Stockwatch: Are Ted Baker shares a bargain yet?

by Edmond Jackson from interactive investor |

Weeks before a trading update, our companies analyst decides if these cheap shares are worth buying.  

Are shares in £183 million “global lifestyle company” Ted Baker (LSE:TED), selling clothing and accessories, finally bottoming out after a torrid fall?

Nowadays, Ted Baker is a small-cap stock, having fallen from near 3,600p at end-2015, to 3,125p in spring 2018, then plunging to where we are now. Monday 17 November saw a capitulation to 370p, then a recovery to 410p through the rest of last week – the current equilibrium.

At this level and if forecasts are fair, the prospective price/earnings (PE) ratio is just over 6x and the yield 7.3% covered 2.2x by 2020 earnings.
Transient row or losing the marketing plot?

Last October’s interims revealed a shocking swing from £24.4 million profit to a £23 million loss, on revenue easing 0.7% or 2.5% in constant currency. The founder CEO had resigned early in March after an internal row over “forced hugging”, seen as constituting harassment, so it’s easy to see the profits downturn following a jolt to the company and possibly deterring some customers. Otherwise the five-year historic table shows respectable revenue growth.

But you could interpret this chiefly on operational grounds, seeing Ted Baker as the latest victim in high street retail, and also as a relatively small UK business trying to be many things on a global scale. High inventories - £210 million, or a remarkable 115% of market cap – could suggest management is losing its way, or at least needs a lesson in stock control.  

Source: TradingView Past performance is not a guide to future performance

These results were also below internal expectations and the second half-year (from mid-August) had “started slowly, not helped by warm weather in September,” adding, “if these trends continue, we will achieve a second-half result below that of last year. We also have a number of significant trading periods across the balance of the year with forward visibility significantly reduced...”

It’s possible to interpret this as autumn/winter collections sparking no enthusiasm, although management said they had been “well received and we are excited about our new product initiatives including monthly product drops and speed to market developments.”

Short sellers start to close ahead of trading update

Fundamentals make for a dicey situation, as represented by short sellers lacking conviction.  Published positions (over 0.5%) recently showed a modest 2.13% of Ted’s stock out for loan and only three hedge funds involved, each increasing from September to early October. That took the overall short position back to a high seen briefly last January, but it soon dropped back near an historic median of 0.6% over summer.

Then, last week, the overall position reduced to 1.87% as GLG Partners cut by 0.23% to 0.59% (a 28% reduction) and WorldQuant shaved theirs 0.03% to 0.58%. It could explain the share price rebound from 370p. Such trading conveys belief that if the next update due Wednesday 11 December is “in line”, the stock can rise. Both cuts to short positions followed an 18 November company news release flagging the update.

Consensus appears to be for a drop in net profit from £40.7 million to £23.0 million in respect of the current financial year to 26 January, stabilising around that level. Down at 370p the yield was around 8%, assuming expectations for a halving in the dividend to 28.7p a share in respect of this financial year, edging up thereafter. With 44.6 million shares issued that would cost £12.8 million in context of the 10 August balance sheet showing £11.7 million cash, down from £19.1 million a year before. Much therefore depends on cashflow holding up. 

Encouragingly, the interim cash flow statement showed net cash from operations up 152% to £41.3 million (from a year before), albeit due chiefly to depreciation (being added back) up nearly thrice to £37.7 million and a £15.9 million decrease in inventory versus a £15 million increase before.

At least this showed management tackling high inventories, but a key part of the cash flow equation was a £19 million profit for the period swinging to a £20.5 million loss. Also, the net finance expense had tripled over £6 million. So, if trading festers henceforth then, yes, the dividend is exposed, there’s no cash buffer in support.

Mystery of the inflated inventories

For the last financial year, inventories as a percentage of turnover stood at 36.6%, while looking back to 2014 they were 25% - as if management’s claims about product being “well-received” may need a pinch of salt. They could instead be sitting on stock that needs (further) discounting to shift. Management should really explain why inventories reached this level at all and the actions being taken to deal with it given the critical importance for margins.

The 10 August current ratio (of current assets to current liabilities) was 1.17x, i.e. a bit of wiggle room perhaps for liquidity risk, although trade payables exceeded trade receivables by a factor of 1.54, bank overdraft was £108.1 million.

There was also a £4 million current term loan and £35.8 million lease liabilities, relative to cash of £11.7 million. So there really isn’t much leeway considering near-term liability specifics if trading deteriorates further.

With a further (non-current) term loan of £41 million that makes financial gearing of 71% (albeit with inventory value potentially dubious within net assets) where the net interim finance charge was £6.1 million – up from £2 million - a bit curious since debt levels are quite constant year-on- year.    

Taking a one-year forward view of trading and cash flow, the directors expressed “a reasonable expectation that the group has adequate cash headroom to meet all banking covenant requirements,” though, already the recent past has been below expectations.

A potential positive has been September’s appointment of a new chief financial officer with a “strong” retail background – if you are content to include Debenhams (LSE:DEB), where she was in the same role from September 2018. Ted’s previous CFO resigned last August after 17 years to join luxury retailer Mulberry (LSE:MUL).

The market already rates the stock at a 13% discount to August’s net assets per share of 472p, or a near 10% premium to net tangible assets per share of 376p per share. So, with inventory potentially in question, you can’t be sure of an asset prop.

Ted Baker - financial summary
year-end 26 Jan 2014 2015 2016 2017 2018 2019
             
Turnover (£ million) 322 388 456 531 592 617
Operating margin (%) 12.3 12.8 13.0 11.8 12.0 8.8
Operating profit (£m) 39.6 49.8 59.4 62.5 70.7 54.5
Net profit (£m) 28.9 35.9 44.2 46.6 52.7 40.7
IFRS3 earnings/share (p) 66.3 81.0 99.3 105 118 91.3
Normalised earnings/share (p) 68.6 82.9 99.7 118 131 122
Operating cashflow/share (p) 73.1 68.7 93.3 118 98.4 142
Capital expenditure/share (p) 41.6 57.6 201 98.2 82.0 67.9
Free cashflow/share (p) 31.6 11.1 -108 20.2 16.4 73.9
Dividend/share (p) 33.7 40.3 47.8 53.6 60.1 58.6
Covered by earnings (x) 2.0 2.0 2.1 2.0 2.0 1.6
Net Debt (£m) 8.8 18.8 84.6 95.2 112 1.2
Net assets per share (p) 257 320 393 477 504 549
Source: historic Company REFS and company accounts    

Still good online reviews, for what they are worth

TrustPilot reviews remain strong: Ted achieving a 4.5 out of 5 “Excellent” rating from 13,678 reviews, with customers generally pleased with the quality of products and service. Not untypical is: “Love everything about Ted Baker, from the gorgeous range of clothing, quality of goods, the extra touches when despatched. Never disappoints; is one hell of a designer!”  That’s the fan club view, obviously; but at least one exists, hence genuine brand value.  Capable management therefore has goodwill to work with, and a corporate buyer might be tempted while sterling is relatively weak and Ted Baker stock unloved.

The big marketing question, though, is whether this brand is currently being surpassed.  Founded in 1988 and floated in 1997, Ted Baker went for quirky details on shirts, suits and dresses, helping to distinguish it, albeit in a fast-moving space.

Nowadays, there are 560 stores/concessions globally: 199 in the UK, 124 in Europe, 136 in the US, 96 in the Middle East, Africa and Asia, and 9 in Australasia.  E-commerce represents about 17% of group revenue, although interims showed it slipping 1.3% versus stores down 2.5%. The figures show revenues merely treading water despite “wow” reviews: US sales growth of 3% offsetting UK/Europe down 4% while rest-of-world slumped over 15%.

Accounting issue behind the £23 million loss

However, the £25 million profit at the October 2018 interims became a £2.7 million pre-exceptionals/IFRS 16 loss that extended to a £23 million reported loss due to an accounting adjustment on a footwear business acquired.

Distribution costs leapt 14%, chiefly due to annualising the cost of a US warehouse, and administrative costs by 22% “due to continued investment in our people”. With adjusted earnings per share (EPS) 4.5p in the red, the interim dividend more than halved to 7.8p, albeit in line with consensus for the year.

It all amounted to stunning change in a tough retail sector, where the only responsible view is to await more evidence. I’m intrigued by Ted Baker’s valuation and short sellers buying back, to flag this as a stock to watch, with the 11 December update looking pivotal.

But two short sellers starting to buy back stock does not add up to a fundamental ‘buy’ stance, even if it is notable for traders. Ted Baker is potentially a recovery play, but I’d await the update. Avoid.

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

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