Interactive Investor

Stockwatch: have sellers of this FTSE 100 share got it wrong?

17th June 2022 10:47

Edmond Jackson from interactive investor

There’s currently a stand-off between directors and hedge funds at this established blue-chip company. Analyst Edmond Jackson reveals which side he’s on.

Who should you trust for judgement of stocks, as the going gets tough: dealings by independent directors, or hedge funds? 

While hedge funds continue to borrow and sell Kingfisher (LSE:KGF) shares - making it London’s third most-shorted stock at 7% of the issued share capital – two non-executive directors recently bought materially around 260p.  

The price drop continued and is currently around 240p, which is 34% down on last September, albeit around the middle of a 20-year sideways-volatile trend and well up on April 2020’s low of 144p. 

Recent consensus market opinion on Kingfisher expects a 26% fall in normalised earnings per share (EPS) to 29p for the current year to 31 January 2023 and is tipped to remain broadly flat in the January 2024 year.

Both sides of the trade have strong conviction 

After dealing restrictions ended with the 2021 annual results last 11 April, one independent director spent over half a million pounds buying 200,000 shares. More recently, on 7 June, the senior independent director spent over £26,000 doubling her holding to 20,000 shares. 

Meanwhile, the trend in short selling has continued sharply upwards from around 1.3% of Kingfisher’s equity last October – rising from 5.1% in early June to 7% currently. 

With retail stocks now in the eye of a storm whipped up by belated central bank responses to inflation, it looks as if the hedge funds have a keener sense of the macro context and market sentiment. 

On 10 June, Marshall Wace, a seasoned operator in short trades, edged its position up 0.08% to 1.52% of this £4.8 billion stock. 

Then on 13 June, two Citadel funds increased their shorts slightly to 0.51% and 1.03%, and on 14 June BlackRock edged up to 1.63%. 

On 13 and 15 June respectively, AKO Capital slightly trimmed its short to 1.46% and GLG Partners to 0.86%. 

Halfords has just shown the near-term risk  

Kingfisher has no established “growth” credentials, its appeal lies in a modest circa 8x price/earnings (PE) and a potential 5% yield covered over twice if you trust consensus for around £280 million net profit this financial year and next. The stock also trades at 0.7x net assets (as of 31 January) albeit 1.2x net tangible assets  

The directors are also likely attuned to the 23 May first-quarter trading update to 30 April citing “good momentum” both from the DIY and building trade channels. Quite for how long it lasts is unclear, but the hedge funds demonstrate doubt.  

Yesterday’s 28% drop in Halfords (LSE:HFD) shares below 143p, despite reporting a 20% annual revenue advance, was due to a near-term caution about inflation and declining consumer confidence.  

Mind how before its plunge from 198p, Halfords traded on an exact 6.0x PE according the consensus forecast, with a 4.5% yield covered well over 3x with market value just above 0.8x net assets.  

“We rest our case about so-called value”, hedge funds might retort, as such credentials prove no prop – at least in the short term. 

Yet Halfords’ net gearing is 99% compared with 23% for Kingfisher; hence the former has a riskier financial profile to cope with recession. Otherwise, both companies have sported strong records of free cash flow. 

If hedge funds are so clever then why was the reported short level zero in Halfords before its drop?  

Well, Marshall Wace only reduced from 0.59% to 0.49% of the issued share capital as of 8 June, where there is a 0.5% threshold for reporting. They were broadly on the mark. 

It affirms how some of the riskiest stocks are those appearing to offer “value” in the early stage of economic downturn.  

Much therefore depends how bad things get; and with headlines liable to batter consumer sentiment further, the near term does not look good. 

Yet the hedge funds will be alert to start buying back stock well before the market starts to consider recovery prospects in the January 2024. Prices are likely to bounce well before the numbers; the question is from what level?   

The case for long-term value in DIY retailers 

The two Kingfisher directors are respecting a long-term maxim about how you will not time a stock low precisely. 

While the media proclaims economic hell is about to break loose, Pantheon Macroeconomics for example does not consider a UK recession as likely. 

A long-term attractive context is still needed for the Kingfisher business, which you could say is offered by the ageing nature of UK housing. 

Kingfisher is substantially exposed to DIY fascia's such as B&Q and Screwfix, also TradePoint building supplies.  

On the one hand, the Covid lockdown boom in home improvement has ended and this is an easy area for consumers to rein back spending. 

But if housing transactions do cool with the mortgage market, it is possible home improvement chugs along as people look to smarten up and develop what they have – rather than engage transaction costs of moving also of refurbishment. I recall Howden Joinery (LSE:HWDN) doing surprisingly well in years post the 2008 crisis, amid demand for kitchens and bathrooms.  

Mind, City promoters of Wickes (LSE:WIX) pushed an “ageing UK housing stock” story last December, arguing the stock was worth 310p to 420p. Seven months later, it is 184p. Wickes is expected to see a similar magnitude drop in EPS as Kingfisher, consolidating around 27p which implies a 6.8x PE. A maintained 10.9p dividend implies a yield just below 6%. 

Wickes is arguably a riskier stock, however, given it only floated in April 2021. Its disposal by Travis Perkins is looking astute timing. 

Kingfisher - financial summary
Year-end 31 Jan

  2017 2018 2019 2020 2021 2022
Turnover (£ million) 11,225 11,655 11,685 11,513 12,343 13,183
Operating margin (%) 6.8 5.9 4.1 2.4 7.4 8.7
Operating profit (£m) 767 685 480 276 916 1,144
Net profit (£m) 610 485 193 8.0 592 843
EPS - reported (p) 27.0 22.0 9.0 0.4 27.9 39.8
EPS - normalised (p) 27.4 22.2 24.4 33.7 29.8 39.5
Operating cashflow/share (p) 34.5 13.3 51.9 42.4 77.9 55.7
Capital expenditure/share (p) 17.9 16.7 15.7 16.3 13.4 19.3
Free cashflow/share (p) 16.6 -3.4 36.2 26.1 64.5 36.4
Dividends per share (p) 10.4 10.8 10.8 3.3 8.3 12.4
Covered by earnings (x) 2.6 2.0 0.8 0.1 3.4 3.2
Return on total capital (%) 10.2 7.6 5.4 3.3 10.1 12.4
Cash (£m) 795 230 850 790 1,142 823
Net debt (£m) -597 2,692 2,537 2,474 1,382 1,569
Net assets (£m) 6,771 6,263 6,149 5,802 6,571 6,778
Net assets per share (p) 302 290 291 275 311 328

Source: historic company REFS and company accounts

Less than half Kingfisher’s revenue derives from UK 

Kingfisher is not so wholly-exposed to the UK economy, like I mentioned earlier this week regarding sub-contractor MITIE Group (LSE:MTO). Significantly why I could only muster a “hold” stance was 96% of revenue deriving from the UK.  

Kingfisher stretches across France, Poland, Iberia and Romania – such that the UK & Ireland represented just 49% of group revenue. Obviously, if a general slowdown takes hold, then European consumers will be affected. No one can avoid higher costs of energy and food, and interest rates are rising globally. 

This overseas income does however help offset risks with sterling if Brexit is compounding the problems we face.  

Embarking on another share buyback programme 

Notably perhaps, Halfords has not bought back any of its shares in recent years, yet the Kingfisher board implicitly sees value – another buyback programme is underway, barely a month after the last one completed.   

Until 27 July this year, up to £75 million worth may be purchased by Goldman Sachs as agent, in context of an overall commitment for £300 million to be spent.  

You might want to consider if that provides an aspect of comfort – say to buy a starter position, with a view to averaging in. 

While I find buybacks can affirm scepticism - management does not envisage worthwhile investment projects – i.e. growth credentials - I would not dismiss what could be a positive support. 

It also only needs a couple of hedge funds to start locking in gains on their shorts as part if prudent risk management, to see some recovery in Kingfisher shares. 

Be aware, a consumer recession probably means further downside in retail stocks; but if you can see through: Buy.   

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

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