Warpaint London (LON:W7L) Reports Falling Growth, Shares Fall 40%

By | 29th October 2018

Cosmetics company Warpaint London (LON:W7L) today announced a reduction in growth and profits. If there is something the market hates, it is a newly-listed company disappointing. If there is something else, it would be a company trying to sneak something out. Given that the figures did not mention previous expectations, it doesn’t read like a warning. But the share price reaction was savage: a profit miss saw the shares fall by 40% at the open. As of midday, this fall was still going:

No doubt that at the moment we are going through a period of mistrust regarding newly listed firms. Were the projections ever reliable? The effect has been more pronounced for firms such as Warpaint, which already traded on a premium valuation.

Warpaint may have a larger footprint that one realises: they trade underneath their own main W7 brand but also produce white label cosmetics, which appear in high street retailers. Their reach is international, having their products in over 50 countries.

It is fair to say there are many defensive aspects to the share. Personal healthcare is a sector where spending is not likely to take too much of a hit even if times go bad. Straddling a premium/generic position offers an additional dimension of safety.

The Warning

We kick off with some good news:

As at 30 September 2018 Group sales to the USA were up 60% compared to the same period in 2017 (up 74% in US$ terms) and sales in the EU (excluding the UK) were up 13% year on year.  We are also pleased to have recently made our first domestic sales in China from our newly established Chinese trading subsidiary and to have made the first Group sales into Russia.

Then the bad news:

However, the UK market, as highlighted in our interim results, remains challenging.  The UK market, which accounted for 44% of Group sales in the first half of the year, has seen further softening recently, with retailers reducing stock levels and Christmas orders.  This reduction in previously anticipated UK sales will have an impact on Group performance for the full year that will not be completely offset by better than anticipated performance in our major overseas sales territories.

We come to the figures:

Based on current expectations the Company’s board anticipates that revenue for the year ending 31 December 2018 will be in the range of £48 million to £52 million.  Consequently, the Company’s board currently expects profit before tax for the year ending 31 December 2018 (excluding amortisation in connection with acquisitions and exceptional items, which total approximately £2.5 million) will be in the range of £8.5 million to £10 million.

The profit warning here is slight. The latest forecasts showed revenue at £55.2m and profit before tax to be £10.6m, so in the best case scenario this is a narrow miss. At the worst case however, it is a poor miss. The market seems to be pricing in the latter as more probable as the price continues to decline.

The Business

Warpaint has been growing rapidly since its flotation almost 2 years ago, having scaled up its operations. It retails into the lucrative 16-30 age segment using its own products (Brand W7) and also produces white-label products for retailers via an acquisition of Retra. It has also used monies generated from placing to purchase out its USA distributor, giving them a foothold into the large US market.

As you may imagine there is a decent mark-up in the cosmetics market. There are no expensive storefronts to pay for and good brands can command incredible premiums, if we use the comparison of other similar markets such as hand soap. The business also has huge seasonality, as many of its products are gifted as opposed to being purchased all year around.

Balance-sheet wise there is a lot to like. The business has been consistently profitable and is cash generative, and a large chunk of this is being paid out as dividends. Having chosen to finance their acquisition via the issue of shares rather than debt, there are only a small amount of liabilities on the balance sheet, and a positive cash balance. So despite the adverse news today it does not seem as the business is in any danger.

Comment

Despite the decent metrics on the business, the nature of the warning is worrying on a few levels. The first being whether credibility has now been lost by the board. Would an optimistic outlook in the next statement carry much weight if trading conditions could produce a reversal just a couple of months later?

The second is more fundamental. Just why has the UK market softened? The reasons are not clear but on a very basic level I would have envisaged demand for these products to be more or less the same as last year. Which, if we choose to believe that, we could say that market share has been taken by competitors.

This is perhaps a reasonable explanation. The company has been trying hard to expand its reach to reduce the dependence on the UK (which accounts for 44% of sales) and in the process has taken its eye off the ball to an extent.

The bigger question is whether this loss is reversible or not. For sure, it is not the case that women in the UK will be using less product. The next question is whether their products can successfully enter mature markets such as the US, which has many alternatives to choose from at varying price points.

Whilst no expert on womens make-up I think this is an attractive enough proposition, although the share price could have further to fall in the short-term. Their products look well positioned, and a white-party operation has a lot of potential in emerging markets. I would rate this at 4/5, although I’d expect more share price weakness.

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