Cube Midcap Report (31 July 2019) – NXT, INTU, AML

Cube Midcap Report (31 July 2019) – NXT, INTU, AML

Good morning, it’s Roland here with today’s Midcap report.

It’s another busy day for news. Here are the companies I’m planning to cover today:

Next (NXT)

  • Share price: 6,100p (+9%)
  • Market cap: £8.1bn

Q2 trading statement

Today’s second-quarter update from Next is a textbook reminder of why this retailer has a great reputation with investors. The firm has upgraded its guidance for the current year, following stronger than expected full price sales in May and June.

The three main changes to guidance are:

  • Full year full price sales guidance increased from 1.7% to 3.6%
  • Full year profit guidance increased by £10m to £725m (+0.3% vs last year)
  • Earnings per share guidance increased from 3.4% to 5.2%

The clarity and reliability of Next’s guidance is always impressive. It’s always backed by detailed analysis and explanation of how the business is performing and how things are expected to change.

But for all that I admire Next as a business, I think it’s worth pointing out that profits have been falling since 2016:

Year ending January Next pre-tax profit
2015 £782.2m
2016 £821.3m
2017 £790.2m
2018 £726.1m
2019 (forecast) £725m (forecast)

Earnings per share growth is being achieved by funnelling the group’s impressive free cash flow into buybacks. There’s nothing wrong with this, but it doesn’t alter the fact that in some ways this can be seen as protracted turnaround situation.

The continued decline of high street retail remains a serious challenge. Unlike some retailers, Next provides very transparent reporting in this area. Today’s figures are a good example of what the firm is having to contend with:

NXT Q2 trading FY20

One of the strategies Next has adopted to help counter the decline in high street retail is to make its sophisticated online and logistics infrastructure available to other brands. A huge number of brands now sell stock through the Next website.

This is helping the group to maintain the scale it needs to be profitable. It’s also supporting group’s store estate. In common with most retailers, Next’s shops also as online collection and return points.

My view: The strategy devised by Next’s management is clever and very apt, in my view. The continued strength of its consumer credit offering is also important. Finance profits accounted for 18% of underlying profit last year.

I think this strategy could deliver a return to absolute growth. I’m not entirely sure how likely this is, though.

At the last-seen price of £61, Next is trading on 13.3 times forecast earnings, with a dividend yield of about 2.9%. In my view, that’s probably about right.

Intu Properties (INTU)

  • Share price: 55p (-21%)
  • Market cap: £750m

Interim results

The share price of retail landlord Intu Properties — which owns properties such as Lakeside and the Trafford Centre — is down by more than 20% at the time of writing. INTU stock has now lost more than 80% of its value over the last five years.

The problems being faced by Intu make it clear just how well Next is doing, in my view.

Today’s half-year results from INTU are something of a car crash.

Earnings collapse: Net rental income is down by 8% (£17.9m) to £205.2m. The company says this is the result of retailer administrations and CVAs.

The impact on underlying earnings is even more severe. In addition to the fall in rental income, Intu has faced a £6.2m increase in finance costs and an extra tax expense of £8.3m. Underlying after-tax earnings for the half year are down by 33% to £66.4m.

Property values crumbling: There’s been some suspicion among investors that big landlords may have been slow to write down the value of their retail properties. Finding valid comparisons for valuation is often difficult, as large shopping centres aren’t sold very often.

I don’t know whether these allegations are true, or whether they apply to Intu. But the firm has certainly been busy with the red pen over the last six months.

The valuation of Intu’s property portfolio was cut by £872.1m during the period. After adding back £71.7m of capex, the end result was that the portfolio valuation fell by £810m to £8,357.5m. That’s an 8.8% reduction in six months.

Gearing up, NAV down: Disposals helped to reduce net debt by £153m to £4,714.2m during the half year.

This leaves shareholders with net assets of £2,999.2m, or 252p per share (FY18: 312p).

The all-important loan-to-value ratio rose by 4.5% to 57.6%. That compares poorly with higher-quality rivals such as British Land (in which I have a long position), which recently reported a LTV ratio of 28.1%.

Turnaround strategy: New boss Matthew Roberts has put in place a five-year turnaround strategy. Mr Roberts says his priority is to fix the balance sheet by 2021, when the firm’s debt starts to mature.

Capex has been cut and the group is aiming to agree more part-disposal deals, such as the recent intu Derby JV.

Looking ahead, the company wants to make changes to include more food and experiential offerings in its centres. It’s also trying to find ways to profit from online sales. Examples given include “curated space for pure-play online brands” and “modernising the lease structure, to include store generated online sales”.

Finally, Intu will intensify its efforts to monetise its land bank for non-retail projects such as housing, hotels and shared workspace facilities. It says that sites for 6,000 potential residential units have already been identified.

My view: I have to admit that I have some sympathy with Sports Direct founder Mike Ashley’s recent rant comment that CVAs are unfair on more successful retailers. History also suggests that CVAs often only prolong the agony for failing retailers.

The signs certainly seem to suggest that landlords are going to face pressure on rents for several more years. Next reported an average rent reduction of 29% on lease renewals last year. And I note that according to the FT (paywall), Primark is seeking reductions of up to 30%, mirroring those reported by Next.

In my view, what’s worrying about this is that Intu says that lease renewals during H1 were completed with an average rental uplift of 1%. This appears to contradict the rental savings being reported by savvier retailers, such as Next.

This disconnect suggests two possibilities to me. One is that this rental uplift figure excludes some big incentives for landlords, such as rent-free periods. The other is that in aggregate, rents still have some way to fall.

Neither option sounds very appealing to me, given Intu’s debt burden.

The market seems to share this view, given that the stock is trading at an 80% discount to NAV after today’s drop.

The company says that self-help measures under review may include “raising equity”.

I suspect shareholders will face dilution or further losses at some point. In my view, Intu should only be of interest to sophisticated investors with an expert insight into this sector.

I don’t have this kind of edge, so my interest is currently restricted to property firms with high-quality portfolios, modest discounts and much stronger balance sheets.

Aston Martin Lagonda (AML)

  • Share price: 495p (-13%)
  • Market cap: £1.3bn

Interim results

The Aston Martin share price has now fallen by about 70% since the group’s IPO in October 2018. This must surely be a serious contender for one of the worst IPOs of recent times.

It seems clear to me that the stock was far too expensive when it was floated. When you combine this with high levels of debt, weakening trading and terrible cash flow, you get a toxic mix. Today’s half-year results illustrate this painfully well.

Unwinding inventories: Wholesale sales to dealers rose last year, leaving dealers with above-average inventories. Slowing sales in Europe and the UK have forced the company to cut back on production to allow dealer inventories to unwind.

The company says this is happening, with retail (dealer) sales up by 26% during H1, compared to a 6% increase in wholesale numbers.

We might speculate that dealer channels were stuffed with inventory ahead of last year’s IPO to boost numbers. The company denies this, and attributes the increase to new model introductions and supply chain issues.

Poor financials: Revenue fell by 4% to £407.1m, despite the rise in wholesale numbers. This reduced the average revenue per unit from £184,819 to £166,708. The company says this is due to a changing mix, with fewer Specials (limited edition models).

Slower wholesale growth has exposed Aston Martin’s high operating leverage. Manufacturers like this tend to have high fixed costs. If capacity utilisation or selling price falls, then losses can quickly result. I think that’s what we’re seeing here.

Profits: Adjusted EBITDA fell by 79% to £22m during the first half, down from £105.9m in H1 2018.

On a statutory level, the group reported an operating loss of £37.7m for the half year, compared to an operating profit of £64.4m last year.

As in previous years, the company wouldn’t have reported any profits at all if it hadn’t capitalised most of its R&D expenses. During the first half, £121.3m of R&D spending was added to the balance sheet. Just £1.9m of R&D was expensed.

If all of this spending had been expensed, I estimate that Aston Martin would have reported an operating loss of £158m for the half year.

Cash flow: Operating cash flow for the half year fell from £62m last year to just £20.8m. There was a free cash outflow of £138.2m, compared to £88.1m last year.

Net debt: The group drew down £138.6m of new borrowings during the half year.

Net debt rose to £732m, which represents 4.7x trailing 12-month EBITDA. This compared to 2.3x EBITDA at the same point last year. This is a big red flag for me.

Trading outlook: The dreaded second-half weighting makes an appearance here. The company is banking on a “significant weighting of Specials …” and other higher-margin models during the second half of the year.

Last year’s results show a 35%/65% split between H1 and H2 wholesale volumes, so perhaps there is a seasonal weighting here.

Profits are expected to be skewed to the second half as well. Despite H1 losses, the company is guiding for an adjusted EBITDA margin of 20% and an adjusted operating profit margin of 8%.

My view: I don’t want to spend too much more time on this. In my view this business is uninvestable at the moment, given its high debt levels and dire cash flow.

Aston Martin is a great brand and I’m sure it will prevail. But that doesn’t necessarily make the equity worth buying at any price.

This business has been bankrupt seven times before. The previous owners’ decision to float the business without raising any fresh cash means that shareholders have been left carrying the can for an undercapitalised business.

Aston Martin’s weak balance sheet and uncertain outlook mean that for me, this remains a stock to avoid.

I’m afraid that’s all I’ve got time for today. Thanks for stopping by.





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  • comment-avatar

    Good stuff Rollers . keep it up.

  • comment-avatar

    As always a most interesting analysis.
    Thank-you Roland.

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