Niche footwear and sportswear firm Footasylum today announced a fresh profits warning which sent shares in its stock tumbling. This is the second such warning in the space of a few months, and I feel quite sad for any investors that clung on to the shares in the belief that things would get better, as like the first time, the shares have halved in value on the back of it.
Footasylum is a relatively new company: established in 2005, they floated on the market just last year in 2017. Originally priced at 164p, and promising a growth story to investors, it seems increasingly so that the projections were overly optimistic; and that IPO was a route out for the founders.
As you may have guessed, the share price chart does not make pretty reading:
The profit warning today was actually buried slightly in the trading statement, although of course it didn’t take long for the news outlets to report the bad news. The first aspect was an update in revenues, which were all positive:
There are fewer figures kicking around due to the fact that the IPO only came last year. But it these figures will have been slightly hampered by weather, and the lack of the busier Christmas trading period. As we can see, the growth of the wholesale division can be seen to be particularly exciting, as well as the fact that a good proportion of sales take place online.
The profit warning comes in soon after:
Whilst trading since the beginning of the current financial year has been impacted by weak consumer sentiment on the high street, the Company’s store performance for May and June was positive, as reflected when the Company gave guidance for FY19 in June.
However, store performance during July and August was more challenging which, in the context of there being no sign of a recovery in the short-term on the high street, has led the Board to reassess its overall expectations for the balance of FY19. While online and wholesale revenue continues to perform strongly year-on-year, store sales have been disappointing, which has been exacerbated by some unforeseen delays in the Company’s new store openings and upsizes.
There is no real reasoning given for the performance during July and August, and on the face of it, no real excuses either. In both months we have had exceptionally good weather, and the footfall on the high street has been good. A similar competitor (JD Sports) has been rather upbeat in the current months about its prospects.
The ‘unforeseen delays’ sounds a bit more of a viable excuse, and on the face of it there should be no excuse for this given that this is not dependent on any other factor, rather just bad project management.
There is also forward guidance of the magnitude of the effects:
Despite an ongoing programme of investment to drive sales, Footasylum’s revenue growth for FY19 is now expected to be below current market expectations. As a result of this, and a lower overall gross margin from a higher amount of clearance activity in stores, the Board now expects adjusted EBITDA for the full year to be significantly lower than previous guidance, at less than half of the FY18 adjusted EBITDA of £12.5 million.
So that gives an expected adjusted EBITDA of £6.25m. How much of this converts into cash remains to be seen as the company is still expanding and investing heavily in new projects:
The Board believes that upsizing certain stores will materially improve Footasylum’s existing strong brand relationships while enhancing the consumer experience in store. Reflecting this investment, capital expenditure and associated depreciation is expected to increase in the medium-term, with capital expenditure peaking at around £16 million in FY19.
In that context, that capex looks big. On a cash level, this will almost certainly put some strain on the cash balances, as additionally more stock will be required as the store estate gets bigger.
It’s fair to say that the market was not impressed with any of this and take a rather dim view of the outlook: from the share being valued at over 265p in January, we have now hit a low of 40p today: a real fall from grace and a vote of no-confidence. There is a certain ‘premium’ I think added in here because the warnings have come so soon after the IPO.
I am not that wowed by the firm in general: retailers such as this as almost entirely reliant on the big brands, and there is a growing trend among them, especially Nike to start going it alone. That puts stores like Footasylum at risk of getting the best stock. It also would be the case that their pricing power would be weak: there are plenty of places to buy trainers, for instance.
On the flip side of that, they are showing that they are aware of this, having diversified into own-brands. And the sector in general is quite strong: both Sports Direct and JD Sports are having good times of it at the moment. There are also further opportunities to expand the store estate, as other failing firms vacate their shops. There probably hasn’t been a better time to get a good deal. It should be said that Footasylum is a rather different beast to both the above firms: they operate much smaller stores, more akin to Footlocker.
As an investment case currently I think there are too many uncertainties. The roadmap for Footasylum seems hugely ambitious. The sportswear side of things faces quite stiff competition from both the retailers and manufacturers – and in any case this side of the business should not attract too high a valuation because of the low pricing power. Shoe Zone is an example of such a mature business – about as well run as can be imagined, but is not rated any higher than a P/E multiple of 10.
The wholesaling and own-brand side of the business seems to be more interesting. But this is also fraught with huge competition. Internet players are also starting their own brands, not to mention the big high street names. It would not take much to turn their attention towards sportswear, that is if they have not done so already. Having viewed the annual report, I can say I have never heard of any of the own-brands mentioned, and for good reason: it would take a hell of a lot of spending power to make one popular today.
Some of the problems seem more challenging to me. The balance sheet looks fine currently: there is no debt, and the company held £11m of cash at the end of the last year. But this is picked apart from the cash flow statement:
The IPO raised £41.1m, which had to pay a shedload of costs: £4.1m for the IPO alone – and a £22.7m payment to clear the preference shares (shown on the previous accounts as short-term debt). Together these accounted for almost half of the money raised, before the business could even benefit.
It goes without saying that the increased level of investment needs to have an immediate impact. On the back of the increased capex costs and reduced EBITDA, we are likely to see some pressure on the cash balance sooner rather than later. There is a current facility of £30m so there a few years left on paper, but some questions have to be asked of this: would HSBC be comfortable to continue this facility given a poor result this year? It was agreed when the picture was much rosier. There could be a scenario where capex wipes out the cash inside a year and the banking facility is withdrawn or made smaller. That would be a precarious situation.
Another problem I have is the rather strange structure of the management. The CEO is just 31 years old, and would have been an eyebrow raising appointment, save for the fact that her father was one of the founders of JD Sports, whose previous owners have a massive interest in the shares. This may have advantages: I am sure Footasylum would love to replicate JD Sports but on an operational level it is hard to know who is really calling the shots. Whether that matters is also unclear: they evidently have a lot of expertise.
What is clear is that Footasylum are lacking the cash to fight on all fronts, and also at present seem to lack the market or the products to generate more cash. The path to expansion for the bigger brands has been not to develop a brand, but simply acquire them. JD and Sports Direct have acquired literally dozens of brands over the years, which has saved them having to develop their own. In my view Footasylum need all the cash they currently have to expand their store estate (their current strategy). Would they be better off using it to acquire an existing brand that contributes to profits (and also have synergies for their online/wholesale operations)? I suspect the answer might be yes. The high street is not a great place at the moment, and from the point of view of some retailers it might provide better conditions in a few years.
I am rather pessimistic about the chances here. I don’t think they would make a good acquisition for either of the giants of the industry who seem to favour much larger stores, and currently there is very little to pay up for here, and I would rate this at 1/5. The shares are cheap at present, and I could easily see a small bounce, but in the longer term I am not sure that the profitability needed will arise.