Interactive Investor

Stockwatch: are Dr Martens shares a bargain at half price?

20th January 2023 10:26

by Edmond Jackson from interactive investor

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A pair of profit warnings has caused the iconic bookmaker to halve in value, attracting the interest of analyst Edmond Jackson. 

Dr Martens boots 600

A fall in US equities shows sentiment remains edgy and January’s rally may prove one in a medium-term bear market.  

While Americans obsess about inflation and interest rates, here the initial challenge of 2023 is deciphering where truth lies – amid some pretty resilient updates from firms, yet some pretty doom-laden indicators. 

Latest data from market research firm GfK shows UK consumer sentiment falling for the first time in three months – back near historic lows – as concerns about the economy and soaring cost of living tighten the squeeze on household finances.  

This sounds odd so soon after we heard about Sainsbury (J) (LSE:SBRY)’s record sales of champagne and Prosecco, and at Hotel Chocolat Group (LSE:HOTC), where my early December “buy” case for the stock at 147p is looking sweet at 210p after citing Christmas sales up  10% in the UK and Ireland. 

So, quite how the trend in discretionary consumer spending may pan out is unclear. Relatively strong sales at Aldi and Lidl imply a trend towards value-retail, only for luxury to outperform. Or perhaps such examples show a rising propensity to treat during a recession? 

Bear market in Dr Martens affirms concept of mean reversion 

Dr. Martens (LSE:DOCS) floated in early 2021 at 370p a share and hit 515p in the aftermarket, but its near-relentless fall to 140p, down well over 70%, affirms the need to be sceptical when private equity owners and company management extract vast equity.  

Senior executives of Permira (which originated from Schroder Ventures) made nearly £500 million and 22 Dr Martens staff £350 million. 

There is a wider issue about how this flotation occurred right at the top of the era of ultra-low interest rates, which resulted in absurd valuations among growth stocks. We now need to get used to inflation settling possibly in a 4% to 6% area, and interest rates accordingly, hence price/earnings (PE) multiples over 20 times may apply only where technology for example can radically expand a new market. 

Yes, Dr Martens has made great advances since my 1980’s schooldays when teachers banned teenage rebels from wearing them. Nowadays it is an advancing global brand with more sales momentum among young women.  

But despite raising its operating margin to over 25% in its March 2022 year, it does not compare say with the history of ARM Holdings. When listed, this microchip maker enjoyed margins of 30% to 40% and a mass global market in myriad devices. 

It is still timely to question if Dr Martens’ de-rating – accentuated by two profit warnings in two months – starts to overdo momentum on the downside. Might low sterling in due course tempt an international trade buyer to make an approach? 

Down 61% to 145p since listing, the mid-cap stock is capitalised below £1.5 billion – and if a mix of guidance and projections is fair, may now be on a forward PE around 10 times, yielding over 4%.  

As an example of mean reversion - involving a brand with proven long-term appeal – that could have gone far enough, according to how the story evolves. 

A dose of bad luck or harbinger of more trouble ahead? 

Interims to 30 September showed an 11% advance in underlying revenue at constant currency, albeit an 8% fall in net profit as the operating margin eased to 21% amid opening new stores and investing in people. 

Yet despite raising the interim dividend by 28% (to 35% of earnings), the outlook cautioned of slower consumer growth and a higher US dollar. Margins were also affected by port strikes and staff shortages at a Netherlands distribution centre, impacting margins.  

Price rises would be attempted this year, although its annual sale shows currently shows reductions of as much as £169 cut to £99. Is that now necessary to sustain sales in a toughening context for discretionary spending? 

Mid-teens revenue growth was still guided for the March 2024 year; we shall see.  

Yesterday revealed the kind of trouble you would associate with poor controls: US revenue hit in the fourth quarter, not only by slower consumer growth – blamed on warm weather - but operational issues at a new Los Angeles distribution centre.  

Deliveries arrived sooner than expected, hence temporary warehouses were opened at a cost of £11 million, also up to £25 million wholesale sales lost. Stocks of boots were moved from a Portland centre to LA sooner than planned, and requests were accepted from wholesalers to store them, all of which is basic stock management.  

The snags plus “a more uncertain economic environment", are expected to persist – hence a current challenge for investors is to guess how bad consumer discretionary spending could get. 

It is another example of why we watch short-selling data. Last Tuesday, Woodson Capital Management went just over the 0.5% (of issued share capital) disclosure threshold for selling short, before yesterday’s 31% slide. 

Fair value on current numbers, if lacking historical context

Guidance is for a £16 million to £25 million hit to EBITDA (near to operating profit), which I estimate may bring net profit down to around £150 million – for earnings per share (EPS) of 15p, hence a circa 10 times PE multiple. Consensus for a 6.5p dividend for the March 2023 year would thus be amply covered. 

A market value near £1.5 billion otherwise represents barely 1.4 times expected sales in the current year, and 4.2 times last September’s book value – with over three-quarters of this constituted intangibles. 

Financial information disclosed at flotation shows a good profile of free cash flow – albeit during recent good years for consumer spending, hence it remains early days to judge reliability of dividends. 

Dr Martens - financial summary 
Year-end 31 Mar

20182019202020212022
Turnover (£ million)349454672773908
Operating margin (%)11.515.021.214.625.2
Operating profit (£m)40.268.0143113229
Net profit (£m)-5.717.274.835.7181
EPS - reported (p)-0.61.77.53.618.1
EPS - normalised (p)-0.42.18.47.718.1
Operating cashflow/share (p)4.65.612.116.018.4
Capital expenditure/share (p)1.61.72.21.92.5
Free cashflow/share (p)3.03.99.914.115.9
Dividends per share (p)0.00.00.00.00.0
Covered by earnings (x)0.00.00.00.03.3
Return on total capital (%)10.317.627.122.532.6
Cash (£m)86.458.4117114228
Net debt (£m)334332378253166
Net assets (£m)-29.4-8.470.5151328
Net assets per share (p)-2.9-0.87.115.132.8

Source: prospectus and company accounts.

Unfortunately, there does not appear a reliable source of Companies House accounts to convey group trading in the 2009 recession and its aftermath.  

Affluent younger people living with parents may help 

Wealthier youngsters still living at home may be a reason why JD Sports Fashion (LSE:JD.) was able to report over 10% like-for-like sales growth in the second half of 2022, compared with 5% in the first half.  

In the UK especially, younger people are staying in the family home much longer – hence have disposable income when not servicing mortgages and other cost-of-living rises. Quite how extensive this features globally, to explain JD’s progress, is not yet clear. But I imagine a majority of Dr Martens’ customers are likely under 35 years-of-age. 

Narrative of a failed flotation is usefully depressing the price 

Normally after a shock profit warning, an early mark-down to accommodate sellers stabilises and creeps back up. Yet the decline in Dr Martens continued throughout yesterday, and early dealings today show a 5p fall to 140p – amid a broad reaction of consternation about how private equity flotations let down investors. 

But if portfolio investors let good times go to their heads and apply no valuation discipline – which applies significantly to fund managers who agreed the 370p offer price – then it is futile to blame private equity for astute timing. Such ownership has bolstered international sales, and we'll  see if management can stay better on the ball. 

If a PE multiple say in a 10 to 13 area is more representative of ratings in future, for such a consumer products business – JD’s forward PE is around 12 times – then Dr Martens’ mean-reversion probably has now completed (on current guidance for prospects). 

Obviously, judging “P” is one thing, there remains uncertainty as to “E”, and the future could prove more challenging. But using company fundamentals, a case exists for a starter position. You decide the precise timing. Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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