Interactive Investor

Stockwatch: A speculative AIM trade

17th November 2017 10:49

Edmond Jackson from interactive investor


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Is it time to buy into AIM-listed provider of quality interior furnishings Walker Greenbank, having plunged nearly 40%?

Barely a month ago, I compared it with Topps Tiles with a caution about the near term after a vague profit warning, but putting Walker on the watch list. While Topps had less downside given a higher yield and expectations already set for earnings to decline, my rationale was Walker becoming attractive in due course - especially to an American trade buyer.

A third of Walker's overseas revenues are nowadays derived in the US; it also has good representation across Europe and most other territories, to dovetail with another operation; and because sterling has devalued against the dollar.

Wider warning for UK discretionary spending

Five weeks ago, chairman Terry Stannard said: "Encouragingly, the Brands' order intake is growing ahead of last year and is on an improving trend in the run-up to our key autumn selling period."

I picked up on: "Subject to this momentum continuing, the board expects to meet its expectations for the full year" (to end-January 2018), albeit with profit guided to the lower end of expectations.

His narrative has changed to "order intake not being sustained" such that brand sales in the UK "have weakened significantly against expectations..." thus profits for the full year now expected to be 10% below recent guidance - implying £1.4 million based on recent consensus for £14.3 million pre-tax profit.

That's actually a big cut for such a short time-frame and considering 45% overseas sales; a warning how inflation/wage constraints may be curbing appetite for credit and discretionary spend.

Also, higher stamp duty has slowed transactions among higher-value properties likely to involve luxury refurbishment.

Potentially, next Tuesday's budget could offer change if the net effect of higher stamp duty has undermined tax revenues, although a Tory chancellor would meet with Labour accusations of helping the rich.

The UK Brand sales downturn is said not to affect Clarke & Clarke, a Lancashire-based fabric and wallpaper designer bought for over £40 million a year ago, otherwise it would cause consternation if slowing already. Wallpaper is enjoying some revival and the rationale was Clarke's strong growth boosting Walker's earnings while raising the US presence and offering scope for collaboration.

Canny presentation yet a longer-term opportunity

Various sops are employed. Like-for-like Brand sales are cited "ahead of the same period last year in international business", but this isn't quantified nor whether at constant currency.

So, it's a guess, what extent it may substitute UK shortfall. Management does cite licensing income up 15% like-for-like in line with expectations, but, looking back to segmental information in notes to the interim accounts, it represented only 3% of external revenues hence it's also easier to show grow from a low base.

Management is reported saying it intends to grow overseas sales to 60% over the next three to five years; but, in the meantime, what extent and duration of UK slowdown is going to sully the financial reports?

This warning feels more like wind whipping up before a possible storm, than a shower passing through.

How nimble is management to capitalise on exports while sterling is low? Given 30.6% of export revenues derive from Western Europe, what liability in Brexit negotiations and is management planning for? Mind this uncertainty in the exports story here and in other EU-driven stocks.

Stock has de-rated to exact a higher yield

It's often said the stockmarket is manic-depressive, thus an initial impression this 40% plunge to about 145p is overdone.

And it generally pays to exploit drops like this, buying into well-established companies facing short-term issues, and the de-rating does put Walker on about 10 times the current earnings per share (EPS) downgrade for its year-end January 2018. Some bid premium is also likely to exist.

But I've made clear to beware how market price can fall sharply in response to warnings, to exact a higher dividend yield as compensation for holding risks.

A circa 2% yield applied at 235p and the drop could - in yield terms - be regarded as merciful so far, given recent consensus for a 4.5p per share total dividend i.e. a still-modest 3.1% prospective yield.

Moreover, the table shows a good cash flow record, albeit capital expenditure taking about one half to two-thirds of this, i.e. genuine cover could be tested given further profits erosion and exports development.

Thus, the stock is in a delicate equilibrium between a fair earnings rating, long-term brand values and takeover potential - counter-balancing a rather scant yield.

Five weeks ago, I suggested the downside risk at Topps was less than Walker due to a 5.5% prospective yield backed by strong cash flow and 2x earnings cover.

That was strictly true in the sense Topps has only fallen 12.5% to 63p, but it shows the market is pricing in higher risks for stocks exposed to UK discretionary spending. Also, the real downturn may be yet to manifest.

Walker Greenbank - financial summary              
year ended 31 Jan           Consensus estimates
  2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 75.7 78.4 83.4 87.8 92.4    
IFRS3 pre-tax profit (£m) 4.9 5.5 6.3 7.3 7.0    
Normalised pre-tax profit (£m) 4.9 5.5 6.3 9.5 4.7 14.3 15.2
Operating margin (%) 6.7 7.2 7.8 11.0 5.3    
IFRS3 earnings/share (p) 6.9 8.1 8.3 9.5 8.1    
Normalised earnings/share (p) 7.0 8.2 8.2 12.9 4.6 16.0 16.9
Earnings per share growth (%) -0.1 16.5   57.4 -64.7 252 5.1
Price/earnings multiple (x)         31.5 9.0 8.6
Historic annual average P/E (x) 15.3 22.8 24.6 16.2 45.3    
Cash flow/share (p) 10.1 10.2 5.5 10.5 15.8    
Capex/share (p) 5.4 8.1 5.4 4.2 10.6    
Dividend per share (p) 1.2 1.5 1.9 2.4 3.0 4.5 5.4
Dividend yield (%)         2.0 3.1 3.7
Covered by earnings (x) 5.7 5.6 4.4 5.5 1.7 3.6 3.1
Net tangible assets per share (p) 29.7 33.2 33.1 46.8 28.3    
Source: Company REFS              

On balance it's better to wait

There's a behavioural finance aspect to bid speculation. Anyone potentially interested in buying Walker faces the current dilemma the board can probably muster a successful defence based on export potential, unless a knock-out price is offered.

But, if UK sales fester, then the narrative will be a soggy mix of "weak domestic versus robust overseas" requiring a higher dividend yield to retain investor support. At such a future point, a successful approach would be easier to table, offering value both to shareholders and the bidder.

In the meantime, the balance sheet profile is fair, albeit with modest cash of £1.7 million versus (near-term) debt of £6.9 million.

The table implies EPS has to make a big leap this year, even with near-term earnings forecasts set to be trimmed to about 14.5p, although I question REFS' citing 4.6p for last year, e.g. the company's definition of underlying EPS was 13.7p, which appears more consistent with its commercial trend. The Clarke & Clarke purchase will also bolster comparative progress for the current year.

Mind how this is a wake-up call for UK smaller company investing after years of strong gains - some funds have enjoyed gains in the region of 50% this year alone. When perception changes from earnings growth to yield, big drops are inevitable.

Not to turn overly fearful, but respect how this management bowling a googly shows just how edgy the UK situation is. Serious investors including any bidder are likely to await the next update in early February 2018. Speculative buy if there's further weakness before then.

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