I’m sitting at my desk feeling sore after finishing another BJJ class and doing some cardio, and I’m staring at four medals (three silver and one gold) that I won competing in three tournaments in three consecutive weekends. At this time I realise it’s been over six weeks since I wrote an article for this blog, and there have been some very interesting developments since (as the title suggests)…
Looking for another company to invest in around early November and put more of my money to work (I only had 50% of my ISA invested), I used the FT screener yet again and put in the following criteria:
- Country: United Kingdom (since I would prefer to avoid currency risk);
- Market Capitalisation: above £5m;
- Dividend Yield: above 5%;
- Price to Cashflow Ratio: below 5;
- Total Debt to Capital: less than 25%;
- 10 Year EPS Growth Rate: above 10%.
The above returned one, and only one, company: Dixons Carphone.
DC is an electrical and telecommunications retailer and services company that resulted from the all-share merger of Dixons and Carphone Warehouse in 2014. It operates through four segments: UK & Ireland, Nordics, Southern Europe, and Connected World Services (CWS). Its main brands are Carphone Warehouse, CurrysPCWorld and Simplifydigital in the UK and Ireland (I pass these stores almost every day); Elkjop, ElkjopPhonehouse, Elgiganten, Elgiganten Phone House, Gigantti and Lefdal in the Nordic countries; Kotsovolos in Greece and Phone House in Spain. Its service brands include KNOWHOW in the UK, Ireland and the Nordics; and Geek Squad in the UK, Ireland and Spain. Its B2B services are provided by Connected World Services, CurrysPCWorld Business and Carphone Warehouse Business.
As of today, DC has a market cap of £1.95b, a dividend yield of 5.92%, a PCF ratio of 4.06, total debt to capital of 13.58% (very solid financial position), and a 10 year earnings per share growth of 21.63%. When I was first looking at DC it had a market cap of £1.78b, a dividend yield of 7.31% and a PCF ratio of 3.74 (for a cashflow yield of about 27% per year!). On the surface, it looked like an excellent company trading very cheaply.
The first thing I did was dive into the latest trading statement available at the beginning of November. It was published on August 24 and the share price dropped from 235p to 180p (about 23% down) that day, so I’m not expecting all around good news.
Q1 2017/2018 Trading Statement
- Only one page long!;
- Good performance in electricals in the UK & Ireland, Nordics and Greece;
- Core trading profitability expected to be in line with last year;
- Q1 revenue like-for-like change up 6%.
- Challenging conditions in the UK mobile phone market;
- Receivables revaluation expected to be negative this year;
- honeybee (software product) business model changes (from upfront sales to software-as-a-service) expected to lead to lower earnings this year;
- Profit before tax for 2017/2018 expected to be between £360m to £440m, taking into account the disposal of their Spanish business, down from £501m in 2016/2017 (a 12% to 28% fall).
Not too much information to go on, so the annual report (published July 19) was next.
2016/2017 Annual Report
- Group like-for-like revenue up 4% and total statutory revenue up 9% (page 4);
- Group headline profit before tax of £501m, up 10%, and total statutory profit before tax of £386m. Group headline basic EPS of 33.8p and statutory basic EPS of 25.6p, giving me a PE of 5.9 (share price of 150p at the time divided by 25.6p). I’ve read a few annual reports and this is the first time I’ve read ‘headline’ and ‘statutory’. ‘Headline’ profit is basically another way of saying ‘profit from continuing operations’ and I guess it’s used here to paint a better picture of the company. ‘Statutory’ profit is the total company profit, including results from discontinued operations. The £115m difference between headline and statutory profit before tax means that discontinued operations contributed a loss of £115m to group profit. Although I like the 10% increase in headline profit, I really dislike the use of this confusing language to try to hide the fact that real profits before tax were £386m, not £501m (page 4);
- Dividend of 11.25p (7.5% over then share price of 150p) (page 4);
- EPS increased every year from 10.9p in 2012/2013 to 33.8p in 2016/2017, growing at about 33% per year (page 4);
- Headline profit after tax of £389m, up from £347m (page 24);
- Statutory (real) profit after tax was £295m, giving me a PE of 6 (£1.78b/£295m=6.03), up from £161m. For a company of this caliber, with great brands, a nice dividend, and very low debt, this might just be too cheap to pass up (page 26);
- Due to the fall in DC’s share price since the Brexit vote, shares awarded to management under the previous long term incentive plan may not vest, which I consider very positive (less expense for the company) (page 63);
- The CEO’s base salary was £836,000 per year at 29 April 2017, which I consider very reasonable for a company with a market value around £2b (page 76);
- Depending on several performance metrics, such as EBIT, net debt, ROCE, customer net promoter score and employee engagement, management may receive a maximum annual bonus of 125% of base salary (page 77 and 78);
- The new long term incentive plan will vest depending on a 20% growth in EPS until the end of 2019/2020, and a relative total shareholder return performance condition measured against the companies ranked FTSE 51-150 (page 78);
- Profit after tax was £295m, up 83.2% from £161 in 2015/2016, mainly due to lower non-headline losses (£94m in 2017/2016, £186m in 2016/2015) (page 97);
- Diluted EPS of 25.2p, up 67% from 15.1p in 2015/2016 (page 97);
- Total comprehensive income was £288m, up 40.5% from £205m (page 98);
- Shareholder equity of £3,055m (after paying £115m in dividends), up 6.8% from £2,860m, although I do not know how reliable these figures are. Goodwill alone is higher than this (page 99);
- Long term loans of £381m, down 6.8% from £409m, and only 12.47% of shareholder equity. Very solid financial position, since the company could pay this off in less than one and a half years from profits after tax (£381m/£295m=1.29) (page 99);
- Net cashflow from operating activities of £364m, giving me a PCF ratio of 4.89 (£1.78b/£364m) for an operating cashflow yield of 20.4% (not bad at all), although it did drop 8% from £396m in 2015/2016 (page 101);
- The company has funding available of £1,050m from nine banks (page 140).
- 168 pages long;
- Free cashflow (FCF) of £160m, implying a PCF ratio of 11.13 (£1.78b/£160m=11.13) instead of the 3.74 ratio published by the FT screener. I suppose it’s using cashflow from operations to calculate it, instead of FCF (page 4);
- Net debt at £271m, flat year-on-year (page 4);
- Headline revenue was basically flat from 2012/2013 to 2015/2016, and increased 8.6% in 2016/2017 (page 4);
- FCF decreased from £202m in 2015/2016 to £160m in 2016/2017, down 21%, mainly due to higher restructuring costs (page 25);
- Pension contribution of £43m, up from £35m, to reduce its deficit. This means that the company has a defined benefit pension plan, and this is a serious liability for the company (page 26);
- Dixons Retail UK pension scheme deficit of £589m at 29 April 2017, up from £472m, mainly as a result of changes in financial assumptions (page 28);
- Very high goodwill and intangible assets figure of £3,664m, almost 50% of total assets, arising from the 2014 merger. This may cause some challenges when valuing the company, since I don’t know how reliable the methods used to determine this figure are. There is always a level of judgement here, and this value may not be correct, or severely impaired if the company faces adverse events (page 99);
- Inventory and trade receivables are also high at £2,237m, meaning the company has a high risk of inventory obsolescence or payment defaults (page 99);
- Acquisition of property, plant and equipment, and other intangibles (in other words: capital expenditures) was £242m, up 9.5% from £221m, and two thirds of cashflow from operations (page 101).
After reading all the above I realised that my first impression was mostly correct: this is a good company trading very cheaply. Although it has some weaknesses, such as a pension deficit, high goodwill and intangibles, and profit will be lower this year, it has many strong points that offset these, such as great brands, increasing profits for the last five years, strong earning power, a good dividend, low debt, and a management incentive plan highly geared towards shareholder returns.
Due to all the above, I decided to put Dixons Carphone on the ‘Yes’ tray.
At the time I was researching this company its share price was at around 150p, its lowest level in the last five years (with the highest level reaching around 500p at the end of December 2015).
After finding that I liked this company, and its reports, I quickly performed a back of the envelope calculation of a fair price to pay for a share, since time was of the essence. Revenue had been mostly flat for the last five years but earnings per share increased around 33% per year (implying a reduction in costs every year), so I decided that a PE of about 15 would be more than fair (less than half the earnings growth rate).
The average EPS for the last three years (after the merger) was about 20p. Multiplying this by 15 gives me a share price of 300p.
My Third Investment
Seeing this I immediately put in an order to buy 400 shares at 150p (since they were trading at a 50% discount to my estimated fair value), which was executed on November 13. The total investment, including commission and stamp duty, was £615.42 (about a quarter of the funds in my ISA at the time).
And meanwhile, Dixons Carphone published another trading statement on December 13.
H1 2017/2018 Trading Statement
- The first thing I noted is that, while it says that the UK mobile market remains challenging, DC is looking to reposition the mobile business to deliver a simpler, less capital intensive business;
- Interim dividend of 3.5p announced (meaning I will receive a dividend payment of £14 in January) and full year dividend of 11.25p confirmed (£45 in total for me);
- Headline profit before tax expected at £360m-£400m, in line with previous guidance;
- Group like-for-like revenue up 4%;
- Free cashflow of £169m, up 164% from £64m, due to reduced capex, improved stock management, and favourable timing on working capital;
- Net debt of £206m, down from £285m.
- Profit after tax of £46m for the first semester of 2017/2018, compared to £135m for H1 2016/2017, a 66% drop!
I guess the market liked the pros more than the major drop in profit, because since I invested at 150p per share, its price rose to 189.40p, a 26% rise! Because I had other costs, my profit on this investment so far is 23.1% (189.40p*400=£757.60; £757.60/£615.42-1=23.1%).
Not too shaby…