Shares in multi-channel, multi-gift retailer TheWorks.co.uk (LON:WRKS) slumped over 40% today as the half-year trading update painted a grim picture for investors, guiding profits for this year to be significantly under expectations. The fall seems to have steadied at around 40% after the latest TheWorks profit warning:
Today’s news is only the latest in a raft of disappointments for investors. Only coming to the market in July 2018, the IPO price was set at 160p, and the shares have drifted relentlessly since then. At today’s lows of c.40p the company is worth a quarter of what it was just over a year ago.
Many people will be quite familiar with TheWorks, as it is one of the winners in the changing face of High Streets up and down the country. Akin to Card Factory, Shoe Zone and other stores such as Poundworld, they retail goods at the ‘value’ end of the market. Stores like this have sprouted up like mushrooms in almost every primary and secondary retail outlet around the country filling the void left by others. At the current market cap of under £30m, you get a company with over 500 stores.
What did TheWorks profit warning say?
We get some more detail in a half-year trading statement today, which covers the half year to 27 October. We are short on numbers here, but undoubtedly TheWorks will have a significant H2 weighting as many of its goods are bought for Christmas. It starts with some bad news:
Total revenue increased by 5.4% year-on-year, and when excluding the impact of the prior year Mega Trend, LFL sales were -1.9%. This performance reflected the difficult consumer backdrop over the Period. When including the prior year Mega Trend LFL sales were -3.6%.
There is a note explaining what ‘Mega Trend’ is – any product exceeding 3% of weekly sales. Like for Like (LFL) are from stores opened for at least 63 weeks. The total revenue trend is less impressive considering that the store estate has been expanding by roughly 50 stores a year, and is expected to do so again this year.
We come to the profit warning:
Whilst LFL sales have improved over recent weeks, as the impact of the prior year’s Mega Trend eases, they were not at a level previously expected. Accordingly, the Company is taking a more cautious view on trading ahead of the Christmas trading period and, as such, the Board now expects full year profit before tax to be significantly below current market expectations.
The expectations are not mentioned, neither are there any broker notes on Research Tree. Stockopedia guides an estimation at £6m net profit.
A tale of declining metrics
The figures paint a rather sad story. Most of the important ones have taken a nose-dive in the past couple of years. Turnover has risen, but we would expect this to be so as the number of stores is constantly rising. But profits and margins have slipped as Stockopedia figures show.
Admittedly, in the past couple of years, costs related to IPO have heavily bit into statutory profits. In the last year (which contained the IPO) there was £4.4m worth of adjusting items which related to relocations, IPO costs and staff bonuses. Clearly all of which may not be repeated.
Still, even when taking this into account, it seems as if the business is being squeezed in some way, with margins on goods decreasing over time. This is not particularly surprising considering that TheWorks competes on price. Comparing margins to others such as Card Factory (c.17-20%) shows the real power of vertical integration. TheWorks makes few, if any of the products it sells and they are available elsewhere.
One must wonder about the cost of opening so many stores. We can surmise the cost of opening new stores is fairly cheap. The last report referenced a cost of £5.0m for new stores, which works out at £100,000 a store. Given the large number of stores and the rate of expansion, this quickly adds up though. Prior to the IPO the company was around £25m in debt, and in part the proceeds were used to clear this.
However, it may be the case that the rate of expansion has to slow. Revolution Bars had a similar problem in that these costs were greater than money coming in (a problem compounded by the fact that they kept paying dividends). TheWorks started paying out a dividend in the past year at 3.60p a share. It seems unlikely that this can be kept in the face of decreasing profits.
Capital expenditures are stated to remain at the £10m level in the near term as the company invests in a new web platform. This is quite an uncomfortably high level relative to cash flows, which have not been much above this level. This puts pressure on the cash, although the company has an credit facility of £25m which is untouched. Even on the current reduced trading seems likely to finance plans for a few years at least.
With over 500 stores and more to come, paying for rent on shops becomes a major consideration for this type of business. This also can have the effect of making accounts look worse than they are as the remaining payments are highlighted as debt under new financial standards. The simple figures are shown from the financial statement:
This seems to me to be a good result. Stores have risen but lease commitments have remained virtually stable. We may be able to conclude from this that the average cost has gone down. Or that renewed leases have come in at a lower cost. There does not seem to be many leases of massive length. Those that are I would guess to be in proven locations.
This is a really important factor when thinking about the company, as it is a significant cost. It has helped that many of its locations are non-premium, and average cost per store is quite low.
Is TheWorks profit warning a buying chance?
It is clear that TheWorks is still expanding. Due to these expenses money is going to be tight as capital expenditures dominate the cashflow. This is quite a similar position to other value-orientated businesses such as The Gym Group. But in that case the business is quite a good one where revenue is sticky and has opportunities for up-selling other products.
Having been to a TheWorks store, it seems to me to be a bit of a modern-day Woolworths in covering many different bases. It’s not quite a book store, gift shop, craft shop, decorations shop or games shop. Thus there is a feeling of confusion in the stores: some may be a little different from others. On each front, the company faces significant competition from other retailers.
With 500 stores and a projected £6m of profits after tax, this equates to a very tiny contribution per store. Performance must target efficiencies in both the central costs and the stores themselves. There is not much room to get much wrong here, and today’s share price clearly demonstrates that.
Even assuming a cut of 20% below expectations, the shares are going to be very cheap for a profitable retailer which is growing. Underneath that great description is a company that is spending most of its cash on its expansion and website. This may or may not work out. The downside risk would be if it got into trouble it could be recapitalised, leaving investors heavily diluted.
The share price seems like value to me on a snapshot of the company. If the Christmas season is a good one there could be a decent bounce. Longer-term I am not convinced about the expansion plans or the viability of its business, particularly if minimum wages increase. 2/5.