Travis Perkins (TPK) no longer wants to own Wickes and is spinning it off to its existing shareholders. Should they hang on to them and should new investors get on board?
Does spin off mean cast off?
Travis Perkins shareholders will receive one Wickes share for each share of Travis Perkins they currently own. The Wickes shares will start trading on the London Stock Exchange on Thursday 29 April at 8am.
Travis Perkins wants to focus on its trade-only business and is spinning off its Wickes home-improvement business. It says it is doing this to simplify the company, but the truth is that Wickes has not been a great business for Travis Perkins and its shareholders.
It paid just over £1bn for it in early 2005 when it was being sold by Focus Do-it-All and has never been able to make satisfactory profits from it. Despite growing the number of stores over its years of ownership, TP wrote off £246m of goodwill relating to Wickes in 2018 and still could not make a return on capital of more than 10 per cent from it.
Getting Wickes off its books will clean up Travis Perkins and allow it to focus on its core builders’ merchants business and the fast-growing Toolstation accessories and building supplies business where the returns and prospects are arguably better.
A cursory glance at Wickes can lead you to think that it is an unwanted cast-off, but the business could be interesting to investors at the right price.
Spin-offs can be good investment opportunities. This can be the case as the business being spun off may be seen as too small and unappealing for existing investors. If lots of them decide to cash in on the shares at the time of the spin-off then the value of the new shares can begin to look too cheap and offer a decent buying opportunity.
How it makes money
Wickes can trace its roots back to the US in the 1850s. The first UK stores appeared in the early 1970s. The company has been listed on the stock exchange previously, before being bought. Travis Perkins has owned it for the past 16 years.
Wickes’ stores are a common site in many UK towns and cities. There are currently 233 of them battling for a slice of the UK’s £25bn home repair, maintenance and improvement (RMI) market. In 2020, they generated revenues of £1.35bn. The average store size is 28,400 square feet.
The company’s business model is based around three distinct types of customer. These are trade customers such as small builders and tradespeople, do-it-yourself (DIY) property owners and a relatively new type of customer that wants someone else to design and complete their home-improvement project. These are called do-it-for-me, or DIFM for short.
Wickes operates in fiercely competitive markets. It is up against the likes of B&Q and Homebase in the DIY segment, as well as local independent stores plus Amazon and discount retailers. Its trade business competes with its own Travis Perkins-branded builders merchants and Toolstation as well as outlets such as Screwfix, Selco and Jewson. The DIFM business has few national competitors, but its kitchen design service would bring it into competition with companies such as Howden Joinery.
The company has been working hard in recent years to improve its competitive positioning and has had some success.
Its trade business accounts for around one-third of its annual revenues and sells items such as timber, plasterboard, sheet materials and quick-drying cement to small builders for projects such as house extensions, bathroom and kitchen renovations, flooring and tiling.
Wickes, tries to win and retain their custom by selling them convenience and good product availability at good prices. The business has seen significant investment in digital selling with 550,000 customers using its Trade Pro mobile app, which gives benefits such as 10 per cent discounts and personalised promotions. It does not offer credit to its trade customers.
DIY is arguably an area where Wickes has punched below its weight for too long. It sells core everyday products such as paint, hand tools, light power tools and landscaping supplies, but has not done as well as its competitors in other areas.
It has spent a lot of time and money revamping its store footprint by getting rid of larger stores and making its smaller stores more welcoming and easier for customers to get around. 142 of its stores are in a new format that has generated an uplift in sales per square foot from £170 in the old format to £227, which has been sustained.
Covid-19 has seen Wickes’ investment in in-store storage space pay off. Combined with handheld technology, the company’s ability to offer more click-and-collect slots has seen it win market share and improve the utilisation of its store assets.
Where Wickes can claim to offer something different is in its DIFM business. This is based in showrooms in its stores and is based on kitchen and bathroom projects. It employs more than 550 design consultants to help customers create what they want and has done this virtually over the internet in lockdowns. Customers are offered credit from a third-party provider to help finance the project. Wickes bears no credit risk if customers cannot repay their loans. It teams up with more than 2,300 external installers that work in customers' homes.
Wickes is essentially offering a hand-holding service here that can take the stress out of big home improvements. This is potentially a key area of growth, but also one that comes with a number of reputational and financial risks as Wickes is ultimately responsible for putting things right if its contracted installers do a bad job. Wickes sold 14,200 DIFM projects in 2020.
This is a seasonal business with demand peaking in the spring and summer months, especially around Easter and the May and August bank holidays. Kitchen and bathrooms tend to have a peak winter sale in January and February.
Bad weather at peak selling periods can see the business facing the risk of holding too much stock and having to discount the price of it heavily to get rid of it, which can blow a hole in its profits.
A low-margin and low-ROCE business
Wickes is not particularly profitable as evidenced by its low operating margins. This is a telltale sign of the price competition that it faces in its markets.
|Wickes: sales mix|
Its gross margins are just under 40 per cent and are determined by its sales mix. Its core product sales to its trade and DIY customers have higher gross margins than its DIFM sales, which employ larger numbers of staff for each sale made, according to the company.
|Wickes: Key financials|
Free cash flow
LFL Sales %
|Source: Prospectus/Investors' Chronicle|
Only three years’ financial information is given in the prospectus, while Travis Perkins bundled Wickes’ results with Toolstation and Tile Giant before 2018. This makes it difficult to look in detail at how the company performs in different economic climates. However, its fortunes are essentially tied to the strength of the UK economy and the housing market in particular. Investors should expect it to suffer in a severe recession and weak housing market.
What we can see is that the company has been good at generating revenue growth in the past couple of years. However, it did take something of a battering in 2018 when the new owner of Homebase adopted a very aggressive pricing strategy in an attempt to win market share. Wickes has successfully seen this off and recovered from it.
The lockdown last spring saw a huge upturn in demand for DIY materials as previously time-constrained homeowners and the lack of professional help saw a sales boom that has continued into 2021.
Unfortunately, profits were held back by Covid-19 costs and unproductive labour which reduced them to the tune of £16m.
The real telltale number from Wickes’ financials is its very modest return on capital employed (ROCE), which reflects how difficult it is to make good returns from the markets it operates in.
Wickes will begin life as a separately quoted company with no borrowings, but has arranged a credit line with banks. All of its 233 stores and warehouses are leased and there were outstanding liabilities of £790m at the end of 2020 with an annual rent bill of around £100m. Leases are signed on terms of five-15 years with break clauses every five years. The average unexpired lease term is 9.4 years.
Where’s the growth going to come from?
The UK home-improvement market has been a steady grower in the 2-3 per cent-a-year range for much of the past decade. It’s unlikely to accelerate from this rate, but there are good grounds for thinking that it can continue to grow.
The UK has an aging housing stock which increasingly requires work doing to it. The increase in DIY activity could be sustained and has received a boost from the 18-35 age group.
The trade and DIFM markets are also well-supported by time-constrained households and a continuing decline in DIY skills and capabilities. The challenge for Wickes is how it will maintain and increase its slice of the money being spent.
In DIY it is going to concentrate on increasing its share of markets where it is underweight in sales compared with its competitors. It will also continue with its store improvement and digital sales investment in areas such as click-and-collect. A DIY app is expected to launch this year.
Wickes is not a retail roll-out story. It is about getting more out of what it already has. It does have plans to open 10 new stores, but these will replace 10 stores that are being closed. Around 15-20 of its stores are too big for its business model and will be right-sized which should hopefully boost returns. Between five and seven stores are to be relocated and a further 35-40 are to be refitted. If the company is successful in generating sales uplifts from refits as it has been in the past then this should be a source of revenue and profit growth.
The Trade-Pro mobile app has been a big success and Wickes has ambitions to increase its users to 1m and to double revenues from the £225m that came from it in 2020.
DIFM seems to have lots of potential when life returns to normal and showrooms can reopen again. While kitchens and bathrooms will remain the core revenue stream, the service has been extended into tiling projects as well as home offices and doors and windows.
Current trading within the business is strong. The first quarter of 2021 has seen like-for-like sales increase by 19.7 per cent. DIY and trade demand has been especially strong, which has driven core sales up by 38.5 per cent on a like-for like (LFL) basis with digital sales and click-and-collect performing very well. This was offset by a 25 per cent LFL decline in DIFM sales.
With showrooms opening up on 12 April, DIFM should recover going forward and there should be some rebalancing in the revenue mix, which may change gross margins slightly. The key uncertainty is what happens to DIY sales volumes as the beneficial operating leverage on store costs could be lost if they fall off sharply as lockdowns end.
How much is Wickes worth?
The company is in a better position than it was a few years’ ago and has performed well over the past year. That said, it operates in markets that are unlikely to grow strongly and generate significant and sustainable profits growth over the long haul, in my opinion.
The weak ROCE and lack of growth investment suggests that Wickes is not going to be a company that offers investors a significant compounding wealth opportunity. It may be more successful in improving the returns of its existing assets.
The challenging economics it faces does not lend itself to a high business valuation in the form of a high multiple of profits. Near-term profits are difficult to predict, but if the £16m of extra costs incurred last year were to disappear then the company could get close to making £100m of operating profits in a more normal trading environment.
If I take away last year’s financing costs of £32.1m (mainly leases on store numbers that are not expected to grow) and apply a tax rate of 19 per cent, this gives post-tax profits of £54.9m or earnings per share of 21.8p. Kingfisher currently trades on a forecast PE of 13.7 times. A similar multiple for Wickes would give a share price of 298.7p and an implied market capitalisation of £753m.
This is a rough-and-ready estimate, but hopefully one that will give readers something to work with when the shares list next week. If professional investors rush to offload their Wickes shares then it is possible the shares could trade for much less than my calculation. This may provide a short-term trading opportunity.