Shares in window specialist Safestyle UK (LON:SFE) today slumped 15% as the turnaround plans it has put into place in the past year have not delivered margin improvements as anticipated. The shares are down at the time of writing:
As usual, this isn’t the full picture, and it has been a huge roller-coaster ride for holders. This profit warning perhaps was not forecast by the market, as the shares had appreciated over 20% in the previous month leading up to this. The decline today takes us back to March prices.
Even so, we are still almost double the price of the lows seen last year, and in truth the last couple of years have been very troublesome for Safestyle. Once a darling of Stockopedia carrying a huge rank of 99, the share has since dealt out a couple of profit warnings, had problems with competitors trying to steal their business, had legalities on-going with previous directors and also swung to a large loss in 2018 and cancelled the dividend.
As we can see from this pictorial, the drop-off has been rather immediate:
For those not familiar, Safestyle UK manufacture and sell replacement windows and doors – a reliable market which has plenty of customers, but also plenty of competition. It is the latter factor which has given the industry a bit of a bad rep, with ‘double glazing salesmen’ a pretty generic term for high pressure tactics.
The profit warning comes in an RNS simply entitled ‘AGM Statement’, which may have been overlooked. We start with quite a lot of promises about the future:
“Following the progress made during H2 2018 in stabilising the business, Phase Two of our Turnaround Plan is now well underway. Our focus for Phase Two continues to be on recovering volumes and market share, restoring our operational effectiveness, reducing our costs and enhancing our margins. We remain on track to conclude this Phase at the end of 2019 and then plan to move into Phase Three in 2020 which has a primary focus on accelerating our growth.
We then have some financial metrics; expected revenue growth is 10% on H1 2018 and 20% H2 2019, and margins are up 4.7%. It should be noted that these are very soft comparatives to go on, and given there was a large loss in 2018 may not be the best guide. This is pretty much confirmed by the warning as such:
Despite the progress, margin improvement has been slower than expected, impacted by higher lead generation costs and the pace of recovery in improving the Group’s operational effectiveness. Consequently, whilst the Board does expect turnover to remain broadly in line with current market expectations and continues to forecast a small profit for the full year, it does expect this profit to be below current market expectations.
There is a final note on cash:
The Board also continues to forecast that the Group’s net cash position will increase versus 2018’s closing positive level (£0.3m) as a result of effective management control on capital expenditure levels and working capital management.
The cash position was quite healthy, but the 2018 losses knocked this out. It does look as if getting back there will be a slow journey.
Safestyle was a great business, so it seemed. All the metrics were pointing in the right direction and the business was growing:
The business was simple to understand, and also generated high margins. Cash conversion was very clean, with almost all profits going to cash, and in turn most of this being paid out as dividends. The business was also relatively undemanding on capital expenditures and also had no debt, giving it a very high returns. Receivables are low, which gives the impression that customers pay up front for their orders, another bonus.
We can see from the results that somewhere in between the end of 2016 and 2018 things went to go badly wrong, and things started slipping away. At the peak, its shares were worth over 300p and considering profits were projected to breach £20m this was an expensive, but not undemanding valuation.
However since then, there has been a double whammy for Safestyle. Consumer confidence has deteriorated, which is understandable as this is a common theme across many sectors. Additionally the competitive landscape changed, and a new market entrant called Safeglaze entered the fray. Made up of disenfranchised former associates, they rapidly took away business using the classic method of undercutting. The two companies came to a financial agreement in the past year, with Safestyle effectively paying off Safeglaze (who then went into administration). This has caused the share price to recover, and anyone who bought at the all time lows may have tripled their money.
So the question has to be, whether this setback is permanent or temporary? One feels that perhaps Safestyle were a victim of their own success. Margins of 10% in a market where the product may be considered a commodity could have naturally seen other players come in, and whilst it seems that Safeglaze were motivated by other means, you could not rule it happening again. Customer confidence does not seem to have improved over the last year and is difficult to see this changing any time soon. Upgrading windows and doors for many is a discretionary expense.
The financial security of the firm may be a worry. Last year’s working capital management showed a £5.5m improvement which helped to massage the losses suffered. The tangible asset position is not great, as of the last financial statement current liabilities are greater than the current tangible assets, with almost half of the assets being intangible. Of this goodwill makes up £20m which has not been reduced in cost at all, considering that the value is based on cash flow projections there is a good case that some impairment is necessary.
The cash balance showed a worrying downturn. 2018 showed that Safestyle took out a new loan facility of £7.5m, on which £4.5m was taken as a loan and £3m as a revolving credit facility. This is expensive, at LIBOR + 7%. The group also has a lot of lease payments, including a large amount of vehicles – perhaps specialist machinery required. This adds a degree of operational leverage, as these will still have to be paid for even if business dries up.
For some while investing in Safestyle has been a binary bet on whether the business will recover to its previous levels. It is clear that a repeat of 2018 would not be possible and the business would be unlikely to survive another year the same. At one point last year it is fair to say that the business was priced for failure.
There have been some crumbs of comfort in that the aggressive competitor has been taken out, and as a result margins and turnover have gradually started to improve, although not as quickly as the board anticipate, which is the result of the warning today.
My own view is that the level of profitability seen before will be hard to maintain if it ever goes back there. As we have seen before, setting up a competitor doesn’t require much in the way of resources, and a new player in the market may have more staying power as it seems that Safestyle would be vulnerable to a price war.
The current market cap offers no bargains. £65m buys you a very small profit this year and some prospects of rather benign growth. Even the optimistic forecasts show net profit of £6.5m in 2020, it seems we are being asked to pay for that now with no real reward for the risk that further things might go wrong. 1/5.