Stockwatch: Attractive 8.5% yield, or value trap?

by interactive investor |

Have the mid-cap shares in Card Factory, the retailer of greeting cards and gifts, fallen too far given the board's guidance for an implied 8.5% yield at the current buy-price of 199p?

The stock initially fell in response to a Q1 update at Card Factory's AGM, but 194p triggered an intra-day rally to 206p, settling back under 200p as traders ponder how durable is Card's payout policy.

Operational cash flow eased 11.1% to £72.7 million in the last financial year to end-January 2018, and management continues to progress store openings. Thus, with modest cash reserves of around £3 million, it conveys "peak dividends", also because the board has indicated it will roughly halve the element of special payout this year, from 15p to 5-10p (my factoring 7.5p into the sense of an 8.5% yield).

•    Card Factory runs into fresh selling

Regular greetings cards in long-term decline?

The stock is effectively back to its listing price four years ago, in a game of snakes and ladders between fears for the longevity of greeting cards retail, and a cash generative business with margins over 20% - hence appeal for income investors.

Over 15 months, initially, the stock doubled, but since early 2016 has trended overall downwards with big swings. It hit 186p last February, then April saw a brief rally near 250p, which didn't hold, and in terms of fundamentals Q1 saw 3% sales growth boosted by new store openings while like-for-like sales slipped 0.4% "against strong comparatives and in a tough retail environment".

Source: interactive investor          Past performance is not a guide to future performance

Some allowance is justified for harsh winter weather, but the board's vigorous roll-out - a net 10 new stores opened in Q1 with an overall 50 targeted for the current financial year, in context of 915 at last January-end -quite shows its awareness this is the chief means to demonstrate growth. For context, like-for-like sales have slipped from 3% in respect of the 2016 financial year to 0.6% in 2017, but were 2.9% up in the year to end-January 2018 - i.e. volatile at a low level.

The dilemma is greetings cards and associated gifts nowadays being a challenging sector. Remember, Clinton Cards ended up in administration in 2012 (albeit rescued/restructured) after supermarkets expanded their card ranges which people may find more convenient for birthdays within families. If a special occasion to share between friends, photographs on social media may be more apposite for celebrating. Christmas cards appear steadily eroded by postage costs and generational interest.

Online cards have sprung up as a means to bridge the gap if "not the real thing" to elders and maybe superfluous to those younger. Such is the existential dilemma, but if an established cards business is well-run then it can be a cash cow, hence appeal to income investors once the market prices its stock for attractive yield. Yet Card's volatility implies investor concern over like-for-like sales and lately cash flow.

Underlying growth more narrative than numbers

Management says its performance is "robust...reflecting the strength of our offer and the continuing work to re-design and refresh products, particularly in our seasonal card and gift ranges." Online, "customers are responding well to range expansion and new designs across card and non-card products...our social media presence is maturing with growing communities and engagement across key platforms..."

Yet trading at, offering personalised and unique gift ideas, remains disappointing amid heavy discounting and higher customer acquisition costs. That begs a question what exceptional costs may eventually be required to sort out or close it, and a reminder how online marketing is not necessarily a solution.

In terms of numbers, the last financial year showed an 11.9% fall in group operating profit and by 5.5% at the underlying pre-tax profit level to £80.5 million, on revenue up 6% to £422 million. Management proclaims "a lessening impact of cost headwinds and the benefits of a significant number of business efficiencies being implemented during the year...a platform for further growth in the medium term."

Given this numbers/narrative disparity it looks like stock volatility will persist until updates due early August then interims late September, which may provide more substance.


Card Factory - financial summary           Estimates
year ended 31 Jan 2014 2015 2016 2017 2018 2019
Turnover (£ million) 327 353 382 398 422  
IFRS3 pre-tax profit (£m) 30.1 42.7 83.7 82.8 72.6  
Normalised pre-tax profit (£m) 30.1 54.2 83.8 84.8 80.5 87.0
Operating margin (%) 21.1 18.9 22.8 22.0 17.9  
IFRS3 earnings/share (p) 5.4 10.6 19.5 19.3 17.1  
Normalised earnings/share (p) 5.3 14.3 19.5 19.9 18.9 18.0
Earnings per share growth (%) 35.5 167 36.8 2.0 -5.0  
Price/earnings multiple (x)         10.5 11.1
Annual average historic P/E (x) 40.3 25.4 17.3 14.8 12.3  
Cash flow/share (p) -12.1 21.4 22.4 23.3    
Capex/share (p)   3.2 3.4 3.1    
Ordinary dividend per share (p)   6.8 8.5 9.1 9.3 9.4
Special dividend per share (p)     15.0 15.0 15.0 7.5
Total yield (%)         12.2 8.5
Covered by earnings (x)   2.1 0.8 0.8 0.8 1.1
Net tangible assets per share (p)   -14.1 -19.2 -23.7 -33.2  

Source: Company REFS       Past performance is not a guide to future performance

Will interest rate rises compromise debt accumulated?

The end-January 2018 balance sheet showed total debt up 19% to £164 million with both short and long-term elements rising; net debt being 74% of net assets, albeit 152% of which represent intangibles. That may look askance to investors taking a raw view of debt, although in the last financial year its net interest charge of £2.9 million shaved just 3.5% of operating profit - so it could be said fair policy in a low interest rate environment.

Currently, it is helping sustain the roll-out together with high dividends - the cash flow statement showing £82.9 million paid out versus £13 million investment in the last financial year, which compares with about £80 million versus £10 million in the 2016/17 financial years.

Mind that under a more "normal" interest rate environment such payouts would likely require trimming in order to drive expansion; possibly what the board anticipates already in roughly halving the special payout for this year.

When it introduced "specials" - towards a more efficient capital structure - such a distinction implied they would be transient. The crux is how high interest rates rise, which may not be very much given the Bank of England is wary of Brexit damage to the UK economy and inflation has dipped since sterling's devaluation two years ago.

Sterling has weakened just recently again, as EU negotiations fester, but renewed import cost pressure looks liable to fuel inflation once more. Card's debt looks manageable if liable to see higher service costs.

Vague read-across to Trinity Mirror

FTSE Small Cap media group Trinity Mirror  is a more extreme example than Card, albeit with similarities as a strongly cash generative business and expansion being bought as a means to show growth.

The market prices Trinity for high yield of 7.6% on a prospective price/earnings (PE) below 2.0 amid broadly flat profits as management wrests efficiencies. The stock was an excellent recovery play when I drew attention in May 2011 at 50p, along a rationale cash flow would cut debt and the pension deficit, reaching 234p by mid-2014. But since then, Trinity's chart has been volatile downwards and now trades at 85p.

With both stocks it's a similar question whether the business is genuinely value-accretive, or management is teasing shareholders with bought growth in a challenging sector.

Directors yet to buy into a sub-200p trading range

While it doesn't now look as if dealing restrictions apply, the last buying was January when the chief executive added 20,387 shares at 239.1p to own a total 107,226 shares, and the wife of a non-executive director bought 22,520 shares at 219.9p. End-April the chairman sold 100,000 shares at 234.15p, nearly a third of his holding, although without knowing personal circumstances it's hard to know if that was any verdict on value.

Now may still be opportune to begin averaging into Card Factory. My view is cautious given operational cash flow, as well as profit, reduced in the last financial year, hence the market is likely to want further reassurance. So, the stance significantly relates to one's risk appetite. Buy on weakness.

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