Interactive Investor

Stockwatch: is this ex-growth stock now attractive for income?

11th November 2022 11:42

Edmond Jackson from interactive investor

After tipping this share earlier in the year, analyst Edmond Jackson issues an update following recent first-half results.

Five months ago, I made a tentative “buy” case for B&M European Value Retail SA (LSE:BME), an FTSE 100-listed “variety goods retailer” after a 40% drop to 390p.  

I found it a tricky, potentially premature call, writing: “conservative investors should avoid but if you appreciate the risks then consider a small position with a view to averaging in”. 

That initially worked quite well as the price crept up to 415p in August.  

Yet despite its value/discount retailing profile, B&M has not been immune to growing fears for consumer spending, hence a slide to near 300p by mid-October.  

Likewise with the market, it has rallied in recent weeks, then yesterday’s interim results to 24 September prompted a 6% drop to 350p before yesterday’s wider rebound has seen it recover to 380p. 

An update is warranted as the results need deciphering for their essential message.  

A confident pitch, stabbed by gardening forks 

B&M’s chief executive said: “Sales momentum is good as we enter a difficult period for the economy and consumers...our value-based approach is winning...a relentless focus on price and product.” 

Yet adjusted EBITDA (close to operating profit) is down 18% to £232 million, chiefly in the main UK business of B&M stores, down over 22% to £200 million on near-flat revenue around £1.9 billion.  

A 9% first-quarter revenue slide from the UK B&M stores was however against a strong period when we emerged from lockdowns. The second quarter rose 2% and is up 2.5% in the first six weeks of the group’s third quarter to late December. 

What effectively caused yesterday’s drop was a gross margin reduction from 37% to slightly below 35%, blamed on mark-downs in gardening products to clear stock. 

If just one aspect of the stock mix can bring down the results, it begs the wider question where might retailers be in the new year if stock management does not align with Christmas sales?  

It is unclear whether the setback has been due mainly to stock control or tighter consumer spending? 

Progress in France augurs well, scope for expansion 

An 18% rise in interim revenue in France to £184 million and a 55% jump in EBITDA to £18 million is encouraging, given just 111 stores versus over 650 in the UK, albeit similar-size populations. 

Constituting 8% of group revenue, likewise EBITDA, “France is seen as a real growth area”. Three new stores are due to be opened in the second-half-year and ten are targeted for the March 2024 year. 

As relative context, management aims for a 35% increase in the UK to 950 stores, there being “significant localities where B&M is under-represented or not represented at all.”  

Mind how Poundland increased its UK stores estate by 516 over its last financial year, versus a 450 target, and plans to open at least 550 net new stores over its next year.  

Aldi and Lidl also provide consumer goods alongside a mainly food offering and continue to roll out stores. Competition looks to be stiffening in the “value” space. 

B&M may therefore need France as a growth driver. 

Heron Foods, a third element in the mix, represents 10% of interim group revenue but has contributed just 0.6% of EBITDA at £14 million.  

While it has improved both these variables, respectively by 15% and 6% respectively, Heron’s reputation for cheap food makes you wonder, what scope is there to improve margin?  

The business is said to be “well positioned to help consumers manage their budgets” but no expansion targets are cited. 

Has B&M chiefly benefited from Covid lockdowns, as a growth play? 

Recent years’ performance has shown overall respectable growth as the estate expanded, lately on double-digit operating margins. This compares with low-single-digits for Sainsbury's (LSE:SBRY) and Tesco (LSE:TSCO).  

Returns on capital have breached an excellent 20% versus low to mid-single digits respectively for those rivals. 

B&M European Value Retail SA
Year-end 26 March

 2016201720182019202020212022
Turnover (£ million)2,0352,4313,0303,2733,8134,8014,673
Operating margin (%)8.68.47.99.78.712.813.1
Operating profit (£m)174205240319333613610
Net profit (£m)12514318619490.0428422
EPS - reported (p)12.414.318.619.820.442.742.1
EPS - normalised (p)13.214.819.119.817.743.141.6
Operating cashflow/share (p)14.317.919.837.554.982.549.1
Capital expenditure/share (p)5.75.211.510.612.48.88.5
Free cashflow/share (p)8.612.78.326.942.473.740.6
Dividends per share (p)4.85.57.27.68.117.330.0
Covered by earnings (x)2.62.62.62.62.52.51.4
Return on total capital (%)12.813.814.812.012.823.317.6
Cash (£m)91.115690.886.2428218173
Net debt (£m)3493965301,8141,6401,8142,093
Net assets (£m)802800912992867733746
Net assets per share (p)80.280.091.199.286.773.274.5

Source: historic company REFS and company accounts

Yet the stock traded sideways-volatile until March 2020 to early this year, when it took off – justifiably – after lockdowns boosted home living: 

It was not to last, however. Competition and tighter consumers mean the market has likely reverted to price this stock for yield, but is it a compelling case?   

Strong jump in cash generation aids yield appeal  

A flip-side to the gardening products fiasco has been an 83% jump in interim cash flow from operations to £370 million, as stock was cleared. 

A circa 18p dividend - the consensus figure, going forward, implying a near 5% yield – would cost £180 million, where the financial summary table shows only modest capital expenditure needs, despite expanding the stores’ estate.  

Period-end cash has thus jumped 142% to £223 million, although liabilities on the balance sheet show a hefty £951 million long-term debt and £1.3 billion leases, chiefly long term.  

Interim finance costs totalled £48 million which took 19% of operating profit.  

As interest rates rise, B&M might properly apply cash to reduce its liabilities, but given their long-term profile I suspect cash will be used for expansion and dividends.  

A circa 5% yield is not as plump like some, but value retailing should be a more reliable cash generator than industrial cyclicals. B&M is currently priced in between Sainsbury’s offering 5.7% and Tesco 4.6%. 

A modestly declining trend in inflation-adjusted terms 

Best look further ahead than this current cash fillip.

Guidance for full-year EBITDA in a £550 million to £600 million range is maintained, still “significantly ahead of the pre-pandemic level” of £342 million in March 2020.  

That still implies a 16% fall in consensus for £351 million net profit in respect of March 2023, hence a similar drop in normalised earnings per share (EPS) to 35.4p and a 10.5x price/earnings (PE) multiple currently. 

The March 2024 year is projected nominally flat, but amid circa 10% inflation would be a decline.  

Three short-sellers currently, no director buying lately 

At its end-2021 all-time high of 635p, B&M’s valuation was not hugely stretched if lockdowns had persisted. Its re-rating of net profit from sub-£200 million to over £400 million represented a sub-15x PE multiple.  

But as 2022 saw no resurgence of Covid after the festive season, the total short position in B&M rose astutely from just over 0.5% of the issued share capital to 4.5% by last May. It capitalised on the stock’s slide from around 470p at the time, although profits were taken and the short position reduced to 0.9% in August. 

There are currently three institutions over the 0.5% disclosure threshold, constituting 1.7% of shares issued. Blackrock and Marshall Wace are gradually raising theirs this month, while GLG Partners reduces its short position.  

As yet, there are no director/senior manager share purchases since interims have lifted dealing restrictions. The last significant trade was co-founder Simon Arora’s selling 40 million shares at 585p last January, leaving him just short of 72 million currently worth just over £250 million. Otherwise, and aside from options, four directors own just over 57,000 shares between them – which is not great. 

Despite euphoria at US inflation having apparently peaked, I remain wary about how interest rates will continue to rise, and it be many months before such effects manifest themselves in company results.  

After B&M’s stock management upset hit profit, I want to at least see how it copes over Christmas before re-iterating “buy” and therefore temper my stance: Hold. 

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

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