A recovery to prices not seen for three months has given followers of this tip a handsome return, but what will analyst Edmond Jackson do now?
Does a 21% jump in the mid-cap shares of Dr. Martens (LSE:DOCS) – despite management guiding March 2023 profits lower - imply the market valuation for this cult boot-maker simply became too jaundiced?
Its share price rose over 10% from 140p on the day following an 11 April trading update, and has continued to edge up, now testing 170p.
In my last piece, I examined six examples of equities re-rating, as if April’s stock market was in a uniquely positive mood. Dr. Martens is a particularly curious one, with several larger buy orders only yesterday.
It does at least suggest disillusioned holders since the early 2021 flotation have sold out and that, irrespective of wider market sentiment, the “technical position” (of buyers versus sellers) has improved here.
Downward mean-reversion appears to have run its course
Last January, I made a “buy” case at 140p after a relentless fall from a 515p high soon after Dr. Martens was floated in early 2021 at 370p a share. That exemplified a euphoric mood of traders gambling from home during the lockdown era, coinciding with a peak in growth stock valuations linked to ultra-low interest rates. Both drivers turned, hence a long fall.
The situation had also been a lesson in wariness of flotations, especially where private equity sells down. Executives of Permira (originating from Schroder Ventures) made nearly £500 million and 22 Dr Martens staff some £350 million. It was a red flag to wait and see how the business actually performed as a public company.
The financial summary table shows performance possibly skewed on the upside in the March 2022 year-end, by cumulative lockdown spending. Peak earnings per share (EPS) over 18p implying a price/earnings (PE) ratio towards 30 times at the 515p peak. So the stock is much more interesting now at a price which implies around 9 times if such earning power truly reflects medium-term prospects.
Dr. Martens - financial summary
Year-end 31 Mar
|Turnover (£ million)||349||454||672||773||908|
|Operating margin (%)||11.5||15.0||21.2||14.6||25.2|
|Operating profit (£m)||40.2||68.0||143||113||229|
|Net profit (£m)||-5.7||17.2||74.8||35.7||181|
|EPS - reported (p)||-0.6||1.7||7.5||3.6||18.1|
|EPS - normalised (p)||-0.4||2.1||8.4||7.7||18.1|
|Operating cashflow/share (p)||4.6||5.6||12.1||16.0||18.4|
|Capital expenditure/share (p)||1.6||1.7||2.2||1.9||2.5|
|Free cashflow/share (p)||3.0||3.9||9.9||14.1||15.9|
|Dividends per share (p)||0.0||0.0||0.0||0.0||0.0|
|Covered by earnings (x)||0.0||0.0||0.0||0.0||3.3|
|Return on total capital (%)||10.3||17.6||27.1||22.5||32.6|
|Net debt (£m)||334||332||378||253||166|
|Net assets (£m)||-29.4||-8.4||70.5||151||328|
|Net assets per share (p)||-2.9||-0.8||7.1||15.1||32.8|
Source: prospectus and company accounts
Latest consensus is quite sullied: a 23% decline in March 2023 net profit to £140 million, then £129 million in 2024 – for EPS of 14p, easing below 13p, hence a forward PE around 13 times. This reflects both ongoing costs of a Los Angeles warehousing fiasco, but I think the key question is what are the prospects for discretionary spending?
Assuming a circa 5p dividend covered 2.5 times, the yield is not especially supportive at around 3%. The stock trades around five times book value. Earnings are hence the main focus.
Yet there are few companies enjoying operating margins over 20%, and also a long-term cult following of its brand since the 1960s. If the stock market does not value the business reasonably well, another attempt could be made for private ownership.
Is a trend of downgrading company financials over?
Interim results to 30 September showed the operating margin eased to 21% amid opening new stores, port strikes and staff shortages at a Netherlands distribution centre. Yet underlying revenue was up 18% or 11% at constant currencies.
Going forwards, there was a caution about slower consumer growth, yet price rises would be attempted and mid-teens revenue growth remained as guidance for the March 2024 year. I am wary of this “price rise” narrative, as each time I Google on Dr. Martens there appears a sale on various boots, unless it is some kind of rotating tease in an online shop window.
Lower US revenues were blamed on warm weather slowing consumer demand, albeit chiefly trouble a Los Angeles distribution centre that lost £25 million equivalent of wholesale revenue and where £11 million spent on a temporary warehouse.
A 16 January update in respect of the last quarter of 2022 downgraded full-year March 2023 EBITDA (close to operating profit) by £16-23 million to a £250-260 million range – depending on the pace at which the Los Angeles operation normalised.
But the 14 April update cited higher costs to resolve these issues, also softer wholesale revenue in the final quarter to end-March, hence a slight EBITDA downgrade to £245 million. At least shipments from LA were restored to normal.
Annual revenue growth was cited up 10%, albeit with the last quarter slowing to 6% like-for-like. But at constant currency, the revenue rise was 4% for the financial year with the fourth quarter flat – which adjusting for inflation implies slightly negative.
So I am quite surprised that the stock has re-rated over 20% in response, unless it just does move swiftly on occasions – attracting momentum traders. There is a macro scenario where the US could enter recession which tempers consumer confidence in most markets globally.
March year-end cash was also down from £228 million to £158 million. The annual cash flow statement should better explain beyond the warehousing fiasco. In fairness, the summary table shows a good progression in cash from below £100 million pre-Covid. Inventory was £258 million, a big jump on £123 million and £102 million in the last two years, which hopefully just reflects the LA issue rather than softening demand.
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Guidance for mid to high single-digit revenue growth, at constant currency, was re-iterated for the March 2024 year, although I would not assume anything about the second half of this year onwards (generally).
An additional cost in this financial year is repeating some £15 million associated with LA, given a temporary additional warehouse is being kept another year. It will, however, be partly offset by lower year-on-year container and handling costs.
I find this broadly suggests the shock disruption that hit sentiment, is moving into Dr. Martens’ past. What we have yet to learn – and price the equity for – is consumer spending in whatever recession.
The 30 September balance sheet had £439 million debt including leases, albeit only a modest £7.4 million interest charge.
Crux is what happens to global demand
Dr. Martens is a truly international business: its March 2022 year showing Europe, the Middle East and Africa (EMEA) slightly dominant at 44% of revenue, followed by the Americas at 42% and Asia-Pacific at 14%.
Despite China’s rise over decades, devaluing the adage about how “When America sneezes, the rest of the world catches a cold” I would still mind the risk of consumer confidence easing should the US economy slow.
The US Conference Board – which runs a widely respected probability model – predicts near 99% likelihood of a US recession in the next 12 months. It endorses a growing consensus that higher interest rates are steadily bearing down on economic activity.
Interestingly, from Dr. Martens’ March 2021 year, the Americas saw 33% revenue growth which eased to 29% in 2022, well ahead of EMEA and with Asia-Pacific in decline. I suspect that was partly benefited from “helicopter money handouts” during Covid lockdowns.
A bullish contrary argument, however, is macro change being less likely to affect a key portion of Dr. Martens’ customers: younger people living at home with parents, often into their thirties, who may prove uniquely resilient. This social factor probably helps explain 20% revenue growth in the six weeks to end-December at JD Sports Fashion (LSE:JD.).
In early dealings today, Dr. Martens appears to have settled at around 169p. It is a close call, reflecting my caution about medium-term consumer prospects rather than a specific downgrade, as I think broadly the stock offers good long-term value. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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