Interactive Investor

Stockwatch: can these hot stocks keep glowing? 

11th June 2021 09:50

Edmond Jackson from interactive investor

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After a string of bumper results from this sector, our companies analyst shares his view on prospects.

Strong updates and share price rises continue from various companies linked to spending on homes, but how sustainable is this? Is it just a purple streak during exceptional circumstances – of spending diverted from service industries, and people with time and money on their hands due to furlough? 

DFS Furniture (LSE:DFS) and Norcros (LSE:NXR) in bathroom/kitchen products and tiles have just declared better-than-expected results, helping their stocks maintain a firm bull trend since end-March 2020. 

ScS Group (LSE:SCS) in upholstered furniture and flooring has also joined the party, yesterday rising 8% to 279p, despite no update since interims to 23 January cited a £20 million operating profit on sales up 14% to £174 million. A record first half performance was credited to pent-up demand.  

DFS stock chart transformed by Rishi Sunak’s measures  

In recent years, this stock has looked to me as high risk/reward given liabilities verging on “distress” levels. But a chart that had “avoid” written all over it, from 350p at end-2015 down to 117p in March 2020, has been transformed into a stunning bull trend – rising consistently to test 300p currently.  

This looks partly justified by some reduction in balance sheet risk conflating with an exceptional period of consumer demand. In April 2020 there had been a 20% dilutive share issue at 150p to address £224 million trade payables versus just £13 million trade receivables, £194 million debt and £525 million lease liabilities. By end-2020, net bank debt was £38 million, although working capital and lease strains remained.     

Yesterday, DFS closed up 10% at a five-year high after declaring order intake up 92% for its fourth quarter to end-June – all the more remarkable given the comparator period was 2019 not 2020. This was attributed to people waiting for showrooms to re-open, and increased consumer spending on homes. Pre-tax profit for the current year to end-June should be at least £105 million compared with a recent net profit consensus for £45 million. 

That could bring the stock’s price/earnings (PE) ratio down to test single figures in the near term. However, the company is cautioning about tempered profits in the June 2022 financial year due to cost input pressures, and I imagine business rates normalising also. 

In due respect, the update reflects strong marketing initiatives, and management usefully provides low/medium/high scenarios for trading than a single moving target. 

I am concerned that this exceptional period of trading is unsustainable, also that management is guiding for a 7.5p dividend in September instead of further reforming a balance sheet which has negative net tangible assets near £300 million. Fleeting traders may have bought into a fabulous chart in the last year. Holders might therefore want to look for their opportunity to perhaps sell half. 

ScS Group has a much stronger balance sheet 

Capitalised at around £100 million, ScS is one-seventh of DFS’s size but I sense has stronger credentials to justify retaining at 279p currently. Mind, all such stocks could see profit-taking as service industries open up and spending is diverted from goods.

I drew attention to ScS as a ‘buy’ at 216p in November 2019 given an historic PE sub-8x, while its dividend yield tested 8%. M&G investment managers had snapped up nearly 9% of the equity. There was a sound financial record especially on cash flow which supported pay-outs, also considering the balance sheet showed £58 million cash and no debt.  

Interims to last 23 January cited nearly £20 million operating profit on revenue up 14% to £174 million. Notably, £24 million cash was generated over six months alone, and there was £92 million cash at bank. This compares with a current market cap of £98 million with the stock at 280p, an all-time high after 240p pre-Covid and a 139p low a year ago.

I therefore rate ScS a ‘hold’ given interim normalised earnings per share (EPS) alone was 37.5p versus consensus for 23.4p in respect of the current year to 25 July. Active traders may want to consider it as a ‘buy’, but mind any limited small-cap liquidity.

ScS Group - financial summary
Year end 25 July

  2014 2015 2016 2017 2018 2019 2020
Turnover (£ million) 244 278 317 333 313 317 255
Operating margin (%) 2.7 1.0 3.5 3.6 4.4 4.4 0.3
Operating profit (£m) 6.6 2.8 11.0 12.0 13.7 13.9 0.7
Net profit (£m) 5.9 -2.2 8.7 9.4 10.7 11.4 -2.2
IFRS3 earnings/share (p) 14.8 -5.6 21.3 22.9 26.9 27.4 -5.8
Normalised earnings/share (p) 14.8 0.4 21.3 22.9 26.9 28.1 -12.2
Operating cashflow/share (p) 34.6 20.5 26.7 70.0 43.7 51.2 150
Capital expenditure/share (p) 7.7 10.4 8.3 12.7 7.0 13.5 10.0
Free cashflow/share (p) 26.8 10.1 18.5 57.4 36.6 37.7 140
Dividend/share (p)   14.0 14.5 14.7 16.2 16.7 0.0
Covered by earnings (x)   -0.4 1.5 1.6 1.7 1.6  
Net Debt (£m) 3.7 -15.4 -16.3 -33.6 -41.8 -51.8 54.1
Net assets per share (p) 10.6 67.0 74.0 83.2 93.2 107 67.1

Source: historic company REFS and company accounts

Norcros cites very strong recovery from unprecedented uncertainty 

The stock edged up 1% to 322p after annual results to 31 March – as if the market has a measured view of ongoing prospects for selling showers, kitchens and tiles.  

I initially drew attention to Norcros as a tuck-away at 143p in October 2016 given it looked cheap on a forward PE around 6x and dividend yield near 5%. It was benefiting from weaker sterling amid Brexit worries, given a third of revenue/profit derived from South Africa – a feature that has historically meant a cheap rating.  

By June 2018 - when I backed the shares again - its operations narrative continued to improve with the restructuring of Johnson Tiles and the acquisition of Merlyn Industries, the UK/Ireland’s leading supplier of shower enclosures and trays. A bold target was introduced, of £600 million annual revenue by 2023, although this has been extended to 2025 “due to Covid disruption” and after £324 million has just been announced. It implies further acquisitions abroad, given the board wants 50% of revenue to derive outside the UK.

Return on capital remains around 18% as in 2017/18, after a dip to 16% in 2019/20. Despite a 5% rise in underlying operating profit on revenue 5% easier, underlying cash from operations has soared 71% to £47 million, transforming the balance sheet from £36 million net debt to £11 million net cash. 

Diluted underlying EPS of 31p is up 10% - for a PE of 10x - based on £15 million net profit, and the dividend is reinstated at 8.2p. Given Norcros’s strength of cash flow, I think dividend per share could rise to something like 12p in respect of the current year, implying a yield close to 4%.   

Norcros - financial summary
Year end 31 Mar

  2015 2016 2017 2018 2019 2020 2021
Turnover (£ million) 222 236 271 300 331 342 342
Operating margin (%)                4.6 7.1 6.2 6.5 7.6 5.2 7.3
Operating profit (£m) 10.2 16.7 16.8 19.6 25.1 17.8 24.9
Net profit (£m) 8.2 13.0 8.5 9.9 19.4 10.9 15.0
EPS - reported (p) 13.0 20.7 13.3 14.2 23.9 13.5 18.6
EPS - normalised (p) 18.8 23.5 17.7 18.6 28.0 28.2 31.1
Operating cashflow/share (p) 23.2 26.4 35.6 25.1 35.6 32.1 65.9
Capital expenditure/share (p) 11.3 10.5 12.5 11.0 6.9 5.9 3.5
Free cashflow/share (p) 11.9 15.9 23.1 14.0 28.7 26.2 62.4
Dividend/share (p) 5.6 6.5 7.1 7.8 8.4 3.1 8.2
Earnings cover (x) 2.4 3.2 1.9 1.8 2.9 9.1 3.8
Cash (£m) 5.6 5.9 37.5 25.8 27.2 47.3 28.3
Net debt (£m) 14.2 32.5 23.2 47.1 35.0 61.5 -10.5
Net assets (£m) 52.7 47.6 56.6 105 126 104 148
Net assets per share (p) 87.4 77.3 91.5 130 156 130 183

Source: historic company REFS and company accounts

Management says strong trading has persisted into April and May, ahead even of the 2019 comparable period by 23%. They also caution: “The full impact of the crisis is difficult to ascertain, given the disruption in our supply chain, increases in freight and input costs…”  

The stock has effectively recovered its pre-Covid level of 295p and I consider merits a ‘hold’ rating. 

Top US growth fund manager predicts slump in goods spending 

Never lacking a forthright view, growth stock guru Cathie Wood, founder, CEO, and chief investment officer of Ark Invest, has an interesting contrarian view on bullish results from consumer goods firms. 

She reckons people have bought all they need, aided by cash hand-outs, and panicked businesses have ordered too many materials to cope. Commodity prices are exposed to a slump and Cassandra’s on inflation are wrong. 

She cites US goods consumption up 74% over 12 months since Covid-19 struck – to recently represent over 41% of US consumer spending. This is already falling and, in the long run, goods represent only a third of consumer spending.  

Wood therefore opposes Bill Ackman who says inflation is already entrenched and shock interest rate rises may lie ahead. She believes low interest rates will persist, hence her Ark fund remains weighted to high-profile growth stocks. 

Sharply opposing views reflect a tricky call. I concur with Wood in terms of the consumer goods boom liable to prove fleeting. Certain stocks justify retaining, but now is not the time to invest fresh money for the long run. 

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

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