Interactive Investor

Stockwatch: more benefits here as DIY boom has mileage

18th June 2021 11:52

Edmond Jackson from interactive investor

This share has been a great tip for our stock picker who hopes for a more aggressive dividend policy after better-than-expected results.  

When discussing home improvement stocks a week ago, I suggested that at 279p, furniture retailer ScS Group (LSE:SCS) justified retaining – and active traders might want to consider it as a ‘buy’. 

Having originally drawn attention at 216p in November 2019 – yielding 8% on an historic price/earnings (PE) valuation below 8 times – the interim results to 23 January had cited nearly £20 million operating profit on revenue up 14% to £174 million, with £24 million cash generated.  

Meeting pent-up demand with respected service 

A high yield/low PE does not necessarily mean a sucker stock. ScS is currently 320p after Wednesday’s “very strong current trading” update for 46 weeks’ trading to 12 June, published ahead of the company’s 25 July year-end. Not only will annual results be ahead of expectations, next year’s outlook is substantially better than market forecasts. Cash continues to soar, over £101 million at bank as of mid-June, relative to a £116 million market cap. 

Median performance is still a bit of a guess due to store closures disrupting comparisons. The 12-month period from 26 July to 12 June saw a 10.6% like-for-like advance in orders versus 2020, but against the same period in 2019 it was down 9.5%. For the three months from 4 April to 12 June 2021 they were up 79% on 2019. However, this reflects pent-up demand after stores opened last April. 

ScS is a sofas specialist also offering carpets and flooring. It scores a 4.7 out of 5 “Excellent” rating on Trustpilot, although reviews tend to reflect the sales/delivery experience than long-term satisfaction with product.  

While ScS does not disclose its online sales as does DFS Furniture (LSE:DFS), items such as sofas and floor coverings would appear best seen in-store – unless you are some distance away from ScS’s 101 stores across the UK.  

A positive indicator on the UK economy? 

A bullish outlook implies consumer spending on home re-fits and related durables has traction. That is bullish for other smaller companies such as Sanderson Design Group (LSE:SDG)

Yet it continues to reflect spending substituted from services while Covid restrictions continue, also savings accumulated and time at home prompting a re-think about interiors. 

It is hard to quantify the effect of furlough payments, but there seems inequality between those the scheme has not reached and others who have engaged casual work while being furloughed. This may have boosted disposable income for some.

Call me cautious, but home improvement spending looks as if it must temper once spending rebalances to services. Will inflation become sufficiently ingrained to check disposable income? Whatever marginal effect from the furlough scheme, it is going to expire and unemployment may rise.  

It is good that people are spending whether on interiors or £7 a pint of beer from pubs trying to recoup losses. But I would characterise such behaviour as possibly lasting six months, after which “who knows?” 

What is ScS’s appropriate valuation benchmark? 

Versus this uncertainty, ScS’s underlying valuation is anyway not stretched despite its chart at a record high since flotation at 175p a share in January 2015, and 2019 levels up to 250p. 

At 320p, the forward PE reduces from an already cautious 12x (based on earnings per share (EPS) previously projected at around 27p) to near a single-figure multiple if 2022 generates consistently vigorous revenues. ScS has only 38 million shares in issue making EPS sensitive to profit change. 

Most likely the stock has failed to achieve anything near a growth rating because spending on sofas is easily deferred. In recent years, Brexit uncertainties have weighed on consumer confidence and then Covid struck – hence ScS has yet to show how it can perform. 

I pencil in EPS of over 30p for the coming financial year, although it’s unclear whether consolidation then follows. Yet the abnormally strong cash reserves mean PE considerations are hardly the main issue for value.  

Dividend returns could be substantially greater 

A tentative 3p interim dividend will be paid to holders on the register as of 9 July. This appears very cautious given the board’s conviction about strong trading, also given a full restoration of 16.7p a share distributed in respect of the July 2018/2019 years would cost just £6.3 million relative to £101 million cash at bank. Were ScS to pay this, its yield would be a material 5.3%. 

Such is the extent of cash reserves, the ScS board needs to explain how it intends to deploy them: towards a special dividend perhaps, acquisitions, and/or cutting trade payables (among current liabilities) from £71 million? There is no debt to retire and the interim cash flow statement showed under £3 million investment. 

A US company bigger than this would be target for activist hedge funds to buy in and lobby for capital distribution. 

ScS’s £101 million belongs to owners; it cannot simply sit there and continue to augment. Management might prefer to apply it for acquisitions which also justify bigger salaries and potential rewards from share options, if EPS can be boosted this way. A board of directors has to ensure a fair balance in pursuit of shareholder value: potentially there is a double-whammy win, enhancing EPS and distributions to holders.  

ScS Group - financial summary
Year end 25 July

  2014 2015 2016 2017 2018 2019 2020
Turnover (£ million) 244 278 317 333 313 317 255
Operating margin (%) 2.7 1.0 3.5 3.6 4.4 4.4 0.3
Operating profit (£m) 6.6 2.8 11.0 12.0 13.7 13.9 0.7
Net profit (£m) 5.9 -2.2 8.7 9.4 10.7 11.4 -2.2
IFRS3 earnings/share (p) 14.8 -5.6 21.3 22.9 26.9 27.4 -5.8
Normalised earnings/share (p) 14.8 0.4 21.3 22.9 26.9 28.1 -12.2
Operating cashflow/share (p) 34.6 20.5 26.7 70.0 43.7 51.2 150
Capital expenditure/share (p) 7.7 10.4 8.3 12.7 7.0 13.5 10.0
Free cashflow/share (p) 26.8 10.1 18.5 57.4 36.6 37.7 140
Dividend/share (p)   14.0 14.5 14.7 16.2 16.7 0.0
Covered by earnings (x)   -0.4 1.5 1.6 1.7 1.6  
Net Debt (£m) 3.7 -15.4 -16.3 -33.6 -41.8 -51.8 54.1
Net assets per share (p) 10.6 67.0 74.0 83.2 93.2 107 67.1

Source: historic company REFS and company accounts

Net asset value compromised by leases and trade payables 

The 23 January balance sheet had £103 million lease liabilities which accounted for £1.9 million interest payments relative to £20 million operating profit. But these arrangements are unlikely to change, as if cash is needed to own shops. 

There was an imbalance by way of near-£71 million trade payables versus sub-£5 million trade receivables, as if yes, the £10 million interim decrease in trade payables shown in the cash flow statement, should continue. 

With negligible goodwill/intangibles, the net asset value was close to £40 million, or 104p a share – i.e. unlikely to act as much prop should trading soften within two years.   

New CEO from November 2020 is a potential plus 

It is a relevant factor for anyone pondering whether to take profits into this rise or chance a longer haul. Potentially, a fresh pair of hands and vision at the top are key ingredients for long-term value. 

Steve Carson has a decent track record as managing director of Holland & Barratt from March 2018, becoming CEO a year later. But he left in January 2020 with the company saying a simplified structure meant “his career ambitions can only now be fully realised outside of Holland & Barrett”. Who knows if there was friction, but they declared him “a very capable senior leader”. He then appeared to have a 10-month gap before joining ScS.  

Previously, he had been director of retail and customer operations at Argos. 

It is therefore hard to be sure as to his fitting in well, albeit certainly a chance he improves overall disciplines. 

Hold for possible benefits of the cash pile 

Although I anticipate stocks exposed to spending on goods will see profit-taking in due course, the prospect here is tempting – in particular, a special dividend or two, which would certify a return of value to shareholders before any speculative acquisitions. The ordinary dividend could also re-rate to over 20p, implying a 6.5%-plus yield. Hold.

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

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