Interactive Investor

Stockwatch: a new dawn for fallen fashion chain Ted Baker? 

25th February 2022 11:38

Edmond Jackson from interactive investor

Our companies analyst suggests this small cap stock’s derating reflected general small company malaise, and the business is ripe for recovery.

Last Wednesday, the ‘global lifestyle' retailer Ted Baker (LSE:TED) issued a bullish update for its fourth quarter to 29 January. This was quite a test-piece for the circa £175 million group, given it represents a key period for gifting.  

Like-for-like sales jumped 35%, and management cited accelerating sales growth with significant improvement in the full price mix”. This was despite Omicron disrupting year-end shopping and partying, which probably hurt demand for clothes and fragrances, for example. It meant the quarter began with encouraging” recovery but then saw a materialdecline.  

Aspects of the business model also changed, though it’s hard to quantify what the upshot was: the Far East operation moved to a licensing model and House of Fraser-related sales were strictly wholesale. 

A niggle is the overall flat online growth during the quarter. At least that was an improvement on the interim results, which showed a 14% decline to £64 million or 32% of the total.  

Yet the group operating margin enjoyed a material 3.5% increase, helped by an 8% rise in overall prices. It could be said that this shows how premium brands are relatively defensive where price rises can be passed on, although the period reported on does not fully reflect current rises in the cost of living and imminently in taxation.  

The latest UK consumer confidence figures have fallen to the lowest level in over a year, as expectations for the next 12 months deteriorate sharply amid widening price pressures. 

Quite to what extent Ted Baker may be affected seems a key issue. About 60% of its revenue is UK-derived, with the US at 30% and rest-of-world 10%.  

A possible inflection point for profits recovery 

While the first half-year remained significantly loss-making – the reported loss reducing to £25 million from £86 million, on revenue up 18% to £199 million – the company appears close to tipping into profit. 

Interim results affirmed a three-year transformation plan (since June 2020) on track, with the group in line with or ahead of plan for the current financial years operational key performance indicators”. Management has since cited only limited disruption from global supply chains and inflation. 

In contrast with the absence of any guidance at Novembers interims, management has now declared a £30 million free cash flow (FCF) target for the financial year to January 2023, helped by an operating margin rising towards 10%.  

The stock jumped 18% to 104p in response, although busy trading saw that halve by Wednesdays close; then amid Thursdays initial mark-down the stock was back to 88p, where it had closed on Tuesday.  

Yet steady demand has helped it up to 96p, as speculators sense a long-term inflection point for a stock that has fallen from £26.50 six years ago, and from over 220p last May.  

Dividends seem unlikely to resume for a while, although the table shows the 2017 to 2019 period with a decent free cash flow profile – in other words this company does have potential to restore payouts, and managements FCF target is not out of the ordinary.  

The last-published net assets per share were 73p, of which a modest 25% comprised intangibles; yet Ted Baker justifiably has brand value.  

The risk/reward profile therefore looks interesting around this level, with the stock down from around 165p since last September amid small capsgeneral malaise.   

Ted Baker - financial summary

Year end 30 January

2016

2017

2018

2019

2020

2021

Turnover (£ million)

456

531

592

640

631

352

Operating margin (%)

13.0

11.8

12.0

5.4

-9.5

-28.1

Operating profit (£m)

59.4

62.5

70.7

34.3

-60.0

-98.9

Net profit (£m)

44.2

46.6

52.7

24.5

-68.2

-86.4

Reported earnings/share (p)

80.8

85.1

96.3

44.7

-153

-56.2

Normalised earnings/share (p)

81.2

95.8

107

114

6.7

-26.0

Operating cashflow/share (p)

76.0

96.4

80.1

122

180

34.6

Capital expenditure/share (p)

164

80.0

66.8

55.3

47.2

18.7

Free cashflow/share (p)

-87.6

16.5

13.4

67.1

133

15.9

Dividend/share (p)

38.9

43.6

48.9

47.7

7.8

0.0

Covered by earnings (x)

2.1

2.0

2.0

0.9

-0.9

0.0

Return on capital (%)

25.7

23.4

26.0

12.4

-21.7

-37.8

Cash (£m)

13.3

21.4

16.7

14.7

52.9

66.7

Net Debt (£m)

84.6

95.2

112

124

295

73.7

Net assets per share (p)

320

388

410

417

257.0

82.4

Source: historic Company REFS and company accounts

Mind the dilution effect of a June 2020 capital-raising 

In a 2021 year-end review I cited Ted Baker as one to watch this year, given the potential for its transformation programme to start bearing fruit. 

Unlike retail financial disasters such as Edinburgh Woollen Mill and the previously listed Bon Marche, Ted Baker has a quality reputation for management to capitalise on. 

A £105 million capital-raising at 75p a share does however mean shares in issue jumped 236% to near 185 million – making history of earnings per share (EPS) levels near 100p.  

On the basis that annual revenue can recover to over £500 million, an 8% operating margin implies circa £40 million operating profit. If £30 million free cash flow (FCF) is indeed achieved, that would equate to 16p a share and a very low, sub-6x multiple.  

Profit can vary from cash flow, but taking a conservative view, a scenario of £20 million net profit implies a forward price/earnings (PE) multiple in the mid-teens, while £10 million profit equates to a PE in the high teens. 

I am no judge of fashion, but the recent uplift in group sales must say something about Ted Bakers current marketing pitch. Unless spending on luxury goods is hit, there is a fair chance of management achieving its financial targets.   

The chief risk now seems less to do with its execution ability than with a consumer recession affecting discretionary goods; however, luxury has been pretty resistant in past downturns. 

Decline in cash means much depends on move to profit 

While management exudes confidence that this will happen, there really is no room for setbacks.  The 14 August interim balance sheet showed net cash down 74% to £13 million, although £15 million bank debt implied £28 million cash actually in the bank.  

The latest update cites £3 million net cash at the 30 January year-end in line with guidance”, and for liquidity the company can also resort to an £80 million bank facility. Presumably the bank is satisfied with managements FCF projection. 

Costs do now look to be under control, and at this stage it has helped that the CEO from March 2020 was previously CFO from November 2019. During the January 2021 financial year, she took out £31 million in payroll costs and £8 million in rent costs.  

Be aware of £42 million near-term and £95 million longer-term lease liabilities: an interim net interest charge of over £2 million could still imply over £4 million annually, despite rent cuts. While leases are not unusual for a retailer, the element is high relative to £137 million of net assets.  

The latest update cites further progress on increasing the variable nature of rents and reducing length”. We will have to wait to see what the net upshot is.   

No genuine share buying amid recent downtrend 

Despite this being what looks like a rather compelling speculative buy” case, no directors or senior management were motivated to accumulate equity before the closed period.  

Toscafund Asset Management – an enterprising investor – raised its stake modestly to over 26% last June when the price was around 150p, though it has not added further amid a steady de-rating. It cannot reach 30% without triggering a takeover. 

But I suspect this stock recently got caught up in a general de-rating of small caps, so would not read the lack of interest as a negative.  

Two years ago, the disclosed short position (over 0.5%) was 3.5% of Ted Bakers issued share capital; this declined to nothing (over 0.5%) a year ago, as if short sellers had decided the fundamentals did not imply further downside risk.      

With various UK small caps currently subject to takeover, this could be a medium-term possibility – if managements recovery plan starts to show vigour, while the stock is low in long-term context. Ted Baker may be a modest brand by revenue, but it is a global one. 

So long as you appreciate speculation is still involved: Buy.  

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

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