Interactive Investor

Stockwatch: time to buy this contrarian small-cap on the cheap?

16th May 2023 11:47

by Edmond Jackson from interactive investor

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This well-known business has struggled in recent years, but analyst Edmond Jackson believes the share price now looks attractive and that it may have hit a floor.

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Does a surprisingly positive trading update from electrical and technology retailer Currys (LSE:CURY) imply downwards mean-reversion of its equity has run too far?  

Since listing in 2003, Currys has been a roller coaster, with highs of 420p in mid-2011 and 485p at end-2015. Currently at around 57p, the stock is only just off a 55p low in recent days, which has not been seen since 2003. 

Despite a consistent record of £10 billion annual revenue, a market value of £635 million makes it a small-cap. If forecasts are fair, net profit should rise 11% to £79 million in respect of the 29 April year-end. If it made £95 million in the year to April 2024, the price/earnings (PE) ratio would be just below 7 times. A circa 3p dividend is nearly three times covered for a yield over 5%. 

AO World (LSE:AO.) is a similar small cap “box-shifter” valued at £430 million, with its stock around 75p, albeit with annual revenues just over £1 billion and a record of losses only just breaking into profit. A £20 million profit anticipated for March 2024 gives a PE of 22 times and there is no dividend. 

Currys therefore starts to look a classic example of a well-established business with its stock out of favour near-term. Is long-term chart proves sentiment does ebb and flow, sometimes in its favour. “Be greedy when others are fearful.” 

Positive trading update raises April 2023 profit expectations 

The share price added 3% yesterday in response to pre-tax profit expectations raised from £104 million to £110-£120 million, chiefly assisted by better gross margins. Perhaps this signals supply chain costs normalising post-Covid, given Currys is essentially an importer/distributor. 

Full-year like-for-like sales eased 7% in line with consensus, although the true level is worse after inflation. UK and Ireland trading was still better than expected in the final two months of the financial year, although the Nordics remains challenging. 

Operating profit for the UK and Ireland has risen over 40% against £71 million in the April 2022 year. Nordics’ slowdown means the international side is expected to be “materially lower” despite another “robust” performance in Greece. Looking back to the last annual report, the UK and Ireland constituted 54% of revenue, the Nordics 40% and Greece the remaining 6%.  

While the Nordics is therefore a concern, new management is removing at least £25 million of annual costs albeit at an exceptional cost of £15-20 million – which will impact reported profit. 

There has also been a reduction in guidance on net debt, from a £100-150 million range, to “around £100 million”, helped by “a strong finish to the year”. This is encouraging although the update avoids any remark on the trading outlook. 

Implicitly, management is cautious though, given its initiative to have agreed with lenders to relax a key covenant on the revolving credit facility from 1.75 times to 1.5 times in respect of end-October 2023 to same 2024. You could say, with the stock rising overall in response to the update, this is priced in.  

A 10% reduction in year-end stock sounds as if it may have benefited profit. Possibly it hints at a softer trading outlook or may need to rise again ahead of Black Friday and Christmas. 

Currys - financial summary
Year-end 29 April

Turnover (£ million)10,24210,52510,43310,17010,33010,122
Operating profit (£m)436321-225-30.0136220
Net profit (£m)295166-320-16312.071.0
Operating margin (%)4.33.1-2.2-
Reported earnings/share (p)26.620.3-26.8-
Normalised earnings/share (p)31.726.021.310.417.115.7
Operational cashflow/share (p)31.426.924.750.470.736.4
Capital expenditure/share (p)
Free cashflow/share (p)10.510.810.433.960.525.1
Dividend per share (p)11.311.
Covered by earnings (x)2.41.8-4.0-
Return on total capital (%)9.47.0-5.5-
Cash (£m)14716862262814096.0
Net debt (£m)3333093081,6801,1921,253
Net assets (£m)3,0553,1962,6402,2802,3812,501
Net assets per share (p)265276228196204221

Source: historic company REFS and company accounts

Risk of heavy reliance on trade creditors  

Last October’s interim balance sheet had £2,856 million trade payables relative to £785 million trade receivables, as if suppliers are being used for working capital rather than Currys adding to its debt.  

It may also flatter profit, relative to maintaining a more normal balance of payables/receivables – where typically you might see payables up to 1.5 times, but I cannot cite another example of 3.6 times. By comparison, AO World’s ratio is near 1.8 times. 

It’s unclear quite how exposed this leaves Currys to any change in trade creditors’ policies, although you could say in a challenged environment, “they need the business” so may not.  

But I would definitely regard the true level of net debt as higher than the £100 million proclaimed; and mind there are also £1,237 financial leases (behind an adjusted £18 million interim net finance charge).  

A whopping £2,670 million goodwill/intangible assets mean negative net tangible assets of £823 million. 

A £251 million pension fund deficit is requiring £78 million a year of pension contributions – or 15% of operating cash flow in the March 2022 year – with around £50 million of benefits being paid out annually. Last October, the scheme had a value of £987 million. 

Mixed short positions within 2.5% of issued capital

Four hedge funds have targeted Currys for downside potential, and there could be more below the 0.5% disclosure threshold. 

Marshall Wace and GLG marginally trimmed their shorts to around the 0.5% level last April and March respectively. Marshall Wace I regard as “no fools” in the short game, hence it is possible to read their action as time to start closing – if you want to be optimistic. 

Franklin Templeton and JP Morgan Asset Management have, however, very marginally increased their shorts to around the 0.7% level last March and December respectively. 

Such a contrast in tactics reflects scope to take different views – even among critics of the stock – according to how consumer spending may evolve. 

A medium-term bet on the consumer environment  

It is indeed the simplest theory – taking an Occam’s Razor approachhow prospects hinge on discretionary spending. 

The pandemic boom in home interior improvements saw Currys’ stock rise from around 70p in April 2020 to over 140p, although revenue barely rose 2% in its year to April 2021. 

That period is gone and retailers are squaring with sticky inflation and higher mortgage costs limiting spending power. It appears consumers are less likely – so far – to compromise holidays and eating/drinking out, but are electrical and tech goods exposed? 

If the US and Apple Inc (NASDAQ:AAPL) are any guide as to what might happen next in the UK, Apple sales fell 5% in its quarter covering Christmas sales – the largest drop since 2016 - and last week were disclosed as 3% down in respect of the first quarter of calendar 2023.

So, on gut feel and this behemoth’s recent performance, yes there are reasons to be wary. 

But if a 3p dividend is realistic – 1.0p was paid in respect of the first-half-year – the stock should be fairly well supported around its current level. I hope this piece clarifies why “mean reversion” – even mid-way past highs over 400p - is unlikely. 

Competition is strong among white goods and electricals – also including for example, Argos, John Lewis and a host of online relative newbies such as Very. 

If the situation in the Nordics does improve for Currys, however, one that is merely “less worse than 2022” could help grind overall improvement. 

Chair bought 200,000 shares at 61p last October 

Director buying implies the chair believes the Curry shares offer long-term value, notwithstanding the challenge to guess consumer behaviour. Mind, it was also a maiden purchase after being appointed a year ago, hence part-motivated by “corporate governance good practice”. 

I think Currys is a marginal rather than a conviction “buy” case, and a recession would make it one to avoid. Yet the Bank of England has admitted it got that forecast wrong.

Contrarian investors might at least follow the situation more closely and consider a starter position with a view to averaging in. The caveat is that this ought not to be a focused position: Buy.

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

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