Cube Report (30 June 2021) – Dixons Carphone hits the right numbers
Good morning, it’s Roland here with today’s Cube Report.
After yesterday’s dive into small-cap territory, I’m pleased to report that there are some larger companies to look at today. I want to start by looking at today’s full-year results from CurrysPCWorld owner Dixons Carphone. This is a stock I’ve covered here in the past and previously owned.
Today’s results appear to show a decisive turnaround, but they have more moving parts than a washing machine and are somewhat complex. I’m encouraged by progress, but are shares in this low-margin, competitive business still cheap enough to be attractive to me?
- Stock data should display here.
|Writer disclosure||No position|
Many of Dixons Carphone’s stores were closed temporarily during lockdown, but the company adapted well and doubled its online sales to £4.7bn — nearly 50% of revenue.
It’s worth remembering that Dixons’ international operations, mostly in the Nordic countries, now account for nearly half of all sales. This isn’t just a UK retailer.
Financial highlights – headline numbers for the year to 1 May appear quite strong:
- Total revenue up 2% £10,344m
- Group revenue excluding mobile up 12% to £9,623m (+14% LFL)
- UK & Ireland Mobile down 55% to £721m
- Adjusted EBIT (operating profit) up 22% to £262m
- Adjusted operating cash flow up 13% to £338m
- Adjusted free cash flow up 302% to £438m
- Year-end net cash (excl. lease liabilities) of £169m (FY20 net debt £204m)
- Dividend reinstated at 3p per share
However, there are a lot of adjustments behind these numbers. Statutory operating profit for the group was just £147m. That’s 44% below the adjusted figure of £262m.
Of these adjustments, £100m came from impairment charges on store closures and onerous contracts. I’d expect that most of these will be non-recurring, so I would expect to see the gap between adjusted and statutory profits narrow somewhat this year.
Results from the Nordic and Greece businesses were pleasingly free of major adjustments and showed operating margins of between 3.3% and 3.7%.
On balance, I think it’s reasonable to expect that the UK & Ireland business should also be able to achieve a 3% operating margin this year.
Mobile restructuring: Free cash flow of £438m allowed the group to move to a net cash position, but this impressive figure doesn’t reflect trading free cash flow.
Dixons benefited from a £454m working capital inflow last year, as receivables fell sharply. The vast majority of this (£391m) came from so-called network debtors. My understanding is that these are receivables linked to Dixons’ legacy post-pay deals with mobile operators. Most of these have now ended or are being unwound.
For example, Dixons received a £189m early repayment from EE last year, as the group terminated its “unprofitable legacy agreement” with the BT-owned mobile operator.
I think it’s fair to say that company’s restructuring under boss Alex Baldock has largely been funded by the gradual repayment of the network debtor. This has fallen from £1,067m three years ago, to £239m at the end of FY21. As these legacy contracts come to an end, Dixons is replacing them with flexible, capital-light deals that should create a smaller but profitable mobile business. From this year, mobile no longer be reported separately and will be included in UK & Ireland Electricals.
I originally identified this network debtor as a potential value catalyst, but I now think I underestimated how much of this cash would be needed to support restructuring and investment in areas such as IT. What’s actually happened, I suspect, is that unwinding these receivables has enabled Mr Baldock to avoid an equity fundraising.
Pension deficit: It’s worth noting that Dixons Carphone has a fairly hefty pension deficit of £482m. Company guidance is for contributions to rise to £78m per year from 2021/22 onwards. For a business that’s generating EBIT of c.£250m, I’d argue that’s a substantial drag.
Guidance: The company’s guidance for the current year is to maintain a net cash position despite increased capex of £190m.
Medium-term guidance is for a 4% operating margin by 2023/24, with cumulative free cash flow of over £1bn between 2019/20 and 2023/24.
However, as discussed above, I believe much of this will come from one-off payments from the network debtor book. I’m not sure it reflects the underlying free cash flow potential of the business.
Dixons Carphone’s turnaround appears to be working well. But despite the disruption caused by stores closures last year, I think it’s fair to say that last year’s results were boosted by lockdown demand for electricals.
Financially, the firm’s finances have been shored up by the great unwind of its mobile debtor book, which has provided cash for restructuring, deleveraging, and investment.
I have two main concerns about this business which led me to sell my shares and are likely to prevent me investing again:
Growth: Dixons Carphone is already a large player in this market, but it will always face tough competition on price from online-only rivals such as AO.com and Amazon. It’s not clear to me how much growth potential the business has.
Today’s medium-term guidance only talks about margins and makes no mention of growth. That chimes with brokers’ consensus forecasts, which show revenue dipping down below £10bn this year and remaining flat in 2023. Mr Baldocks’ plans for growth seem to depend on getting existing customers to spend more, preferably using the company’s credit scheme.
Profitability: Dixons does have decent scale and the group’s operating margin target of 4% doesn’t seem unrealistic to me. But I don’t see much potential beyond this. Ultimately, the company is a box shifter, selling generic products that can easily be bought elsewhere.
Even if customers value the in-store/support experience provided by Dixons Carphone, I don’t think they’ll be willing to pay much higher prices than they would elsewhere.
I’ve calculated a return on capital employed of 6.2% from last year’s result, using adjusted operating profit. I can see scope for this to rise to 8%-9% over the next couple of years, but I don’t believe much more will be possible.
Conclusion: Although the shares look reasonably priced on 11x FY22 forecast earnings, with a forward yield of perhaps 3%, I think the low returns generated by this business are likely to restrict future share price growth. I don’t see any great reason to buy the shares at current levels.
That’s all I’ve got time for today, thanks for reading.