Our companies analyst assesses prospects for this small-cap portfolio of quality brands if consumer spending is squeezed next year.
Surveys suggest UK shoppers face the biggest price increases in more than 30 years this Christmas, and moreover, that consumer prices have yet to reflect the true level of inflation upstream in industry. The coming year will also herald rises in council tax and national insurance, yet the Bank of England freezes like a rabbit in the headlights over interest rates. It argues that inflation is transitory and wage increases will not become ingrained.
If that is the case, a scenario of modest wage deflation needs to be taken into account for 2022 investment tactics. Food being a first priority for consumers, how ‘discretionary’ are other goods and services likely to be for spending?
A sound portfolio of household brands
UP Global Sourcing Holdings (LSE:UPGS) is an interesting example – both for current decisions on stocks and in light of historic experience. This £170 million consumer products group – known as Ultimate Products – is a portfolio of household brands sold into various retail chains and online stores across Europe.
After falling from about 90p to 40p with the onset of Covid-19, this small-cap business had soared nearly fivefold to 230p by last June, but has since traded volatile-sideways to 190p. As with many other consumer discretionary stocks, the market divides on whether to lock in gains or buy the drop.
- Explore more of our content on UK shares
- Check out our award-winning stocks and shares ISA
- Subscribe to the ii YouTube channel and catch all our latest interviews and video content
With the help of acquisitions, over 50% earnings growth is expected for UP's current year to 31 July, albeit with only (as yet) mid-single-digit growth in 2023. £12 million to £13 million net profit implies a price/earnings (PE) ratio of around 13x, and a 7p dividend indicates a 3.7% yield.
In recent weeks, Ennismore, a generally astute hedge fund manager in European small cap, has raised its stake from 6.6% to 7.3%, in other words buying the drop. Given that small caps are illiquid for institutions, the implication is that Ennismore is looking beyond current macro fears, prioritising UP’s quality of operations.
2017 to 2018 showed a genuine setback
Before considering the group’s set-up, let me revert a few years, as past experience has possible relevance to consumer demand prospects now.
Having floated in March 2017 at 128p, UP twice traded over 220p that summer, then plunged to near 30p by May 2018. A September 2017 update cited the overall environment for general merchandise having become tougher, with wage inflation running behind general inflation. It said: “Consumers’ discretionary spend is under pressure and confidence is therefore lower…which is inevitably being reflected in purchasing behaviour.” Retailers were consequently also exercising caution in buying the kind of non-food items UP supplies.
- Read more articles by Edmond Jackson here
- Friends & Family: ii customers can give up to 5 people a free subscription to ii, for just £5 a month extra. Learn more
This update suggested that revenue growth for the year to July 2018 was “unlikely”; then reality manifested as a 20% fall, with net profit down 23% (see table).
Wage deflation was chiefly blamed, hurting consumer discretionary spending as food purchases were prioritised. Weaker sterling also meant higher costs for imports and intensified competition among suppliers as retailers tried to limit price increases.
Obviously, the fallout from Britain’s decision to leave the EU impacted consumer confidence and currency. But will wage deflation this time around be significantly less harmful for discretionary spending?
UP’s diversification has reduced business-specific risks
If you hold consumer discretionary stocks, you effectively believe those managers have created a set-up reasonably able to withstand headwinds, such that it is unwise to sell on macro fears.
UP, for example, has diversified across country and product exposure, with investors enthusing over last summer’s £34 million acquisition of Salter, the UK’s market leader for bathroom and kitchen scales.
This was part-funded by a £15 million placing at 210p; it’s unclear whether that conveyed a bull market in small caps topping out, or implies 190p in the market now is even better value. If Ennismore participated in the placing, then it might naturally recognise an opportunity to average its buying price. But would you take the same approach with fresh money, at this point?
In fairness, UP offers a mix of essential maintenance products besides discretionary spending. Its brands include Beldray (31% of sales, in laundry, floor care, heating and cooling), Salter (21%, in kitchen and bathroomware), Russell Hobbs (12%, licensing cookware not electrical appliances), Intempo (5%, in audio), Progress (5%, in cookware), Kleeneze (2%, in laundry and floorcare) and Petra (small domestic appliances).
Nearly a third of sales are international, chiefly in continental Europe, where November’s annual results cited a 4% revenue increase; however, Germany was up 27% (only to £3 million though). Despite exporters generally moaning about Brexit, UP says these European prospects “remain very encouraging, with Germany a particularly exciting opportunity”.
Possibly, and considering management’s overall initiatives, this perspective distinguishes the way this group may outperform in the months and years ahead, at least in relative terms.
Strong reputation established with supermarkets
The last financial year showed this segment enjoying 32% revenue growth to £37 million (27% of the total), driven by the Salter, Beldray and Russell Hobbs brands. This part-reflects UP’s capability in design and its relations with external manufacturers – notably with personnel in Asia to ensure swift time-to-market of any new product.
Its main sales channel, however, is discount retailers at 38% of sales, which are typically still expanding their stores. Potentially, this is another positive for UP to negotiate in what could be challenged times ahead, if such stores enjoy greater custom.
- Should investors be CIRCUMSPECT in 2022?
- Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)
Online sales represent 15% of sales, where growth has been hindered by freight constraints and the need to prioritise retail relationships with stock as it has become available. Management sees this as “a momentary pause…the fundamentals are very strong…” and still targets online sales to double to 30% of the group total in the medium term.
It has continued to invest in inventory and new product development; and been proactive in shipping and maintaining the supply chain, building a competitive advantage. The extent of UP’s monitoring is such that any raw material or component delay is quickly picked up.
Thus around £17 million is targeted to be added to 2023 sales, with Salter’s 20% operating margin potentially helping the group operating margin up from 7.4% to around 10%. Management also sees scope for further value-accretive acquisitions.
UP Global Sourcing Holdings - financial summary
Year end 31 Jul
|Turnover (£ million)||79.0||110||87.6||123||116||136|
|Operating margin (%)||8.5||7.2||7.0||7.3||7.9||7.4|
|Operating profit (£m)||6.7||7.9||5.8||8.9||9.1||10.0|
|Net profit (£m)||4.9||5.6||4.3||6.4||6.6||7.3|
|Reported EPS (p)||6.0||7.1||5.2||8.0||8.3||9.1|
|Normalised EPS (p)||6.0||8.2||5.2||8.0||8.3||9.1|
|Earnings per share growth (%)||37.1||38.0||-36.7||53.0||4.1||10.0|
|Return on total capital (%)||164||70.3||54.2||62.9||55.9||19.3|
|Operating cashflow/share (p)||4.5||12.0||-2.5||5.8||19.7||11.4|
|Free cashflow/share (p)||3.7||10.5||-3.5||4.9||18.9||8.6|
|Dividend per share (p)||0.0||5.1||2.7||4.1||4.0||5.0|
|Covered by earnings (x)||0.0||1.4||1.9||2.0||2.1||1.8|
|Net debt (£m)||9.9||5.9||12.8||17.9||7.2||21.6|
|Net assets (£m)||1.2||6.8||8.8||11.6||13.4||32.1|
Source: historic company REFS and company accounts
Overall good, other financial ratios
Although return on total capital has dropped from over 50% to below 20% – despite 2021’s return on equity at 32% – these are good figures helped by low capital intensity and working capital of around only 10% of sales.
This is explained by bank debt up from £4 million to near £19 million to help pay for Salter, plus £3 million deferred consideration, resulting in net gearing of over 60%.
The table shows a generally strong free cash flow profile, despite last year’s fall in operating cash flow. This enables roughly half of earnings to be paid out and a prospective yield of around 3.75% despite the stock’s rise since 2020.
CFO has not just splashed out £300,000 buying shares
A Director Shareholding RNS can be interpreted as UP’s retiring CFO making a genuine purchase at 196p. But a 2 November announcement set the context for the 147,722 shares involved to be transferred to him by the Employee Benefit Trust.
At least he now owns £1.1 million worth, and his replacement from next April – currently CFO at the similar-sized Franchise Brands (LSE:FRAN) – looks to have a decent record.
I am struggling presently to rate this stock a conviction ‘buy’, due to its 2017/18 experience. Yet its underlying strengths are worth watching as a potential buy, especially if consumer discretionary stocks drift in months ahead. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.
Please note that our article on this investment should not be considered to be a regular publication.
Details of all recommendations issued by ii during the previous 12-month period can be found here.
ii adheres to a strict code of conduct. Contributors may hold shares or have other interests in companies included in these portfolios, which could create a conflict of interests. Contributors intending to write about any financial instruments in which they have an interest are required to disclose such interest to ii and in the article itself. ii will at all times consider whether such interest impairs the objectivity of the recommendation.
In addition, individuals involved in the production of investment articles are subject to a personal account dealing restriction, which prevents them from placing a transaction in the specified instrument(s) for a period before and for five working days after such publication. This is to avoid personal interests conflicting with the interests of the recipients of those investment articles.