A rather surprising profit warning comes out this morning from Shoe Zone (LON:SHOE) as it announced a triple whammy for investors: the CEO leaves with immediate effect, a profit warning for the current year and a write-down in freehold properties set to decimate profit figures for this year. The share price was down over 30%:
It has recovered a bit from the low of 116.6p we saw earlier, and any investors buying into at close to this price would have seen an immediate profit.
We say ‘surprising’ as although everybody knows trading conditions on the High Street are difficult (other heavily exposed players like Moss Bros and Superdry have had problems). Other firms such as Bonmarche and Quiz have gone from positions of relative strength to looking like being swept out with the tide.
However, Shoe Zone would be seen by many as a potential ‘survivor’ in this difficult market. Positioned squarely at the budget end of the market, it would seem that they may be more immune than others as people trade down in times of difficulty. Additionally, competition among the budget retailers is limited or fragmented. Primark may be the most obvious, but in their stores lack the space or desire to really compete.
In addition, Shoe Zone boast a good track record of both profitability and financial management. To be sure, growth in revenues has taken a back seat, but this is more a function of re-organising their estate which is closing inefficient stores.
The bad news comes in a trading update RNS. First we start with the news of the CEO:
Shoe Zone PLC (the “Group”), the UK’s largest value footwear retailer, today announces that Nick Davis, the Group’s Chief Executive, has tendered his resignation in order to leave Shoe Zone and pursue other business interests. As a result, Nick will be leaving the Group with immediate effect.
This is not too much of a surprise. Although Davis has been employed by Shoe Zone since 2003 and is a real success story, due to the ownership of the Smith brothers one suspects he would always be playing second fiddle.
On to the warning:
Trading conditions since the Group’s Interim Results on 21 May 2019 have been challenging and as a result, the Board now expects to deliver a full year performance below its expectations.
Whilst the Big Box and Digital growth elements of the Group’s strategy are progressing strongly, in the short term, their performance has been offset by the tough high street trading environment.
Traditional retail must have taken a big hit if the other elements are increasing. Finally:
The Board has also undertaken a review of its freehold property valuations and has concluded that it will be writing down the value of its 17 freehold properties by £3.1m to £5.3m. This will result in a non-cash exceptional charge in its full year results for the year ending 5 October 2019.
That is a material charge to profit, although not cash-based. It is a shame that the full-year performance was not quantified in a similar way.
Shoe Zone hasn’t been a share for anyone looking for growth. In fact, turnover has decreased over the last couple of years as loss-making stores exited the portfolio. For those searching for dividends, this has been a different matter. The company have a very clean record of converting cashflow to profit:
There is a good level of discipline in expansion, which is being financed from generated profits, which leaves the company in a debt-free position. At the last year-end, net cash was £15.7m and this figure has been increasing slowly over the last few years. This is despite paying out the majority of its free cash flow to shareholders. The comment today implies that dividends may drop as any special dividend is being cancelled.
With zero on the balance sheet for goodwill or intangibles, the business seems in a safe position, although not to the extent where it could be considered bulletproof. A worsening recession could easily put pressure on Shoe Zone over the next couple of years, as it lacks the ability to increase prices.
The business has seemed very stable, as evidenced by these metrics from Stockopedia:
This is set to change a little in future, as the firms plans for extending the business lie in the purported ‘Big Box’ stores as well as digital. Big Box stores are much larger than the traditional store format, but obviously need more items to be sold in them. Shoe Zone has managed this by extending their product range to include branded products as well as bags and accessories.
Most of the openings are in this new format, perhaps motivated by the property picture. Given the markdown in freehold value, it seems likely that there would be many out-of-town places which would welcome a tenant such as this, and the good news is that rents are falling (although not totally offsetting the markdown).
The ownership should be mentioned here. The Smith brothers founded the business and speak for over 50% of the shares, and clearly will be the authority on any changes. That could be a curse or a blessing, although so far they have executed their strategy well and will be more motivated by most to repair the damage done by the share price.
Perhaps the biggest own goal is the lack of quantifying the damage in the trading update. A broker note (available on Research Tree) comes to our aid, marking down profit before tax to £9.5m and withdrawing 2020 forecasts. This to me would explain the step down and step up in price.
We also see a picture of two halves emerging, with the newer bigger stores doing well, and the older type stores doing not so well. It could be possible that there is an element of the new stores taking business away from the old, as revenue is forecasted to drop 2%. Whilst the cash balance seems nice, it does act as a brake on the speed of expansion.
There also may be pressure on inventories. New stores carry more items, so perhaps more investment is required into inventory. So far this element has stayed very stable, which could be seen as a sign of disciplined management. And budget shoes stay in fashion a very long time, so valuation of the inventory seems stable.
The most obvious bear case is that it is difficult to see Shoe Zone really transforming their position from what they are now: a budget shoe retailer. To this end, the share price should also reflect that, and be priced at a lower multiple. Today’s share price drop has done just that, so the question may be is this correct?
I tend to view this set-back as temporary and Shoe Zone will be able to get back to making a modest margin on modest products after this year, so I feel the share price offers good value at this time, although not a complete bargain. 4/5.