Supply chain issues and an uncertain outlook for the home improvements market raise doubts for our companies analyst.
Shares in DIY retailer Wickes (LSE:WIX) have risen 12% to 242p, in response to a trading update that raises profit guidance to no less than £83 million at the adjusted pre-tax level, capitalising the business at £629 million.
This marks an advance on a third quarter update on 27 October, when profit expectations were cited as “in line”. Yet the stock remains low on its chart, having fallen steadily from 277p last June to reach 210p in October.
Mixed sentiment post-flotation
Wickes was spun off last April at 250p by Travis Perkins (LSE:TPK), a £3.4 billion building materials group. While you could take a cynical view, Travis divested with good timing after lockdowns promoted a surge in home improvement, and several brokers were positive about Wickes’ long-term prospects.
Peel Hunt argued the business is set to enter a multi-year growth phase amid zeal to improve the UK’s ageing housing stock. Its analysts targeted a three-year compound annual growth rate of 5.5% – slightly above the historic trend – with margins trending towards 7.5% by the financial year to 26 December 2023. Earnings per share (EPS) were expected to average in the mid-teens annually over three years, up to 25p, resulting in a 310p target price.
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Also among bulls was Liberum, which maintains its “buy” stance, targeting 420p due to Wickes’s market-leading position, upgrade momentum and strong cash generation.
This latest update quite clearly affirms the bulls’ position versus sceptics and, with only a modest rebound since the 210p low, it is worth considering if the market has judged Wickes unduly harshly.
Reasons for my scepticism to date
First, I prefer to let a flotation – especially a spin-off – settle down and produce trading results. We cannot see how Wickes has performed over a full year, but the evidence shows it was acquired by Travis Perkins for £950 million 17 years ago, putting that group in the number two position behind B&Q, owned by £7 billion Kingfisher (LSE:KGF).
Travis’s then CEO said the combination “fits well into our strategy and will strengthen our existing builders’ merchant business”, Wickes having a similar customer profile.
The spin-off was initially declared in 2019 after the DIY market weakened from 2016, but it met with anti-retail sentiment amid fears over consumer spending in the wake of Brexit.
Digitising the business has since transformed it, but that applies also to Screwfix (owned by Kingfisher) and Toolstation (owned by Travis); evidently such a step is essential for modern competitiveness.
Much now appears to depend on whether home improvement spending is sustained or reduces in response to higher energy/fuel costs, tax rises next year and inflation on essential items.
Does Wickes have enough of a unique selling proposition?
This is my second key concern. I live mid-distance between two Wickes stores but hardly ever visit either. For most DIY-type items I use Screwfix or Toolstation, which are nearest, or two independent merchants with higher prices but a loyal clientele. That indicates that convenience does matter – when builders are pressed for time, for instance, or DIYers suddenly need more of what they are using.
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Doubtless there are some cheap items at Wickes not offered by Screwfix or Toolstation, but I find these three retailers offer little to differentiate themselves from each other. There is also Homebase – which has had a chequered history, having been sold to an Australian conglomerate in 2016 and ended up in the care of restructuring specialist Hilco for one pound, only two-and-a-half years later.
Moreover, Amazon has muscled into the DIY market, with capable warehousing and delivery logistics.
It is therefore a competitive market; Retail Economics cites Wickes as the number four retailer behind B&Q, Homebase and Screwfix.
Can single-digit operating margins and return on capital improve?
Supply chain issues and inflation have been a more recent concern. Regular news has cited higher raw materials costs for building materials, which are liable to work their way into product prices. Delivery drivers’ wages are also ticking up in accordance with supply/demand.
All these concerns have further discouraged me from confidently calling a turn in the stock’s downtrend from June high to October low, despite the recent bounce.
Yet the latest update asserts: “Our agile business model and strong supplier relationships have resulted in better-than-expected margin performance. We have been able to mitigate the pressures resulting from rising inflation and freight costs, while continuing to deliver excellent value for customers.”
Moreover, November’s construction industry data shows a marked increase, helped by the UK economic recovery, and firms have noted an improvement in the availability of specific items, especially timber. Perhaps this could also in due course support DIY supplies?
Finance costs persist due to £769 million leases
Half-year results published on 16 September proposed a 2.1p interim dividend for the year ending 1 January 2022. Consensus estimates for this year are a 7.3p payout, rising to 7.6p the year after.
Wickes needs to pay out over 7p a share in due course if it is to achieve the 3% yield quoted by some databases. But if revenues weaken, it seems reasonable to question the headroom for dividends.
Although Wickes is fundamentally cash-generative and has no bank debt, around £16 million goes out each six months to service lease liabilities.
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Also, the (fairly constant) £317 million of trade payables suggests quite enough credit is effectively being taken from suppliers, despite trade receivables having reduced to £84 million from £250 million.
The extent of leases plus the latest working capital profile make Wickes unlikely to appeal to a private equity buyer looking to ramp up debt, sell off property, squeeze some suppliers and eventually flip the business.
A 7p dividend would cost £18 million; the first-half 2021 cash flow statement showed £121 million net cash from operations (after paying lease costs) – so there is scope to pay 7p in due course, if trading remains robust. Yet the board has seemingly only committed to 2.1p, despite 2021 being a buoyant year, and also despite the investing side of the interim cash flow statement showing a £115 million net inflow due to £124 million cash repayments from Travis Perkins.
Wickes - financial summary
Year end 26 December
|Turnover (£ million)||1,200||1,292||1,347|
|Operating margin (%)||4.7||4.4||4.5|
|Operating profit (£m)||56.6||56.2||61.0|
|Net profit (£m)||14.9||12.9||26.3|
|Reported EPS (p)||5.9||5.1||10.4|
|Normalised EPS (p)||11.0||14.1||17.8|
|Earnings per share growth (%)||28.5||26.1|
|Return on total capital (%)||5.2||5.3||7.2|
|Operating cashflow/share (p)||70.1||43.0||30.5|
|Free cashflow/share (p)||52.7||33.4||22.5|
|Net debt (£m)||879||830||784|
|Net assets (£m)||264||279||130|
Source: historic company REFS and company accounts
CEO proclaims ‘we have the right business model’
In regard to my concerns about the UK consumer context and the board’s apparently timid dividend, the CEO proclaimed in September: “Beyond this financial year, we have the right business model to win over more customers and capitalise on the growth opportunities within a large and growing home improvement market.”
If life does not get materially tougher in 2022, then Wickes should at least be able to stand its ground. To rate it a conviction “buy”, however, I think one needs to be confident the DIY market can float most boats.
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Demand also relates to the housing market, and especially to buyers personalising newly acquired homes. Annual house price growth hit 10% in November, despite the end of the stamp duty holiday and the furlough job support scheme. Yet the number of mortgages fell in October to the lowest level in six months. Both factors imply fewer homes are becoming available, which would seem to affect the level of refurbishments – unless people opt to refurbish instead of moving.
In conclusion, I find Wickes’s risk/reward profile quite finely balanced between downside risk and upside potential. I respect the fact that it has contained cost rises better than expected, but it remains significantly at the mercy of home improvement spending. Take your view on that. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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