Institutional and director share buying has reignited interest in this popular company, and analyst Edmond Jackson believes there’s good reason to follow suit.
Last weekend, a story broke that Sparta Capital – a two-year-old US hedge fund run by a former executive of activist investor Elliott Management – had accumulated a stake in mid-cap footwear group Dr. Martens (LSE:DOCS) and been engaging with management to improve underlying performance.
It is unconfirmed by published information, but a £50 million holding would not pass the 3% disclosure threshold for a near £1.5 billion company. I imagine Sparta is intrigued by the prospect for turning around US sales given the 1 June annual results proclaimed: “Returning America to good growth is our number one operational priority” after recent mistakes such as a Los Angeles distribution centre.
This is not isolated buying: Artemis Investment Management passed the 5% threshold on 7 July; implicitly buying at least 2% given it was below the 3% disclosure level. Obviously, it could have meant averaging down a loss-making stake.
It at least offers encouragement to other holders while forecasts are uninspiring. Consensus expects a near 20% drop in earnings per share (EPS) this financial year to March 2024, with net profit down similarly to £104 million, then a circa 14% recovery to 2025. With the stock around 151p it implies a 12-month forward price/earnings (PE) ratio approaching 14 times, vaguely in line.
Shifts in the dividend are pegged similarly, with 5.4p a share expected in 2025 actually below the 5.5p maiden dividend as a listed company for 2022. There’s a mid-3% yield.
Ironically, there was £158 million of balance sheet cash as of 31 March and a £50 million buyback programme started only last month. It could have nothing to do with boardroom incentives being geared to earnings per share?
Dr. Martens - financial summary
Year-end 31 Mar
|Turnover (£ million)||349||454||672||773||908||1,000|
|Operating margin (%)||11.5||15.0||21.2||14.6||25.2||17.6|
|Operating profit (£m)||40.2||68.0||143||113||229||176|
|Net profit (£m)||-5.7||17.2||74.8||35.7||181||129|
|EPS - reported (p)||-0.6||1.7||7.5||3.6||18.1||12.9|
|EPS - normalised (p)||-0.4||2.1||8.4||7.7||18.1||13.2|
|Operating cashflow/share (p)||4.6||5.6||12.1||16.0||18.4||7.7|
|Capital expenditure/share (p)||1.6||1.7||2.2||1.9||2.5||5.1|
|Free cashflow/share (p)||3.0||3.9||9.9||14.1||15.9||2.6|
|Dividends per share (p)||0.0||0.0||0.0||0.0||5.5||5.8|
|Covered by earnings (x)||0.0||0.0||0.0||0.0||3.3||2.2|
|Return on total capital (%)||10.3||17.6||27.1||22.5||32.6||21.3|
|Net debt (£m)||334||332||378||253||166||294|
|Net assets (£m)||-29.4||-8.4||70.5||151||328||404|
|Net assets per share (p)||-2.9||-0.8||7.1||15.1||32.8||40.4|
Directors have accumulated material equity
Notably, the CEO bought £400,000 worth of Dr Martens shares at 129p on 14 July, which goes some way to being in the same boat as “outside” shareholders.
Yet at end-June he was granted over 1.5 million performance shares, which will vest subject to achieving EPS (67% weighting) and shareholder return targets over three years; then subject to a further two-year holding period.
Now we see a £50 million share buyback programme which will help achieve this remuneration scheme’s principal EPS target.
One should not get too cynical otherwise one misses a pattern of belief in value existing here.
Two non-executive directors also bought in June. One could be seen as meeting expectations to hold equity, picking up nearly £25,000 worth at 135p after being appointed in May. But another, appointed in January 2021, followed with a £5,000 purchase near 136p.
Marketing is the crux in context of consumer demand
Despite signs of encouragement from two institutions and three directors, I think the reception to Dr Martens’ sales pitch remains key.
Its strategy is to sell boots, shoes and sandals, with original models at the core. Shoes and sandals enjoyed 51% and 54% revenue growth, respectively, in the last financial year to 31 March. They are seen as a long-term growth opportunity; hence ranges being improved. Boot sales fell 10%, blamed on the Los Angeles warehousing fiasco and marketing mistakes rather than lack of appeal. Ending shipments to a China distributor also affected boots revenue in Asia Pacific.
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Sales growth potential is placed on the use of softer leathers and wider colour ranges, and collaborations with various fashion outlets. Prices have increased by 6% on average to cover supply-chain cost inflation.
Yet the question remains: what might be the effect of interest rate rises on footwear discretionary spending? Or are the alleged 30-something customers of Dr Martens largely living at home with parents, hence relatively immune to the cost-of-living crisis?
Theme of mixed trading - wholesale versus consumer - persists
While March 2023 annual revenue grew 10% to £1 billion, net profit plunged 29% to £129 million. US wholesale was disrupted at a Los Angeles distribution centre - said to be resolved at near-£15 million extra costs - although group operating expenses increased £57 million to £373 million.
It was thus a tale of two sides, with wholesale easing 3% at constant currency due to warehousing issues, while the consumer-facing side saw retail up 25% (albeit e-commerce flat) and direct-to-consumer up 11%.
Perhaps Sparta sees potential in 14 new stores opening in the US last year. The US represented 43% of last year’s group revenue and 41% of EBITDA despite a margin hit from warehousing. Europe, the Middle East & Africa dominated at 44% and 60% respectively.
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A 13 July AGM trading statement then cited lower US revenues, chiefly wholesale, while direct sales will take until the second half-year to show meaningful improvement. “Addressing our performance in this region remains our top priority,” the company said.
Overall like-for-like trading since March was cited “in line,” although the first quarter to end-June is the characteristically smallest in Dr Martens’ financial year. Direct-to-consumer sales showed “very good growth” in Asia-Pacific (driven by Japan) and Europe, Middle East & Africa. But wholesale revenue was lower, partly the effect of strategic decisions, and without seeing numbers it is impossible to say if they have largely offset growth.
Near £300 million net debt implies 73% gearing
I’m inclined to include leases given they are a cost but which does add to debt given retailers often rely on leases.
The end-March balance sheet had £299 million of borrowings and £152 million such lease liabilities, mitigated by £158 million cash – resulting in a near £17 million net interest charge, which took 10% off £176 million operating profit.
The bank debt was refinanced at end-January 2021 with an early-February 2026 maturity date.
It therefore looks a manageable - if less-than-ideal - debt profile, for the new era of moderately higher debt costs.
You would think a retailer’s cash generation should help debt reduction, although a need for higher inventory (said to improve availability) walloped last year’s operating cash generation from £208 million to £48 million.
Reduction in forecasts but still a long-term ‘buy’
I drew attention to Dr Martens at 140p last January, suggesting mean-reversion had run too far (from a 515p high in early 2021) amid cynicism at yet another over-priced private equity flotation at 370p a share.
The forward PE looked then to be around 10 times and the yield over 4% - seemingly low for a brand with proven appeal over decades – but forecasts look to have been worked down.
The stock still rallied 21% to 170p despite an 11 April trading statement cautioning of 10% annual revenue growth slowing to 6% in the final quarter to 31 March, plus year-end cash plunging. I adjusted my stance to “hold” given a case to lock in short-term gains versus uncertain consumer prospects, but did not see a downgrade to “sell” as appropriate.
Shares then fell to a 116p low in early July despite the 1 June final results maintaining guidance for March 2024 annual revenue of mid to high single -igit growth at constant currency – plus an improvement in the EBITDA margin.
The company said: “In the medium term, we expect double-digit revenue growth and further margin expansion.”
Somewhere along the way, numbers still got downgraded. I would not fixate on this nor chase the latest spike related to Sparta. But the message from recent share buying signals long-term value, hence I again conclude: Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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