Stockwatch: Will high-risk Patisserie Valerie shares be worth buying again?

This posh cakes chain has blown up in spectacular fashion, but companies analyst Edmond Jackson thinks this might happen when trading begins again this week.

Should enterprising investors consider buying into "financially rescued" AIM-listed Patisserie Holdings, owner of the Patisserie Valerie chain, upon return from suspension?  

Guidance as to when share dealing resumes comes across as reflecting the stress of all involved – after a week of revelations, the holding company's financial strengths had been over-stated and £20 million was required immediately to fend off administration.  

Dealings to (re?) commence this Thursday

There was ambiguity last Friday afternoon about how at 15.44 the "proposed placing" announcement declared in paragraph 5:

"At present, the directors do not expect that suspension to be lifted at least until (a) there is greater clarity disclosed around the financial position of the group and (b) they are satisfied that the company's financial reporting function is appropriate for a quoted company." 

These words followed a caution in paragraph 4 about how investigations into irregularities remain "at a very preliminary stage, subject to further comprehensive review in weeks and months to come...any further findings of financial irregularity could result in yet further material losses..." 

Then further down that release: "dealings in the placing shares will commence at the same time of admission, on or before 8am 19 October..."

Within two hours, a "result of placing" announcement at Friday's close brought this forward a day, though strictly this relates to "dealings in placement shares".  Unless those involved were suffering sleep deprivation, existing shareholders should not therefore assume they can sell from Thursday - as currently being reported - though quite how reasonable two-way trade will happen if they can't.  Speculators will note the possibility for a price squeeze up, if last Friday's announcements are reliably accurate.

Anyway, it's clear Patisserie Holdings will represent a high-risk bet for the foreseeable future.  In an odds-setting situation, institutions likely negotiated a deep discount to 50p (from 438p), not only due to past misrepresentation but in respect of risks of further skeletons.  

Yet their involvement, also the executive chairman's stumping up £20 million of cash, underlines belief in a viable business, just not one on a fanciful growth rating based on likely over-stated figures (see table).  If the situation can be stabilised, then upside from 50p should be possible.

Behavioural economics also point to long-term upside

Moreover, and with executive chairman Luke Johnson being tested, to draw a line with the past he looks likely to at least replace the chief executive; and if the successor is a capable/respected individual, this will help the stock recover.  Johnson being an inveterate deal-maker also means that in the very long run and as part of a recovery task, when the time is right he will negotiate a sale at some kind of premium for control, assuming the business performs.  

Speculators who respect that this stock is all about odds-setting - certainly no "investment" with a margin of safety - may therefore find it interesting to decide their trading more specifically when market price emerges.

Operating margins more in line with industry standard

The (now quite discredited) table shows progression from an operating margin around 16%, whereas in terms of comparable listed companies, Whitbread's accounts has Costa Coffee on 12.3% in its last financial year, and Greggs on 8.6%.  

Meanwhile, and via Companies House, the 2017 accounts for the privately-owned Paul retail outlets – a chain I would regard as Patisserie Valerie's key competitor, offering high-quality sandwiches and bakery items – show an operating margin of just 1.5% (adjusted positively for £1.1 million of exceptionals) up from 0.6%, on revenue advancing from £32.3 million to £35.4 million.  This, for a company established 19 years.  

Last Friday Patisserie Holdings indicated a likely outcome for its current year to end-September 2019 as £12 million EBITDA (operating profit before depreciation is added back) on £120 million revenue, i.e. a circa 10% margin on this basis, with a caveat how limited work has so far been undertaken to revise group financials.  You could say that this estimate therefore begs questions, although if Johnson seeks to rebuild credibility with investors then his view ought to be conservative – at least in terms of what he knows.

Source: Company REFS         Past performance is not a guide to future performance

Numbers/estimates for illustration, pre-warnings

Opaque justification for the history of high margins 

In past reports, Johnson has re-iterated the chief executive's point about a "vertically integrated and flexible business model" in support of margins well above industry averages.  

This was quite opaque, while period-end cash balances showed rising balances from £16.2 million in March 2017 to £21.5 million in September 2017 and £28.8 million in the last interim results to March 2018.  Mind they showed just £1,000 financial income on this extent of cash deposit and £44,000 for the previous financial year versus £36,000 finance expense despite allegedly no debt, all of which look odd.

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I've occasionally glanced at Patisserie Holdings and assumed that eventually it would lose its growth rating – see from the table, annual average historical price/earnings (PE) multiples well into the twenties – and based on forecasts prior to the debacle, dividing the PE by the growth rate gave a soaring PEG ratio from about 1.5 to 2.3, decidedly expensive versus buyers’ aim for sub 1.0.  

Looking more closely now at the accounts, there do seem a few flags, and it's been well-documented how the chief executive and finance director exercised options and sold shares, this year. Note also, the deputy chair who heads the audit committee cut his stake by 68% at 469p as soon as the company came out its closed period at end-June. 

Near-term perception to focus on EBITDA multiple

Post re-listing, chart behaviour may well dictate sentiment, the only sense of fundamentals being whether to trust the £12 million EBITDA guidance, then consider what multiple that deserves.  

By way of comparison with Greggs for example, its £82.2 million operating profit in 2017 compares with a market value around £1,140 million, and adding back £53.5 million depreciation/amortisation means EBITDA around £136 million i.e. a multiple of 8.4.  

Applying that to Patisserie Holdings' estimate implies a market cap just over £100 million, i.e. a 74p share price considering a total 135.3 million shares issued post-placing.  Quite reasonably, and time being of the essence, institutions insisted on a 30%-plus discount to possible fair value in respect of the risks, and the company accepted this as the price for near-term survival.

Yet the stock may not hold in a mid-70p area; much of a premium will encourage flippers, and a risk discount is appropriate.  Moreover, and with historical financial statements needing revision, Patisserie Valerie's true earning power has yet to be seen.  

Even if better than rival Paul on far lower margins, this private company represents potentially stiff competition as an "ambassador of French artisan foods" as it expands from London.  Not having to placate public shareholders means it can focus on a premium service.

Tactical share trading

Altogether it implies some premium to the placing price when dealings in Patisserie Holdings shares start on Thursday. The extent of uncertainties and scope for contrasting views mean volatility, which traders are likely to accentuate in a tight market.  

Medium-term upside is offered if chairman Johnson thoroughly revamps a board that has looked incestuous, though ultimately the crux is Patisserie's high prices proving they can withstand competition to meet management’s 2019 forecast.  Speculative Buy.

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