Can AIM-listed luxury furnishings group Walker Greenbank (WGB) regain momentum, or is it best to sell lest discretionary consumer spending falters?
It’s also a pertinent example of export issues under Brexit and valuation, compared with Topps Tiles (TPT) in the FTSE SmallCap index, whose sales are wholly-UK. Both are long-established having weathered downturns, although Walker Greenbank enjoys the better valuation and chart.
At 227.5p it’s on about 14 times forward earnings, though yields only 2%, having traded sideways these last few years after soaring in 2013 when QE prompted demand for riskier assets.
Prioritise expectations for earnings or yield?
Helped by a sizeable acquisition, Walker’s earnings are projected to re-rate, thereby reducing a price/earnings (PE) multiple averaging in the 20s historically.
Topps likewise enjoyed a powerful re-rating in 2013, but became volatile as investors questioned the durability of spending on home improvements; and (coincidentally?) since the EU referendum has slumped from about 140p and briefly dropped below 70p after a latest update, currently 72p.
If forecasts for slightly declining earnings are fair, then its PE is about 10 times and a yield near 5% seemingly attractive; but may imply the market is wary of profit warnings as inflation creeps above wage growth.
It’s a classic dilemma: should you prioritise what looks fairly priced, but has the better story, or what has fallen to offer a useful yield but is historically volatile? Macro questions are involved, too: are “consumer discretionary spending” stocks now fundamentally at risk after a long period of credit growth?
Both these companies are helped by a firm housing market while mortgage rates remain historically low: demand for wall-coverings and fabrics possibly linked to moving house and creating what one wants out of new/empty interiors; while tiles and wood flooring may relate more to home improvements.
Acquisition has rekindled expectations
I’ve favoured and unfavoured Walker variously over years: bullish from 22p in January 2010 when it traded on a forward PE of 8 and revitalised brand strengths were showing through; then wary how at 150p in summer 2013 it seemed fully-priced if retail sales and the housing market ever turned down.
A period of sideways trading implied a fresh catalyst was needed, which the board introduced by way of the October 2016 acquisition of Clarke & Clarke, a complementary designer of fabrics, wallpapers and cushions. Its substance for re-rating profits was shown by a £25 million initial payment and a £17.5 million earn-out.
Yet I was intrigued to resume coverage again at 220p last July, mainly by sterling’s devaluation enhancing export potential and, also, making the group attractive to a foreign buyer.
Of £31.6 million export sales in the year to end-January 2017 (34.2% of group revenues), £10.3 million represented the US – i.e. Walker has a decent foot-hold and there’s a long history of US firms swallowing British brands.
Mind that £14.5 million export sales represented Europe including Eastern/Scandinavia, thus post-Brexit terms of trade are an uncertainty.
Total manufacturing sales are up 7.5% helped by a “vertically integrated high-quality British manufacturing base, offering innovative printing techniques, (which) differentiates us from others in our industry” – another attraction for a private owner.
Overseas brand sales offset weaker UK sales
Latest interims show this already: total brand sales including Clarke for Clarke jumped 33.4% but excluding (i.e. like-for-like) were up only 3.1% and slipped 2.6% in the UK, “impacted by a weaker UK consumer environment”.
Excluding Clarke & Clarke, overseas brand sales jumped 10%, albeit only 2.7% in constant currency – i.e. the true underlying trend. This has wider relevance, affirming what some economists have started to point out: how exports aren’t improving to the extent they ought, post sterling’s devaluation; the benefit to firms appears chiefly a one-off currency boost (unless sterling de-rates again).
In the first nine weeks of the second half-year (i.e. from August) like-for-like brand sales excluding Clarke & Clarke are down 3.8% in reported currency or 4.8% in constant currency, despite jumping 31.7% in reported currency inclusive of Clarke & Clarke.
This is explained by way of a tough comparative period due to a backlog of orders in the third quarter of the previous financial year, after an end-2015 factory flooding, with reassurance “the brands’ order intake is growing ahead of last year and is on an improving trend in the run-up to our key autumn selling period”.
Sensitivity is conveyed, however, by “subject to this momentum continuing [ed: my italics], the board expects to meet its expectations for the full year.” Thus, the stock initially rose from 238p to 242p on first reaction to the results but has slipped back to 227.5p.
With UK consumer spending under pressure and only a 2% dividend yield, Walker’s valuation is starting to look risky. But if it does proceed to warn, this could hasten yet another transfer of British brands into foreign control.
Does Topps’ represent better risk/reward?
In response to a trading update, this stock has behaved inversely to Walker – a drop which then mostly reversed – given its near 5% prospective yield backed by a cash flow trend that’s some 1.5 times earnings and the dividend’s almost twice covered by earnings.
Yet, this assumes no profits downturn as pressures build on discretionary spending, even if the housing market ticks along on low mortgage rates and Help to Buy.
There’s already a soft caution: “Whilst we have seen a moderate improvement in trading in our final quarter, market conditions remain challenging and the group expects pre-tax profits for the 52-week period ended 30 September 2017 will be at the lower end of the current range of market expectations.”
If the narrative proceeds to Topps’ dividend merely being held at 3.25p, as opposed to a rise to 3.5p, then the yield would be nearer 4%; is that enough to attract income buyers given Topps has been hard-hit by recessions?
Its balance sheet and cash flow profile is robust, though. At 1 April 2017 barely any goodwill and despite nearly £40 million longer-term debt the net finance cost clipped a modest 4.6% of interim operating profit. There was £13.4 million cash and the last annual accounts to 1 October 2016 showed net cash generated from operations up from £18.5 million to £24.2 million.
So, the company ought to be capable of useful dividends so long as UK consumer spending isn’t badly hit.
Topps is therefore a potential buy, though I’d wait for more evidence of consumer spending trends; whereas Walker still rates a “long-term buy” based on its brand qualities like I suggested in July. But I must cite caveats of weaker UK demand and export performance hardly sparkling as yet.
Topps’ shares can be sensitive to trading updates so if its narrative worsens they could be worth buying on a further mark-down given its strong balance sheet for payouts; but that depends “how worse”?
Likewise, if Walker starts guiding expectations down, the worst-case scenario being a de-rating to exact a higher yield, but which could hasten takeover interest. If my analysis is right, it reflects just how tricky consumer discretionary spending stocks are right now.
Walker Greenbank – financial summary year ended 31 Jan Consensus estimates 2013 2014 2015 2016 2017 2018 2019 Turnover (£ million) 75.7 78.4 83.4 87.8 92.4 IFRS3 pre-tax profit (£m) 4.9 5.5 6.3 7.3 7 Normalised pre-tax profit (£m) 4.9 5.5 6.3 9.5 4.7 14.3 15.3 Operating margin (%) 6.7 7.2 7.8 11.0 5.3 IFRS3 earnings/share (p) 6.9 8.1 8.3 9.5 8.1 Normalised earnings/share (p) 7.0 8.2 8.2 12.9 4.6 15.9 16.9 Earnings per share growth (%) -0.1 16.5 57.4 -64.7 249 6.7 Price/earnings multiple (x) 51.1 14.3 13.5 Historic annual average P/E (x) 15.3 22.8 24.6 16.2 45.3 Cash flow/share (p) 10.1 10.2 5.5 10.5 15.8 Capex/share (p) 5.4 8.1 5.4 4.2 10.6 Dividend per share (p) 1.2 1.5 1.9 2.4 3.0 4.5 5.1 Dividend yield (%) 1.3 2.0 2.2 Covered by earnings (x) 5.7 5.6 4.4 5.5 1.7 3.5 3.3 Net tangible assets per share (p) 29.7 33.2 33.1 46.8 28.3 Source: Company REFS
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