Join our community of smart investors

Buy into Howden's resilience

The trade-focused kitchen specialist is delivering against a tough backdrop and an end to the political uncertainty could further propel momentum
November 28, 2019

Howden Joinery (HWDN) manufactures and sells kitchen and joinery products to the trade, operating through a nationwide network of 708 depots, mainly in the UK. Addressing the ‘done for you’ market, the group’s core customers are small builders who install its products for everyone from individual homeowners through to housing trusts and developers. This model has established a loyal base of repeat customers, avoiding the costs associated with consumer-facing kitchen retailers, such as delivery and installation, expensive showrooms and big advertising campaigns. Even adjusting for lease liabilities, the group has seen its return on capital employed remain above 20 per cent since 2010.

IC TIP: Buy at 620p
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points

High return on capital employed

Improving depot economics

Loyal trade customers

Improving gross margins

Bear points

Cyclical

Director share sales

The trade-only focus means the group carries a high level of inventories to ensure stock availability while providing eight weeks’ credit so builders can be paid for their work before paying Howdens. Debtors were up £17m at the half-year stage and stock increased by £21.3m due to the introduction of new product ranges, more depots and an additional £12m of inventory for ‘no deal’ Brexit planning. Still, debtors and stock relative to revenue over the past 12 months remain relatively low at 13 per cent and 16 per cent respectively. Meanwhile, bad debts and write-offs were less than 1 per cent of sales in 2018.

Locating depots on industrial estates avoids the high overheads of high-street retail premises. The group believes there is “some way to go” before the UK market becomes saturated and has found greater density lifts sales. Howdens ramped up depot openings from 19 in 2017 to 33 last year. Opening 14 new depots in the first half, it aims to open 40 in 2019. A typical depot takes two years to break even and seven years to mature, giving a steady source of underlying earnings growth – and around a quarter of depots are yet to mature. A new more efficient depot format promises to reduce the space needed by 25 per cent. With the compact footprint offering scope to open smaller ‘infill’ depots in rural areas and big cities, the group has revised its UK depot target up from 800 to 850 locations.

Individual depot managers have autonomy to adjust to local conditions but, alongside cost inflation and adverse currency movements, a focus on volumes has seen moderate gross margin decline over the past two years. Lower prices implemented in the first quarter of 2018 contributed to a 1.6 percentage point gross margin reduction last year. But recent improvement has come from capitalising on customer loyalty and utilising pricing power. A price hike in January added £37m to gross profit; a 0.6 percentage point gross margin expansion to 61.9 per cent. This helped push operating profit up 12 per cent to £77.7m, outweighing higher investment in new depots, distribution capacity and upgrading digital platforms.

Howdens has cyclical vulnerability – kitchens are high-ticket items and spending can easily be deferred during an economic downturn. But the business has form in weathering challenging trading conditions. Although like-for-like sales dropped in 2008 and 2009 (by 3.1 per cent and 4.6 per cent respectively), profits held up well (excluding the end of its contract to supply retailer MFI). The group curtailed capital expenditure and depot openings until conditions improved and took £35m of stock out of business. It could employ similar tactics in another downturn and as a bigger business could take market share from weaker competitors.

In the current climate, it is benefiting from resilience amongst smaller players in the construction market. There were fears the Brexit deadline would disrupt the peak trading season in October. But a November trading update indicated the group remains on track to meet full-year expectations. Between mid-June and the beginning of November, revenue rose 2 per cent on a same depot basis. Although slower than the 4.8 per cent like-for-like growth reported in the four weeks following the first half, this is against a tough comparator and still a creditable performance considering the precarious market backdrop. Perhaps a sign of confidence, full year capital expenditure is expected to be between £70-80m, up from previous guidance of £60m.

HOWDEN JOINERY (HWDN)   
ORD PRICE:620pMARKET VALUE:£3.7bn 
TOUCH:620-620.2p12-MONTH HIGH:629pLOW:412p
FORWARD DIVIDEND YIELD:2.2%FORWARD PE RATIO:17 
NET ASSET VALUE:92.2pNET CASH:£217m 
Year to 29 DecTurnover (£bn)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
20161.3123729.410.7
20171.4023229.811.1
20181.5124231.911.6
2019*1.6225534.512.5
2020*1.7327237.313.5
% change+7+7+8+8
NMS:3,000    
BETA:0.78    
*JPMorgan Cazenove forecasts, adjusted PTP and EPS figures