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Avoid Halfords' margin squeeze

The bicycle retailer is falling foul of squeezed margins and ongoing currency pressures amidst a leadership vacuum
July 19, 2017

Although the full-year numbers from bicycle retailer Halfords (HFD) were largely in line with the City's post-profit-warning expectations, we are growing increasingly concerned about an ongoing margin squeeze and its potential to create future disappointments. A fall in gross margin from 51.2 per cent to 48.6 per cent at the retail division (86 per cent of group revenue) especially highlights how susceptible the group has been to the prolonged devaluation of sterling against global currencies.

IC TIP: Sell at 334p
Tip style
Sell
Risk rating
High
Timescale
Short Term
Bull points
  • Manageable debt
  • Attractive dividend
Bear points
  • Contracting margins
  • Sterling pressure
  • Autocentres like-for-like stagnation
  • Management vacuum

And, while bulls argue sterling weakness could benefit Halfords by increasing the number of ‘staycations’, the logic of how this translates into better sales of bikes looks stretched in our view. Cracks are also starting to show in the group’s autocentres division – once hailed a growth engine for the company. And the group is still without strategic leadership following the surprise departure of recently installed chief executive Jill McDonald. Should consumer data continue to worsen, we see Halfords' shares – even at their current lowly valuation – as vulnerable.

The trajectory of margins is the major concern, with the high and fixed cost of rents, rising staff costs and higher business rates all exacerbating the impact of the decline in gross profits' at the operating profit level (see graph).

 

Margins decline

 

The retailer's robust first half may not prove as encouraging as it first appears. Halfords' sales tend to benefit from good weather, and a sunny spell early in the year coupled with the timing of Easter may have simply brought sales forward. Indeed, broker Peel Hunt thinks sales momentum could fade as the summer continues. The period also benefited from price increases in reaction to the weak pound, which actually has the potential to weigh on demand from squeezed consumers. Indeed, volume growth remains more modest and has largely stagnated across the industry for the past 10 years. Why Halfords should be the one to turn this trend around – particularly when household incomes are feeling the squeeze – isn’t clear.

As far as currency headwinds go, a longer-term challenge for Halfords involves forcing suppliers to offer it better terms, which could be a struggle. There are also mounting concerns about the autocentres division – once considered higher margin and a good buffer to the retail division. Bosses have poured a significant amount of investment into this part of the business, but real profit growth seems difficult to generate. Like-for-like growth is also flattening out, having managed just a 0.6 per cent rise at the time of full-year results, implying that new space is the only serious driver of the top line.

 

One shouldn't underestimate the change in management here either. Jill McDonald, who was only installed as chief executive in 2015, has left for high-street stalwart Marks and Spencer (MKS). That leaves any tangible strategic overhaul on hold for now, although the arrival of an inspiring leader could help the shares to re-rate eventually.

HALFORDS (HFD)   
ORD PRICE:334pMARKET VALUE:£665m
TOUCH:333.8-334.2p12-MONTH HIGH/LOW:381p304p
FWD DIVIDEND YIELD:5.5%FWD PE RATIO:10
NET ASSET VALUE:205p*NET DEBT:21%
Year to 31 MarTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)**
20151.0181.132.316.5
20161.0281.533.217.0
20171.1075.430.217.5
2018*1.1674.130.118.0
2019*1.2178.032.018.5
% change+5+5+6+3
Normal market size:3,000   
Matched bargain trading    
Beta:0.56   
*Includes intangible assets of £394m, or 198p a share
**Numis forecasts, adjusted PTP and EPS figures, excludes 10p special dividend in 2017