Interactive Investor

Stockwatch: long-term value despite economic headwinds

Our companies analyst believes this luxury brands group is attractively priced – and could be a takeover target in due course.

A pertinent example of the way the market currently fails to recognise performance among consumer discretionary and cyclical stocks is the £118 million luxury interior furnishings group Sanderson Design (LSE:SDG)

At 166p, it has barely moved in response to last Thursdays prelims to 31 January 2022 showing that after-tax profit nearly doubled close to £8 million on revenue up 20% to £112 million.  

That, however, has looked short of recent consensus for £9.5 million, which puts a question mark over the £10 million targeted for January 2023 and £10.5 million for 2024. Downturns typically disrupt the pleasant assumption of progress. 

Moreover, even though management cites trading in the first three months of its current year being in line with our expectations”, the cost-of-living increases and a possible cooling of the housing market have yet to take effect. 

Earnings per share (EPS) measures vary, but if you accept normalising for share incentives and a pension charge, then 13.8p in respect of this latest year represents a price/earnings (PE) ratio of 12x – otherwise, 15x on a reported basis. 

A total 3.5p dividend per share marks a dividend restoration after cuts during Covid, but with around 4p forecast in respect of the current year, a prospective yield of 2.4% is not exactly a prop. 

The stock is therefore in something of a no-mans land, waiting to see what happens with consumer discretionary spending. 

Yet Sanderson looks an intrinsically stronger business than £270 million Ted Baker (LSE:TED), where multiple bid approaches for this quite similar luxury consumer brands” company may result in an offer. 

It’s an established pattern that small caps – especially with respected brands – fall out of favour and are subsequently approached by industry buyers. Sandersons progress in the US in particular, ought to be on the radar of international groups. 

Disruption to sales in 2009 quite modest 

I have looked back to the last recession, which does lend some reassurance. The company was in those days called Walker Greenbank plc. Its interim results to 31 July 2009 showed a 12% like-for-like sales decline with its premium brand Zoffany (which continues) affected by customers trading down; while the mid-market brands Harlequin, Sanderson and Morris & Co performed relatively well. Net profit slid from £936,000 to £422,000. 

Yet in the April 2010 prelims, management cited gradually improving revenue which edged up nearly 2% like-for-like in the second half-year. 

That was a period when the housing market took a blow as mortgage lenders retrenched to sort out bad debts: the average UK house price fell to £150,000 after a £184,000 high in late 2007.  

Wealth differentials look to have exacerbated since then, so possibly there are more people able to buy quality furnishings and less affected by the wider economy – unless they have whopping mortgages. 

It is tricky, however, to assess how Sandersons brand portfolio pans out for luxury” versus mid-market” items nowadays. The financial results do not ascribe such a breakdown within brand sales, which comprised 75% of group sales last year, the rest being licensing (other companies paying a fee use the designs) and manufacture.  

Sanderson is also stronger nowadays since Lisa Montague, a highly experienced international luxury goods executive, revitalised products and operations as chief executive from 2019.  

Last years operating margin recovered from 5.4% to 9.2%, although that was when higher costs were successfully passed on to customers. It is not clear quite how possible that will be if demand softens.  

Covid may have induced a rarefied atmosphere for trading 

Management cites the receding impact of Covid”, which is fair enough in terms of lessening disruption. Yet I believe furnishings have also enjoyed boosts during Covid: affluent people sat at home during lockdowns, accumulating cash and deciding to improve their interiors. Stamp duty relief also accelerated housing sales, with buyers then wanting to refurbish according to their own taste.  

All such was chiefly why in August 2020 I made a buy” case for Sanderson at 53p. 

I think the stock market is reasonable to price in the risk of some adjusting back in revenue and margin. If EPS of around 12p is achieved this year instead of the hoped-for 14p, the implied PE of around 14x could be deemed fair – especially for a less-liquid small-cap stock. 

Stock has retreated from 234p mid last September 

In medium-term chart context, a retreat has also looked justified. 

By early 2021 the stock had regained its pre-Covid high around 90p and the bull-run continued, helped by positive trading updates. 

Many smaller and potentially cyclical stocks have trended lower since last September. Sanderson hit 130p in early March with the Ukraine crisis, then recovered to around 150p, where it bumped along until pre-results speculation and release of the results themselves saw the price stabilise around 166p. 

Last October around 200p, I downgraded to hold”, concerned that chasing the price over a forward PE seemingly near 17x involved the risk of a growth multiple at a time when housing could prove cyclical and the exceptional boost from lockdown spending might abate. 

All such context makes the current price understandable. Yet this level ought to enjoy support, given a strong balance sheet where Sandersons end-2021 net asset value was 112p a share – 34% of which comprised intangibles, though that is fair when there are strong brands. 

Arguably, the approaches for Ted Baker are in pursuit of the brands, whereas an industry buyer would take out costs by integrating operations with its own. 

There is no debt beyond £3.9 million of lease liabilities and £19.1 million of cash. 

Sanderson Group - financial summary
Year ended 30 Sep

  2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 13.4 13.8 16.4 19.2 21.3 21.7 32.1
IFRS3 pre-tax profit (£m) 1.5 1.9 1.9 2.0 2.8 2.7 3.2
Normalised pre-tax profit (£m) 1.7 2.0 2.2 2.4 3.0 3.8 5.2
Operating margin (%) 17.8 14.3 13.5 12.0 14.1 13.4 11.2
IFRS3 earnings/share (p) 2.8 3.9 3.1 3.4 4.4 5.2 5.2
Normalised earnings/share (p) 3.5 4.4 4.6 5.1 5.5 6.4 7.9
Cash flow/share (p) 2.0 2.5 4.5 4.5 6.6 9.9 8.8
Capex/share (p) 0.9 0.7 1.5 2.1 2.0 2.3 3.7
Dividends per share (p) 1.2 1.5 1.8 2.1 2.4 2.7 3.0
Covered by earnings (x) 2.9 2.9 2.6 2.4 2.3 2.4 2.6
Net tangible assets per share (p) -5.5 -5.2 -5.0 -7.4 -10.2 -4.5 -14.7

Source: historic company REFS and company accounts

Guarded outlook on prospects  

Management says February to March trading has been in line with expectations, with continued demand for manufacturing and strong sales for both key brands and licensing. Yet it is reserved on guidance: As we carefully navigate another potentially challenging year, the board remains confident in its strategy and the results that are being delivered.” 

This does not really add anything. Directors should be confident in their strategy and progress otherwise they are not up to the job. Most likely, they currently do not want to say much as it could make a rod for their backs. 

Thinking laterally: a less-liquid stock on what appears to be fair pricing” prompts me to look at housebuilding stocks that have had an even tougher time lately: priced for 8% plus yields, despite robust trading statements and strong debt-free balance sheets. Inflation and higher mortgage costs are set to impact affordability, but perhaps not so badly as the stock market reckons. 

Sanderson does appear to offer long-term value; the question is a matter of timing and opportunity cost – i.e. what else could you be investing in?  

Case for a small starter position  

I think it harsh to conclude on avoiding this stock, where the products have international marketing appeal. The UK accounted for 52% of brand sales last year, so Sanderson should not be over-exposed to possible stagflation here. 

North America enjoyed 42% sales growth at constant currency, to constitute 20% of total brand sales. Latest April figures for US consumer sentiment show the first rebound in three months, as Americansoutlook on the economy and their own finances has improved.  

The logical conclusion with fresh money is to take an initial position mindful of the risks, but bearing in mind also how an industry view would ascribe a significantly higher valuation for control of the company. Buy. 

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

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