Halfords Group (LON:HFD) today put out a trading statement which painted a picture of future flat profits, which on closer reading actually constitutes a profit warning without referencing the term. The market was not impressed, with the share price falling 25% in early trading. This doesn’t tell the full story, and 2018 has been an extremely poor year for shareholders as the price graph illustrates:
The company had a capitalisation of £1bn+ not so long ago, so it is clear that they have really fallen out of favour. Some of this is not company-specific, as quite a few high street retailers have been struggling of late with a variety of factors being blamed: weather, Brexit, competition. The strongest bear cases have been seen for firms that have a high concentration of retail versus online sales such as Debenhams and Mothercare. Halfords undoubtedly fits into this category.
The warning comes in the Q3 trading update published in an RNS today. One term states:
Operating costs and gross margins have been well controlled. However, reflecting the impact on revenue of the mild weather and weak consumer confidence, we now anticipate FY19 underlying profit before tax to be in the range of £58m to £62m.
It becomes clear this is a bit of a profit warning in disguise: the previous update projected earnings in line with the previous year, and looking at the previous results for FY18, the same figure was £71.6m. So it can be inferred that the Christmas period was a very poor one for Halfords, and the miss is quite a large one. This is confirmed with the publication of the Q3 figures which shown retail revenues down 2.2% on a like-for-like basis.
The statement goes on in a bit of a ‘jam tomorrow’ way:
At this stage, we believe that consumer confidence could remain weak into next year and therefore anticipate FY20 profit before tax to be broadly flat on the revised FY19 expectation. Evidently, however, we are in an uncertain environment and will provide an update alongside our preliminary results in May. The Group remains cash generative and has a strong balance sheet. We expect free cash flow for the full year to be up on last year and we remain confident that we will grow free cash flow over the medium term, supported by good early progress in our cost and cash efficiency programmes. This, combined with positive longer-term prospects for the Group, gives the Board confidence to maintain its dividend policy.
Halfords is one of the more durable and recognisable brands having a long and distinguished history. From an investor point of view, it floated way back in 2004. Most people would be familiar with its products, a retailer of car-related accessories, although in recent years via acquisitions it has also moved into the spheres of car maintenance and cycling.
Unlike a few companies that end up issuing profit warnings, Halfords genuinely is a viable business: at present: it generates profits, of which dividends are paid. It also is not overly burdened with debt, the level of which is a modest multiple of EBITDA. It serves a market that has somewhat predictable and recurring needs and is not likely to be replaced any time soon.
The problems Halfords faces are more external. Like many retailers such as Debenhams this would be in its prime a decade ago, where there were fewer competitors. The advance of technology has meant competitors such as Amazon can easily supply many of the products found in Halfords stores at cheaper prices. However, change has brought about new opportunities for Halfords: there has been a large growth in certain fields such as sat-navs, cycling and camping, all of which Halfords covers.
Car maintenance is something with a few barriers to entry, although this forms a rather small proportion of revenues at under 15%. With a large exposure to retail, it can be seen that there are some distinct trends. The first being that it is quite difficult to grow revenues:
Much of the increases here have been driven by acquisitions (Boardman Bikes and Tredz). In the past few years, profits have also taken a hit, and with revenues heavily dominated by retail, margins are not large:
The reasons for this almost certainly is competition and a subsequent reduction in selling prices. With the exception of the brands that it owns the items it retails can be bought from other places. Upon a backdrop of rising wages this does not show any sign of reversing.
Debt levels from the same periods tell a similar story:
Debt was being paid down, reflecting the cash generative nature of the business, but in recent years has started to creep back up. Acquisitions and capex have been costly.
Of particular concern are the stores. Halfords have 480 locations, which tend to be large and out-of-town, located in retail parks. 32 of these had lease re-negotiations in the past year, which would likely see preferential terms. The average lease length is between 5 and 6 years, a reasonable length of time.
One good thing for investors is the dividends:
That is looking very generous now considering the fall in the share price. But it does seem that something will have to give soon: on this projected cut to profit, cash flow also reduces. The last year’s divi totalled over £32m, and assuming that Halfords wish to continue with the refresh of their store estate (which was currently only 1/3 complete at the last report), the dividend seems easiest to be cut. As can be seen, the dividend has been cut before when it was not covered by earnings.
Halfords has (almost) dropped to a new all-time low and it is quite easy to see a bull case for it: it makes profits and pays dividends. The P/E even on a reduced profit figure is relatively undemanding, even approaching cheap. However, given a likely dividend cut in the near future it could be the case that the share price falls even further at that stage.
One of the problems Halfords currently faces is that it is struggling to grow revenues and profits, with increased sales coming at the cost of margins. Competitive pressures do not seem to be receding in this era, and the store refresh program underscores that the Halfords store is a bit of a tired format, with a perception of higher prices.
On the flip side, with such a large product offering Halfords may be never far from the next growing market. Sports such as cycling have exploded in popularity in recent years, and Halfords have made the right moves (in my view) to simply retail these bikes in their stores but to acquire other stores and grow that way. There are likely to be further opportunities in future, for example a move to electric cars.
Unfortunately, the rate of change does not appear to be quick enough, or at least slower than the rate of change in the market, which has resulted in the current malaise. Good opportunities exist for Halfords such as the auto-centre and cycling segments, but the nagging feeling is that the rest of the business is not competitive enough, and too generic.
Debt levels do not present too much of an immediate danger (and is less than tangible assets), and looking at some other retailers there may be scope to increase this. They are fighting against the trend, and something needs to be done.
Despite this I don’t believe they are poorly managed and have plans in place. I feel there may be further weakness in the price in the short-term in the longer-term will survive long enough to prosper. 4/5.