Stockwatch: the future of Mothercare

Management is overcoming the various challenges in a long and complicated re-positioning, but can Mothercare transform itself as an international franchiser?

Following my recent points on AIM-listed Cake Box Holdings (LSE:CBOX), it is interesting to compare Mothercare's (LSE:MTC) ongoing efforts to achieve a similar “capital-light” business model, albeit focused on international instead of UK stores. 

It has been a complex restructuring, putting UK retail stores into administration last November, and, with the share price at 6.9p currently, a company value of around £24 million is below what I would normally consider covering.

But, with 169 million free float shares, liquidity should not be a problem. Mothercare is also still a fully-listed stock and, if a franchising business model can be made to work, then such a market value as a percentage of sales would be low.

Presently, that’s tricky to figure versus annual historic revenues of over £500 million until the re-honed business proves what it can do.

The old Mothercare did significantly lose its marketing nous, with a reputation for being expensive versus new rivals, especially online. It also has an interim chief executive due to move on, so much will depend also on the calibre of whoever takes over. 

So the situation is largely “wait and see,” but a franchising objective does hold promise for radically better margins and return on capital. Moreover, the market and most commentators have written off the stock. If the business can gain traction, it will make for a strong inflection point upwards in the stock. 

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

Mothercare has coped pretty well with Covid-19

On 5 November, management asserted “completion of transformation programme,” leaving it with “significant” revenues from an ongoing profitable, franchise operation with over 1,000 stores operating in over 40 territories.

They dangled the carrot of becoming cash generative and profitable in the current year to March 2021, and also eliminating bank debt. 

Such targets would appear compromised by Covid-19, albeit more by way of timing than whether the business is on course.

Yesterday, an update cited two-thirds of partners’ stores now open, and discussions continuing with Boots to finalise contractual terms for a UK franchise operation. The experience of putting Mothercare stores into administration has allegedly served the company well to cope with Covid-19.

Moreover, plans to recapitalise “with the minimum possible further dilution to shareholders” continue with “a number of prospective new debt providers”. This is in the context of £18 million total debt, expected to reduce once a further amount is paid out by the administrators of Mothercare UK. 

Since annual results were announced on 24 May last year - and I can’t find any specified reasons for delay - my gut sense is the auditors insisting on funding being in place to sign off the accounts as a going concern, especially given the last published balance sheet had cash down from £16.3 million at 30 March 2019 to zero on 12 October.

This was probably the reason the stock dropped 1.1p to 6.9p yesterday, given the operations narrative remained overall consistent.

To any frustrated holders, I would say it does look as if management is overcoming the various challenges in a long and complicated re-positioning. What’s tricky to judge from a middle-aged male perspective is how capable will New Mothercare’s marketing prove?

I have no sense for expectant and young mothers’ buying decisions, hence it would help to see a new CEO of proven track record in such an area. Yet some of the franchise partners’ initiatives abroad already look interesting and merit ongoing attention.

A tiresome two-year story of rescue plans

Events have dragged on and “discussions with new debt providers” flags high risk – at least until funding is confirmed. More positively, you’d think that with the Bank of England upping its monetary stimulus by £100 billion, lenders will be motivated to scour for any chance of a return on capital.

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Old Mothercare was lumbered with many under-performing stores on high rents and long leases, requiring time to address group overheads. In 2018, a £19 million cost-cutting drive reduced the number of UK stores from 137 to 79. Then, in March 2019, 200 head office jobs went.

The sale of a subsidiary for £13.5 million plus various properties were said to have cut net debt from £44.1 million to £6.9 million but debt figures have blipped around. 

Last November, £8.7 million was raised from existing investors: £3.2 million of new equity via a placing at 10p, plus £5.5 million convertible loan notes.

The story seven months ago was for a remaining £24 million debt being paid down by the UK administration process, but here we are at £18 million and the accounts delayed.

Looking at the six-year table with only modest profit in 2016 and 2017, it brings to mind the “zombie” concept where struggling indebted businesses are chiefly kept going by monetary stimulus measures since the 2008 crisis.

The raw economics of retail should involve “creative destruction” with new concepts slaying old. 
On such a reading, to back Mothercare is a mistake if its marketing has been surpassed. Yet that doesn’t appear what its international franchise partners reckon, or indeed Boots, so I’d be prepared to at least watch and wait.

A new approach to design and development

This was cited at last December’s interim results, albeit with international sales down 5.3% in constant currency, citing growth in core markets of India, Indonesia and Russia while trading challenges continued in the Middle East.

A lower price offering on around 400 lines was cited, initially being made available in India from January 2020. In context of 130 million births a year globally, with 30 million into households able to afford the Mothercare brand, it is only currently available in 3 out of the top 10 countries by wealth and birth rate.

There’s no presence in the US, Japan, Australia or Brazil or various major European economies. Potential at least then, for a new CEO who is a competent marketer, to leverage sales. I concede a large helping of “jam tomorrow” about this, and updates on 30 March and yesterday did not update on the Indian initiative.

Accountancy change means a big swing to negative net assets

The usual method for judging downside risk, say if marketing hopes aren’t borne out, is to examine the balance sheet. But the dilemma here is a property estate that looks accounted for, as of the last 12 October 2019 balance sheet date, which has presumably moved off following the administration process. Again, this makes things tricky to judge until prelims to end-March are published.

As of October 2019, a like-for-like £38.5 million net asset position had swung to a £62.2 million deficit, due to leases accounting creating £109.4 million liabilities.

It is explained in note 2 to the accounts, “Policies and Standards,” which has a section Adoption of new IFRSs requiring a right of use asset to be recognised and a lease liability for future lease payments.

So, a £48.7 million right of use entry under non-current assets and £109.4 million lease liabilities - somewhat frustrating in the sense what is a form of debt - did not previously appear.

Otherwise the balance sheet was respectable in parts: only £14.6 million intangibles and no goodwill; inventories and trade payables down significantly down, also the pension deficit to £11.2 million. And yet £16.3 million cash as of March 2019 was entirely gone.

Assurances needed on the balance sheet and marketing

The complexities mean investors are justified in so far avoiding Mothercare with fresh money. Accounts detail is required both on overall changes in the balance sheet and profit/loss dynamics, amid the transition to focus on franchising. An international marketing update is also due, and is needed to help judge how successful this could be. Certainly, potential exists, and a franchising model can transform margins, but let’s see more evidence. For those already in: Hold.

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