Interactive Investor

Stockwatch: this could be a small-cap turnaround investment

After a quite spectacular decline, latest results were encouraging. Analyst Edmond Jackson runs through the numbers and believes there’s something there for those comfortable with the risk.

7th June 2024 11:57

by Edmond Jackson from interactive investor

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Spinning on a roundabout at the park

AIM-listed N Brown Group (LSE:BWNG) – a digital retail platform for clothing and footwear – is a chronic disappointer in stock terms, falling over the past decade by 98%. This was from a 565p all-time high after rocketing from just over 100p in 2004, so at least the business has past form.

By convention, such stocks do not come back:

N Brown graph

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

Chief among reasons is the business model, which could be described as a variation on a “sub-prime lender”. Brown extends high-cost credit via a financial services side, to people who on common-sense grounds probably should not be making such purchases anyway. Presumably, Brown would say the items are low-cost and good value and that such customers otherwise would have to go without, so they are at least being provided with a choice.

A whopping current asset could be exposed by recession

The financial upshot, however, is a “gross customer receivables” book above £500 million relative to £600 million annual revenue, financed with the help of nearly £240 million net debt. The issue is not so much £14 million net interest costs clipping £27 million operating profit, as propensity for things to get a lot riskier financially if there is a consumer recession.

Investors’ memories probably remain scarred by any sense of “sub-prime” lending as it affected the US mortgage market in 2007 to the 2008 global financial crisis.

Consequently, Brown stock has kept drifting down amid worries over “the cost of living” and with the UK technically entering a recession in the second half of last year. Even after yesterday’s spike by one-third in market value to 20p, the shares trade at over a 70% discount to the latest balance sheet value for net tangible assets of 69p a share.

I suspect the stock decline also relates to a quite tight market even for a £93 million company - 77% of the stock is held by the Alliance family (including Brown’s ex-chairman) and maverick retailer Mike Ashley’s Frasers Group (LSE:FRAS). Smaller shareholders would have progressively exercised stop losses given the appalling chart, but now there looks to be a break-out, or at least a realisation that the fall is overdone.

It flags the stock at least as a “cigar butt” – a puff or two of profit left – or potentially a recovery play.

Profits turnaround despite revenue slip

The annual numbers show a 10% fall in group revenue to £601 million, clothing constituting 63% and down nearly 11% relative to financial services. Management, however, proclaims “an enhanced experience” for customers via new websites “ensuring more detailed product descriptions”.

There have also been “successful” launches of new product lines across the strategic brands of JD Williams, Simply Be and Jacamo, which cover women and men of different ages. There is the new “Anthology” premium line plus a new lifestyle sports brand “Tala” with selected lines in Sainsbury’s, and new smart casual within Jacamo.

Mind, how the current financial year’s first quarter still shows (we are told) a 6% decline in product revenue, with management predicting “moderate” growth for the March 2025 year. The customer loan book also opened the year lower, like for like, and will take time for improved product revenue to feed through. The company says: “we do however expect financial services revenues to decline at a slightly improved rate to that seen in 2024.”

So, it is all rather early stage and hope-based, although if a Labour government was to protect those on low incomes and benefits from tax rises, such a scenario could help Brown deliver.

Meanwhile, adjusted pre-tax profit has improved from £4.9 million to £13.3 million, and there is also a £5.3 million pre-tax profit at the reported level. An improvement in the gross profit margin broadly offset higher operating costs as a percentage of revenue. This shows Brown is quite “operationally geared” given the way operating costs were actually cut by £15 million, yet this cost ratio stayed up.

It leaves scope for March 2025 profit to surprise on the upside if consumer demand allows, though one must also mind downside risk if it stalls.

A way to go before dividend resumption

Operating cash generation has also improved from £6 million to £92 million, supporting £23 million investment and £31 million debt repayment. Period-end cash nearly doubled to £65 million.

Net debt is down 21% to £236 million, with the income statement showing £13.6 million net finance costs taking half the adjusted £27 million operating profit.

On dividends, the board’s position remains not to re-introduce payments currently given a cautious macro context and investment plans that are competing for cash – although this will be kept under review.

It does not appear there are cash demands from the pension fund – cited as £17 million in surplus – although it’s hard to be sure given actuarial assessments can differ.

The stock market may understandably remain cautious about the heavy trade receivables position - £569 million versus only £65 million trade payables – given receivables took a £122 million write-down in the March 2023 financial year. Is a “cost of living crisis” still biting UK discretionary spending among lower-income people?

I would still target modest dividend restitution for the 2026 financial year. Remarkably, the 10-year record shows Brown consistently paid a dividend above 14p pre-2019 and there does not appear to have been substantial dilution (issuing shares).

N Brown Group - financial summary
Year end 2 Mar

Turnover (£ million)819837866901922914838729716678601
Operating margin (%)
Operating profit (£m)10783.
Net profit (£m)75.951.154.344.312.5-58.327.48.316.2-51.40.8
Reported earnings/share (p)26.821.819.415.74.3-
Normalised earnings/share (p)26.816.312.48.528.838.321.36.811.010.51.7
Operating cashflow/share (p)14.425.922.831.511.3-13.017.845.517.01.319.9
Capex/share (p)7.421.120.614.913.812.813.
Free cashflow/share (p)
Dividend/share (p)
Covered by earnings (x)
Net Debt (£m)214247290291347468504306261297236
Net assets per share (p)17115916816916210911090.496.184.881.9

Source: historic company REFS and company accounts

Another online clothes retailer exposed to Chinese competition?

It is the key reason why it might be hard to target a recovery say over 100p a share despite this looking amply feasible in chart terms.

Investors have seen Boohoo Group (LSE:BOO) plunge from around 300p to a 30p range and into operating losses after previously being feted as a growth star. The rise and reach of Chinese online retail significantly explains why.

Shein, the Chinese fashion giant offering a huge range of cheap clothes, might soon float on the London Stock Exchange – reputedly as a £50 billion company. While it may compete most directly with the fast-fashion retailers, it would seem foolhardy to under-estimate its ability to adapt. 

Brown does have a good offering across age groups and for men besides women, and I would not put it in the “potential marketing failure” category like, for example, Bonmarche became a stock market disaster. Similarly, years ago Marks & Spencer Group (LSE:MKS) lost its way on clothing, refreshment of which has significantly aided that stock’s dramatic recovery.

Dicey yet improving risk/reward profile

The marketing question is admittedly tricky to judge, especially for investors trying to guess whether Brown’s range includes clothes that consumers might want to buy. As for trusting reassurances from management, I fell prey to several CEOs of Bonmarche and their claims as to what it was possible to achieve.

There still looks a case for a starter position in Brown, given the latest profits achievement and fair chance the UK is avoiding a consumer recession. At around 20p, it is speculative and risky but could achieve a benchmark 2p earnings per share going forward. Buy.

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

AIM stocks tend to be volatile high-risk/high-reward investments and are intended for people with an appropriate degree of equity trading knowledge and experience. 

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