Accelerating sales and earnings trends
As I pointed out in my update last month, sales trends are now accelerating which not only underpins full year profit expectations for the financial year to end January 2014, but offers potential that Moss Bros could actually exceed analyst estimates. And that’s exactly what has happened. In the all-important Christmas trading period, underlying sales for the five weeks to 11 January 2014 soared 12.9 per cent on the same period last year which means that like-for-like sales for the 24 weeks of the second half to 11 January 2014 are up 7.3 per cent. In turn, the improved sales performance over Christmas and ongoing tight cost control means that profit expectations for the 2013/14 financial year will exceed market expectations by quite some margin. This news prompted analysts John Cummins at broking house WH Ireland to upgrade his full-year pre-tax profit estimate by 25 per cent to £4m and raise his EPS estimate from 2.3p to 2.9p for the 12 months to end January 2014.
Cash generation has been equally impressive and the board now expects the company to end the financial year with net cash of £28m, or £2m more than WH Ireland had been forecasting. That’s the equivalent of 28p a share. So given the company’s growing cash pile, and having reassessed the capital investment needs of the business, the board have decided to pursue an accelerated dividend policy and reduce the net cash position to a year end position of £15m over the medium term.
As a result Moss Bros intends to announce with its full year results for the year ended 25 January 2014 a final dividend of 4.7p per share, making a total dividend of 5p per share for the year. This compares with 0.9p per share for the year ended 26 January 2013. The board expects to increase the payout progressively thereafter. Mr Cummins at WH Ireland is pencilling in a dividend of 5.5p a share for the financial year to end January 2015. On this basis the current dividend yield is 5.5 per cent, rising to 6 per cent in the 2014/15 fiscal year. That is not only attractive, but with earnings ramping ahead more than analysts anticipated, there should be scope for these bumper payouts to be lifted even further if earnings continue to accelerate.
For instance, for the financial year to end January 2015, analysts are conservatively looking for a sales uplift from £111.7m to £117.8m to drive pre-tax profits up from £4m to £4.5m. On this basis, EPS would rise again to 3.3p. But with clear momentum behind the business there is scope for upgrades as the year progresses given the operational progress being made. That’s why a forward earnings multiple of 19 net of the cash pile (worth 28p a share) is still not too full a valuation for this type of business.
In my view, a better way of valuing Moss Bros is to look at its cash profits – around £9.6m a year – and compare this with the company’s enterprise value (market capitalisation less net funds on the balance sheet). Using this valuation metric the company is only rated on 6.4 times current year cash profits. That’s hardly an exacting valuation and also highlights the fact that the cash profits of the business are over £5m more than its pre-tax profits which reflects non-cash charges (depreciation mainly) deducted to arrive at the pre-tax line. It also illustrates the amount of cash that Moss Bros can reinvest in store refurbishments and other business initiatives in order to drive an earnings upgrade cycle.
New initiatives paying off
Following the launch of a new retail website a year ago, e-commerce sales have ramped up sharply and had almost trebled year on year in the first 45 weeks of the financial year. The segment now accounts for over 6 per cent of the company's sales, and with conversion rates around 50 per cent, this segment of the business is becoming an increasingly important sales channel. For instance, tablet sales already account for 8 per cent of internet sales, even though a mobile enabled site was only launched eight months ago.
Moss Bros is not just a UK growth story either as the management team, led by chief executive Brian Blick, have been exploiting web opportunities overseas by launching country specific, local currency websites to target international customers in a more focused way. Websites in Eire, Sweden and Denmark have gone live since the summer and early this year Moss Bros will launch one in Australia. The company is also using the web to maximise the margin it earns on clearance stock by targeting a wider customer group, maintaining lower stock levels, improving stock turn and reducing the amount of working capital tied up in stock.
Refurbishment programme gathers pace
The other key take for me in the trading update is that the store refit programme is clearly delivering significant sales uplifts which in turn is driving profits higher. Following the upgrade of four stores in the first half, a further nine have been refurbished in the second half as part of an ongoing programme, bringing the total number trading with the new format to 38 stores. This comprises 28 refitted stores and 10 new stores out of a total estate across 133 sites. Another 20 store refurbishments are planned for the financial year to end January 2015. These refits underpin around 50 per cent of the like-for-like sales growth expectations of analyst John Stevenson at brokerage Peel Hunt. That’s well worth bearing in mind given these store refits have a very positive impact on margins given the short payback period for the capital investment made.
Indeed, the return on sales generated from the new format stores are accelerating and delivering sales uplifts of more than 8 per cent in year one, and more than 4 per cent in year two, which means that the cost of the investment is being easily recouped within three years. It is also being entirely self funded through operating cashflow which also explains why Moss Bros’ board can easily afford to payout a part uncovered dividend and target a cash balance of half the current level.
Moreover, Moss Bros is now in an incredibly strong position with landlords when store leases expire. The average reduction on the rent bill negotiated by the company is around 17 per cent on stores in the past year, and the company has been playing hardball on the lease terms with break clauses inserted in these new leases at five or even two years.
These savings are not just significant in terms of Moss Bros' cost base, but are being redeployed to refurbish even more stores to create a virtuous circle. The savings are also freeing up capital to be recycled back to shareholders through higher dividends. Moreover, for a recovery situation in an earnings upgrade cycle, and one that broking house Peel Hunt believes has potential to generate annual revenues of £140m and operating profit margins of 8 to 10 per cent, implying operating profits of between £11.2m and £14m, it’s clear that the growth story has some way to run.
In the circumstances, I have no hesitation reiterating my previous buy recommendation and am raising my target price to 110p a share, in line with WH Ireland’s newly upgraded target this morning. If achieved the company would be rated on 8 times cash profits to enterprise vale, hardly a punchy valuation considering the potential for margin expansion as sales rise given the operational gearing of the business. My timeframe for this target to be achieved is three months to incorporate the company’s full-year results which are due to be released on 26 March. Trading buy.
