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N Brown issues double profit warning

Tightening regulation is impacting the group's sale-on-credit model
N Brown issues double profit warning

Shares in N Brown (BWNG) plunged by more than a quarter following the release of its Christmas trading update, when the clothing retailer warned adjusted pre-tax profits would be in the £70m-£72m range for the full year to March 2020 versus previous consensus expectations of £83m. What’s more, management said the “reduced scope for bad debt provision improvements” combined with regulatory changes to credit limits and affordability meant 2021 profits would stay at a similar level. Prior to the update, Peel Hunt was forecasting profits of £86.7m for 2021.

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Financial services had been a source of growth in recent times, tempering the sales decline suffered by the product (read: clothes not sold on credit) division. We highlighted some concerns about the group’s loan book in our August sell tip - notably that impairments were rising as a percentage of year-end customer loans. The group has been working to improve its lending practices, tightening control on decisions, adopting new guidance on affordability and seeking to help customers who are in persistent debt, but management said the changes fuelled a 4.6 per cent decline in financial services revenues. 

The retailer also blamed its struggles on the “highly promotional” retail environment. It is not the only group to voice such a refrain. Superdry (SDRY) also mentioned “unprecedented” levels of promotional activity when warning on profits earlier this month.

The group has been working to reduce its bad debt provision ratio, so far reducing it from 17.9 per cent when accounting treatment IFRS 9 came into effect at the beginning of 2018 to 11.9 per cent now. But tightening rules on affordability and credit limits - which came into effect in March and December last year, respectively - are expected to have a “significant influence on the size and shape” of the group’s debtor book, leaving management looking for a way to mitigate the impact of the new regulation.

A double profit warning is bad enough on its own, but the group’s guidance also worsened considerably across a range of measures. Gross margin targets for the product division fell from a -50 to -150 basis point (bps) range to -125-175bps, while for financial services it fell from a 0 to 100bps range to -50 to +50bps. Operating costs are now expected to come in two percentage points higher and net debt is expected to come in £20m higher at £490m-£500m.