2018/19, for example, IG Design reported exceptional costs of £8.4m as a result of integrating the Impact Innovation acquisition. Adjusted operating profit for the same year was £32.6m, so this was a material amount.

The CSS Industries acquisition is nearly twice as big by value, so it will be interesting to see what restructuring costs (if any) are encountered.

Despite this caution, I have a positive view of this business, given its successful track record and large market share.

That’s all I’ve got time for today, thank you for reading.


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