It’s “avoid the warnings” time
Last week saw a few profit warnings. Somero, Ted Baker, Quiz, Pendragon warnings were based on revenue disappointments but I suspect cost pressures are building too at the moment. The trend of increasing warnings appears to be a growth trend with Q1 showing the highest number of warnings in this cycle.
Source:EY
Drivers
Weather is a frequent culprit according to company statements, for which investors usually read “anything but the weather”. There is a weak pound making imports expensive (see James Cropper for details) while it also enables overseas competition to compete in our UK market on price; there is Brexit uncertainty, wages starting to increase and competitive threats from technology. So as revenues face headwinds cost pressures are building. These are symptoms of an economic situation but perhaps we should look to the cause to determine how we should position portfolios.
Quantitative Easing
Quantitative easing hasn’t worked. Printing money has generally led to inflation in the past which makes our debt less relative to our assets and thus magically make the governments record level of debt more manageable. It has certainly inflated asset prices. A stable full of “Unicorns” on ludicrous valuation bears that out but consumer inflation is reaching record lows.
Source: Bloomberg
What Happens Next?
History doesn’t repeat itself but it does rhyme. A good example of what debt can do to a country was the debt that was placed on Germany post WWI which is illustrated on the chart below. It didn’t take Germany long to fall into arrears when a helpful chap called Charles Dawes devised a plan to lend Germany the money to make the repayments effectively kicking the ball down the road. This time we just printed money instead through what is termed quantitive easing. Then followed the roaring 20’s. 90 years later they may call this the decade of unicorns. Then came the 1929 crash which involved a bank crisis. With currency linked to gold the ability to devalue currencies in order to kick start exports was limited so countries systematically started to abandon the gold standard in the early 1930’s. Gordon Brown in fact sold the UK’s gold many years ago but sterling has been devaluing this year. The result was a slump which enabled political change when Hitler rose to power gaining popularity through a huge fiscal stimulus. And there does appear to be some political change going on just now. It certainly seems that human nature doesn’t change which ultimately means that history will rhyme.
Japanisation
That would suggest we are heading towards an inevitable slump. Although printing money hasn’t been tried before so I am less convinced of the cyclical depression but it looks like company profits are going to become increasingly hard to grow, which is not a great place. It may be that we don’t face a 1930’s style slump. Maybe we just do what Japan did where quantitative easing combined with deflation has led to anaemic growth for many years. Long term interest rate expectations are certainly following the path that Japan’s did between 1986 and 2004.
Source: Bloomberg
The theme seems to be about rates being “lower for longer”.
Sector Exposure
These low rates are driving asset prices but the deflationary forces are keeping consumer spending reined in. I am not keen to have consumer exposure. If inflation does start to arrive with our low pound it could make imports expensive further squeezing the consumer.
I am comfortable with the property stocks previously covered which trade at large discounts to net asset value while some of the typical recession stocks such as Begbies Traynor may also work well. I notice that property company Helical has had a number of bid approaches which is always a sign of excess gloom being in the market. The key will be avoiding profit warnings.
Markets are cautious. IPO’s this year have been few and far between. DWF and Finablr remain below their IPO price while Loungers has achieved an 11% premium. Surprisingly, Loungers is in the consumer sector so I think I need to take a look to see what I may be missing out on here.
Meanwhile the gold price – always a sign of impending doom – has been ticking higher over the last 9 months.
Source: Sharepad
I want some Gold. The Bank of England doesn’t have any and it could just be as we move to currency wars that is the asset that becomes more trusted. I find myself wondering if that is the driver behind the cryptocurrencies.
Consumer Sector
A search of the Restaurant & Bars sector of AIM produces the following list of which only three – Young’s, City Pub Co and Heavitree Brewery post a positive share price over 5 years.
With Loungers looking to be on a high PE I am expecting it to be special.
Loungers Plc
Share Price 222.5p
Mkt Cap £205m
Source: Sharepad
History
The first Loungers was opened in Bristol in 2002 by the three founders Alex Reilly, David Reid and Jake Bishop. Since then it has rolled out 150 sites across the two formats of Loungers and Cosy Club. Piper Private Equity invested in the business is 2012 and a subsequent private equity round brought Lion Capital as a shareholder in December 2016. The IPO in May at 200p per share raise £60m for the company to repay debt as well as realising £12m for Lion Capital and £10m for management to crystallise some of their stake. The market capitalisation was at a valuation of £185m.
Investment Case
Format
The formats are casual but smart and therefore lend themselves to breakfast lunch and dinner as well as daytime use which due to all day usage ultimately drives a higher return on the property asset. Lease terms are generally for 15 years and fixtures and fittings are depreciated over 3 years generally.
Loungers concepts compete in the Restaurant/ Coffee shop space where Prezzo, Wagamama and All Bar One are while Cosy Clubs tend to compete in the Casual dining/Bars and Pubs space with the likes of Carluccio and Costa Coffee.
Scale
There seems certainly room for the company to expand. Wetherspoon have 883 outlets and Pizza Express have 453. What makes this business particularly scalable is the regional presence. The company avoids retail parks and has modest exposure to primary centres but focuses on regional towns. Performance of sites in consistent across their locations. New openings for Loungers mature within 18 months and Cosy clubs may take 2 years.
Source: Prospectus
Model
The model provides a strong ROI.
Gross margins are 74.5% in line with industry norms. Of the balance labour costs are high amounting to some 33% of revenue and the company employs close to 3,000 staff. Rent and rates is c 6% while energy utilities, repairs etc is some 28% and head office costs are 7-8%. Thus EBITDA margins are 13% of revenue.
It is the cash generative and capital light nature of this business that attracts private equity. While customers pay at the till and suppliers are paid later the business benefits from negative working capital and consequently has generated a 36% ROIC historically.
Thus, we have a business which is economically sensitive but generates high returns. As long as it can continue the roll out without an economic shock, shareholders will do well.
Estimates
Sharepad forecasts show us operational leverage is expected as this year’s 26% revenue growth translates to 37% EBIT growth in the current year to April 2019. The Liberum revenue forecasts are based of a reduced 4% like for like revenue growth combined with 25 site openings per year.
Balance Sheet – Post IPO the net debt is expected to be £25.5m which increases to £27.5m in 2020 before cash generation is expected to start repaying the debt as well as financing the roll out of new outlets.
Valuation
There is a useful valuation table in the Liberum initiation note which shows the comparator companies on an average PE ratio of 19.2 times 2019 earnings.
Source: Research tree
The shares currently trade at 22.9X April 2020 EPS which to my untrained eye appears to be up with events.
Personal View
The problem I have is I am of the “economic shock” point of view. It reminds me too much of Carluccios which I helped to float in 2005. That was one of the first “all day” eateries and was very popular at the time. And it all went very well. Until it didn’t as the graph below testifies.
Source: Sharepad
A look at Carluccio’s 2008 results serves as a useful reminder “Food cost inflation has been in double digits for most of the year and the Euro has strengthened against Sterling by approximately 15% adding further pressure to the cost of our imported retail products” and “There is no doubt that the UK has entered a period of recession with economic activity expected to slow sharply during 2009. “
Personal View
This is a highly economically sensitive stock with very attractive returns from a scalable format. I can’t help but ask myself “what could possibly go wrong”. Weak sterling is happening today, cost pressures are increasing and the economy isn’t exactly on fire. Maybe I am too cynical. Time will tell.
Ramsden
Share Price 174p
Mkt Cap £55m
Source: Sharepad
H&T Group
Share Price 331p
Mkt Cap £123m
Source: Sharepad
History
These two companies are involved in the second oldest profession in the world– that of pawnbroking. A pawnbroker lends short term money and holds an asset such as gold or jewellery as security against non-repayment when he sells the asset and repays any excess above the value of the goods back to the owner having repaid the loan. Ramsden is based in the north (hence sponsorship of Newcastle United FC) while H&T is predominantly in the south.
The main difference between the stores is that Ramsden have a much higher proportion of foreign currency exchange carried out in store while H&T has an unsecured loan product. The foreign exchange is offered at better spreads than most of the large banks offer it and it has long been an unspoken truth that banks make outsized profits from customers from wide foreign exchange pricing. So, Ramsden has found it can provide a competitive product to its customers which is highly profitable.
Stores tend to be in inexpensive locations while ostensibly both companies are in similar businesses the financial dynamics tell a different story.
Investment Case
These companies both have reliable and cash generative business models while growth is not as easy as many of the customers are repeat customers who build up over time. I visited a H&T store once near Elephant & Castle which has been at that site for 100 years. It is therefore harder to grow the stores and borrowing to finance a larger loan book is hard to come by as banks are frequently worried about the reputational risks. However, as both companies have a significant stock of gold in their inventory any increase in the gold price will increase their profits which I am rather liking. These are defensive stocks to own.
The markets obsession with growth over the last 12 months has led both stocks to depreciate and both now trade on a similar PE ratio of 10.3/10.4X and give a 3.5%-4% yield. However, at Ramsden the ROE is almost double that of H&T implying a much more efficient allocation of capital.
The answer to the differing returns is the relatively high proportion of foreign exchange that Ramsden does relative to H&T which makes each branch produce a higher return.
Below are comparative figures for the two companies:
Source: RNS
We can see from this table that H&T, with 182 stores has a higher revenue/store (£786k) but with a lower profit contribution per store of under 10% as it has less of the high margin foreign exchange business. Ramsdens 156 stores have a lower turnover per store (£300k) but a higher margin of 12.6%. The cash generated from this extra margin may be the reason that Ramsden is in a net cash position while H&T has a modest amount of gearing.
Estimates
Analyst consensus is for higher growth at Ramsden as they have recently acquired 4 stores from The Money Store and some loan books from Instant Cash Loans Limited alongside 18 stores from The Money Shop. There is no doubt that their stronger balance sheet leaves them well placed. Conversely H&T’s strategy is around digitising their offering, increasing their online penetration and increasing the foreign exchange.
Ramsden
H&T
Source:Sharepad
Valuation
The PE of both companies is very similar at 10.3 and 10.4X respectively. And there is not much difference in the dividend yields. Given we have better growth prospects one is tempted to plump for Ramsdens with its more acquisitive business and stronger balance sheet.
Sterling Sensitivity
My one concern with Ramsden is the foreign exchange exposure. While it produces a higher return it also may be more volatile. Like in life what comes easily can go easily. The company came to market in February 2017 and soon after IPO it had a number of earnings estimate upgrades because the foreign exchange business was going better than expected. These moments can be seen on the chart below where the share price responded in early to upgrades.
Ramsden Share Price
Source: SharePad
I can’t help but notice these upgrades come shortly after the devaluation of the £ relative to the Euro. Having pondered this curious puzzle for a while I concluded that the link between the price of a Euro and their earnings was remarkably close. The pound dropped relative to the Euro c 20% during 2017 and I surmise that most of their customers obtain their holiday money (say €500) to go on holiday to Europe. So, if I go into a Ramsden shop to ask for €500 it is suddenly costing me 20% more and so Ramsden get a 20% increase in their earnings.
Euro per Pound Chart
Source: Sharepad
Thus the weak pound may help Ramsden’s forex business. The demographic they serve are also perhaps less economically sensitive than some implying their customers are less likely to cancel their foreign holiday due to the weak pound.
Personal View
Of the two pawnbrokers I am swayed by Ramsdens with its stronger balance sheet and superior returns due to the forex business. The acquisitions also have the potential to drive strong growth going forwards.
Summary
As cost pressures increase and revenue drivers are weak over the coming years careful stock selection will be key. I am unsure of the durability of Loungers, which IPO’d in May, in such an environment while I am finding myself irresistibly drawn to the pawnbrokers where Ramsden looks to have a better model and outlook than H&T while both have similar valuations.
Upcoming Events
Weekly commentary: 17/06/19
It’s “avoid the warnings” time
Last week saw a few profit warnings. Somero, Ted Baker, Quiz, Pendragon warnings were based on revenue disappointments but I suspect cost pressures are building too at the moment. The trend of increasing warnings appears to be a growth trend with Q1 showing the highest number of warnings in this cycle.
Source:EY
Drivers
Weather is a frequent culprit according to company statements, for which investors usually read “anything but the weather”. There is a weak pound making imports expensive (see James Cropper for details) while it also enables overseas competition to compete in our UK market on price; there is Brexit uncertainty, wages starting to increase and competitive threats from technology. So as revenues face headwinds cost pressures are building. These are symptoms of an economic situation but perhaps we should look to the cause to determine how we should position portfolios.
Quantitative Easing
Quantitative easing hasn’t worked. Printing money has generally led to inflation in the past which makes our debt less relative to our assets and thus magically make the governments record level of debt more manageable. It has certainly inflated asset prices. A stable full of “Unicorns” on ludicrous valuation bears that out but consumer inflation is reaching record lows.
Source: Bloomberg
What Happens Next?
History doesn’t repeat itself but it does rhyme. A good example of what debt can do to a country was the debt that was placed on Germany post WWI which is illustrated on the chart below. It didn’t take Germany long to fall into arrears when a helpful chap called Charles Dawes devised a plan to lend Germany the money to make the repayments effectively kicking the ball down the road. This time we just printed money instead through what is termed quantitive easing. Then followed the roaring 20’s. 90 years later they may call this the decade of unicorns. Then came the 1929 crash which involved a bank crisis. With currency linked to gold the ability to devalue currencies in order to kick start exports was limited so countries systematically started to abandon the gold standard in the early 1930’s. Gordon Brown in fact sold the UK’s gold many years ago but sterling has been devaluing this year. The result was a slump which enabled political change when Hitler rose to power gaining popularity through a huge fiscal stimulus. And there does appear to be some political change going on just now. It certainly seems that human nature doesn’t change which ultimately means that history will rhyme.
Japanisation
That would suggest we are heading towards an inevitable slump. Although printing money hasn’t been tried before so I am less convinced of the cyclical depression but it looks like company profits are going to become increasingly hard to grow, which is not a great place. It may be that we don’t face a 1930’s style slump. Maybe we just do what Japan did where quantitative easing combined with deflation has led to anaemic growth for many years. Long term interest rate expectations are certainly following the path that Japan’s did between 1986 and 2004.
Source: Bloomberg
The theme seems to be about rates being “lower for longer”.
Sector Exposure
These low rates are driving asset prices but the deflationary forces are keeping consumer spending reined in. I am not keen to have consumer exposure. If inflation does start to arrive with our low pound it could make imports expensive further squeezing the consumer.
I am comfortable with the property stocks previously covered which trade at large discounts to net asset value while some of the typical recession stocks such as Begbies Traynor may also work well. I notice that property company Helical has had a number of bid approaches which is always a sign of excess gloom being in the market. The key will be avoiding profit warnings.
Markets are cautious. IPO’s this year have been few and far between. DWF and Finablr remain below their IPO price while Loungers has achieved an 11% premium. Surprisingly, Loungers is in the consumer sector so I think I need to take a look to see what I may be missing out on here.
Meanwhile the gold price – always a sign of impending doom – has been ticking higher over the last 9 months.
Source: Sharepad
I want some Gold. The Bank of England doesn’t have any and it could just be as we move to currency wars that is the asset that becomes more trusted. I find myself wondering if that is the driver behind the cryptocurrencies.
Consumer Sector
A search of the Restaurant & Bars sector of AIM produces the following list of which only three – Young’s, City Pub Co and Heavitree Brewery post a positive share price over 5 years.
With Loungers looking to be on a high PE I am expecting it to be special.
Loungers Plc
Share Price 222.5p
Mkt Cap £205m
Source: Sharepad
History
The first Loungers was opened in Bristol in 2002 by the three founders Alex Reilly, David Reid and Jake Bishop. Since then it has rolled out 150 sites across the two formats of Loungers and Cosy Club. Piper Private Equity invested in the business is 2012 and a subsequent private equity round brought Lion Capital as a shareholder in December 2016. The IPO in May at 200p per share raise £60m for the company to repay debt as well as realising £12m for Lion Capital and £10m for management to crystallise some of their stake. The market capitalisation was at a valuation of £185m.
Investment Case
Format
The formats are casual but smart and therefore lend themselves to breakfast lunch and dinner as well as daytime use which due to all day usage ultimately drives a higher return on the property asset. Lease terms are generally for 15 years and fixtures and fittings are depreciated over 3 years generally.
Loungers concepts compete in the Restaurant/ Coffee shop space where Prezzo, Wagamama and All Bar One are while Cosy Clubs tend to compete in the Casual dining/Bars and Pubs space with the likes of Carluccio and Costa Coffee.
Scale
There seems certainly room for the company to expand. Wetherspoon have 883 outlets and Pizza Express have 453. What makes this business particularly scalable is the regional presence. The company avoids retail parks and has modest exposure to primary centres but focuses on regional towns. Performance of sites in consistent across their locations. New openings for Loungers mature within 18 months and Cosy clubs may take 2 years.
Source: Prospectus
Model
The model provides a strong ROI.
Gross margins are 74.5% in line with industry norms. Of the balance labour costs are high amounting to some 33% of revenue and the company employs close to 3,000 staff. Rent and rates is c 6% while energy utilities, repairs etc is some 28% and head office costs are 7-8%. Thus EBITDA margins are 13% of revenue.
It is the cash generative and capital light nature of this business that attracts private equity. While customers pay at the till and suppliers are paid later the business benefits from negative working capital and consequently has generated a 36% ROIC historically.
Thus, we have a business which is economically sensitive but generates high returns. As long as it can continue the roll out without an economic shock, shareholders will do well.
Estimates
Sharepad forecasts show us operational leverage is expected as this year’s 26% revenue growth translates to 37% EBIT growth in the current year to April 2019. The Liberum revenue forecasts are based of a reduced 4% like for like revenue growth combined with 25 site openings per year.
Balance Sheet – Post IPO the net debt is expected to be £25.5m which increases to £27.5m in 2020 before cash generation is expected to start repaying the debt as well as financing the roll out of new outlets.
Valuation
There is a useful valuation table in the Liberum initiation note which shows the comparator companies on an average PE ratio of 19.2 times 2019 earnings.
Source: Research tree
The shares currently trade at 22.9X April 2020 EPS which to my untrained eye appears to be up with events.
Personal View
The problem I have is I am of the “economic shock” point of view. It reminds me too much of Carluccios which I helped to float in 2005. That was one of the first “all day” eateries and was very popular at the time. And it all went very well. Until it didn’t as the graph below testifies.
Source: Sharepad
A look at Carluccio’s 2008 results serves as a useful reminder “Food cost inflation has been in double digits for most of the year and the Euro has strengthened against Sterling by approximately 15% adding further pressure to the cost of our imported retail products” and “There is no doubt that the UK has entered a period of recession with economic activity expected to slow sharply during 2009. “
Personal View
This is a highly economically sensitive stock with very attractive returns from a scalable format. I can’t help but ask myself “what could possibly go wrong”. Weak sterling is happening today, cost pressures are increasing and the economy isn’t exactly on fire. Maybe I am too cynical. Time will tell.
Ramsden
Share Price 174p
Mkt Cap £55m
Source: Sharepad
H&T Group
Share Price 331p
Mkt Cap £123m
Source: Sharepad
History
These two companies are involved in the second oldest profession in the world– that of pawnbroking. A pawnbroker lends short term money and holds an asset such as gold or jewellery as security against non-repayment when he sells the asset and repays any excess above the value of the goods back to the owner having repaid the loan. Ramsden is based in the north (hence sponsorship of Newcastle United FC) while H&T is predominantly in the south.
The main difference between the stores is that Ramsden have a much higher proportion of foreign currency exchange carried out in store while H&T has an unsecured loan product. The foreign exchange is offered at better spreads than most of the large banks offer it and it has long been an unspoken truth that banks make outsized profits from customers from wide foreign exchange pricing. So, Ramsden has found it can provide a competitive product to its customers which is highly profitable.
Stores tend to be in inexpensive locations while ostensibly both companies are in similar businesses the financial dynamics tell a different story.
Investment Case
These companies both have reliable and cash generative business models while growth is not as easy as many of the customers are repeat customers who build up over time. I visited a H&T store once near Elephant & Castle which has been at that site for 100 years. It is therefore harder to grow the stores and borrowing to finance a larger loan book is hard to come by as banks are frequently worried about the reputational risks. However, as both companies have a significant stock of gold in their inventory any increase in the gold price will increase their profits which I am rather liking. These are defensive stocks to own.
The markets obsession with growth over the last 12 months has led both stocks to depreciate and both now trade on a similar PE ratio of 10.3/10.4X and give a 3.5%-4% yield. However, at Ramsden the ROE is almost double that of H&T implying a much more efficient allocation of capital.
The answer to the differing returns is the relatively high proportion of foreign exchange that Ramsden does relative to H&T which makes each branch produce a higher return.
Below are comparative figures for the two companies:
Source: RNS
We can see from this table that H&T, with 182 stores has a higher revenue/store (£786k) but with a lower profit contribution per store of under 10% as it has less of the high margin foreign exchange business. Ramsdens 156 stores have a lower turnover per store (£300k) but a higher margin of 12.6%. The cash generated from this extra margin may be the reason that Ramsden is in a net cash position while H&T has a modest amount of gearing.
Estimates
Analyst consensus is for higher growth at Ramsden as they have recently acquired 4 stores from The Money Store and some loan books from Instant Cash Loans Limited alongside 18 stores from The Money Shop. There is no doubt that their stronger balance sheet leaves them well placed. Conversely H&T’s strategy is around digitising their offering, increasing their online penetration and increasing the foreign exchange.
Ramsden
H&T
Source:Sharepad
Valuation
The PE of both companies is very similar at 10.3 and 10.4X respectively. And there is not much difference in the dividend yields. Given we have better growth prospects one is tempted to plump for Ramsdens with its more acquisitive business and stronger balance sheet.
Sterling Sensitivity
My one concern with Ramsden is the foreign exchange exposure. While it produces a higher return it also may be more volatile. Like in life what comes easily can go easily. The company came to market in February 2017 and soon after IPO it had a number of earnings estimate upgrades because the foreign exchange business was going better than expected. These moments can be seen on the chart below where the share price responded in early to upgrades.
Ramsden Share Price
Source: SharePad
I can’t help but notice these upgrades come shortly after the devaluation of the £ relative to the Euro. Having pondered this curious puzzle for a while I concluded that the link between the price of a Euro and their earnings was remarkably close. The pound dropped relative to the Euro c 20% during 2017 and I surmise that most of their customers obtain their holiday money (say €500) to go on holiday to Europe. So, if I go into a Ramsden shop to ask for €500 it is suddenly costing me 20% more and so Ramsden get a 20% increase in their earnings.
Euro per Pound Chart
Source: Sharepad
Thus the weak pound may help Ramsden’s forex business. The demographic they serve are also perhaps less economically sensitive than some implying their customers are less likely to cancel their foreign holiday due to the weak pound.
Personal View
Of the two pawnbrokers I am swayed by Ramsdens with its stronger balance sheet and superior returns due to the forex business. The acquisitions also have the potential to drive strong growth going forwards.
Summary
As cost pressures increase and revenue drivers are weak over the coming years careful stock selection will be key. I am unsure of the durability of Loungers, which IPO’d in May, in such an environment while I am finding myself irresistibly drawn to the pawnbrokers where Ramsden looks to have a better model and outlook than H&T while both have similar valuations.
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