Shares in Card Factory (LON:CARD) slipped by 20% today in early trade as the company slashed its profit forecasts for FY21 by £5-10m, citing challenging conditions. The share price has continued its fall since:
This makes grim reading for long-term holders. Card Factory IPO’d in 2014 and the share price has struggled to go anywhere since. It exceeded 300p during 2017, but a profit warning at the start of 2018 dented confidence from which it has never really recovered. Today’s drop sends the price to an all-time low, and going below 100p does not seem out of the question.
Card Factory has been on my radar for a while, although today’s warning means I will still be holding out for a better price. Many people would be very familiar with their shops, which appear in almost every town and city. Their vertically-integrated model has led to them becoming the lowest cost card retailer, muscling out traditional favourites such as Clintons and supermarkets. It could be said that under a backdrop of retail weakness, they could end up as one of the survivors.
What’s gone wrong at Card Factory?
The bad news comes in a statement today. We have quite a lot of data to process regarding sales, but the key points are that the Christmas period was challenging for them, like-for-like sales growth was slightly negative. We get a quote half-way down:
Reflecting the softer than anticipated Christmas trading period, the board now expects that FY20 Adjusted Underlying EBITDA (excluding adjustments in relation to IFRS 16) will be in the range £81.0m – £83.0m.
There are no references to what this figure was previously. Going back, the last update was on 14 November, which said LFL sales were +0.9% to 31 October, with profits in line with expectations. Even further back, the half-year results at 31 July showed LFL at 1.5%. Underlying EBITDA was £89.4m the year before, so we can see that things must have been quite poor recently.
We also have a profit warning baked in for the next year:
The adverse external factors which have affected performance for a number of years are expected to continue in FY21: declining high street footfall, depressed sterling valuation and high cost inflation (especially wages)
To date there has been significant success in mitigating in large part the EBITDA impact of these external factors through a combination of offer improvements and business efficiencies. These efforts will continue, but the opportunity for efficiencies within the current business model is finite. Accordingly, the board anticipates that, on a business as usual basis, the net impact of market headwinds on FY21 Adjusted Underlying EBITDA is likely to be in the range of £5-10m.
This is not good news, and £10m is a material figure. It seems likely that Card Factory are opening more and more stores while profits are declining.
Card Factory: Retail exposures
Card Factory has been heavily affected by the new IFRS 16 rules, and this heavily affects its accounts as it has many leases. The leases now have to be capitalised as assets, with the outstanding portion of the leases stated as a liability, and a depreciation charge used for rental. This changes many calculations we may have, as debt has jumped and so has depreciation.
Card Factory now have a new metric ‘Adjusted, Underlying EBITDA’ which adds back the underlying charges and takes out lease depreciation charges. This figure was £28.7m at the half-way point this year but with the business heavily second-half weighted this is not of concern.
In any case, lease liabilities seem to be well managed here. The last accounts gave this total at £145m, which is a high enough figure, but with so many shops indicated either indicates low charges or short leases, maybe both. This gives the business plenty of flexibility to get out of underperforming stores.
One inescapable factor is rising wages, with the national minimum wage set to rise sharply this year. Card Factory’s wage bill last year was £80.8m, which was almost 20% of revenues. Yet set across so many stores, this does not seem to be a very large figure either.
Where has all the cash gone?
Perhaps its time to talk up some of the better features of Card Factory. It is a cash machine of a business, with a very high ratio of cashflow to profits:
It also boasts a superb margin on its products: in the last five years averaging over 20% (although this is showing signs of decline). This shows the power of vertical integration: with cards being much of a commodity, this is very impressive. Cards also have very little chance of going obsolete unlike many other consumer products: if a card doesn’t sell this year for Christmas, it can still be sold next year.
Capital expenditures are also low relative to cashflow figures: a relatively stable figure of around £12m a year. It is clear that for Card Factory to open a new shop it is cheap and easy to fit out, and the technology used to make cards is also relatively inexpensive and has stayed current in a long time. Short of the custom card makers such as Moonpig, there has been very little development in cards or their quality.
So it may be a surprise that the company maintains quite a lot of debt. This has climbed every year since IPO apart from the last one, and the net debt stood at £141.3m at the last accounts. This is financed at a relatively cheap rate (1.00% + LIBOR), so the obvious answer to that is ‘why not’. Interest charges amounted to £3.4m on the accounts.
Looking at the cashflow statement the answer is obvious where the cash is going: dividends. This has almost been equivalent to the entire cashflow in recent years: £82.8m, £81.9m, and £82.9m were the payouts in the years from 2015. 2019 saw this figure slashed to £48.9m which has helped the net debt figure reduced. But I don’t see such high payouts as sustainable. If you have a differing viewpoint on this, the dividend yield may be terrific here with the share just over 100p: an anticipated payout according to Stockopedia before today’s announcements was for 13.4p.
Card Factory has held on its balance sheet for some time a large intangible asset of £328.2m which was not amortised for some time until last year, where £11.6m was booked on declining trade of its ‘Getting Personal’ segment.
This large amount leads to Card Factory having a negative tangible asset value, as this intangible amount makes up over half of the total assets. The current ratio here is also less than one with more current liabilities than assets although in the case of Card Factory this becomes less relevant as cash is received up-front by customers.
The amount of cash generation here means that Card Factory is still in a much healthier position than other firms which show these type of characteristics. With its major expenditure (dividends) being largely discretionary it would take a large downturn for it to fall into trouble and be a High Street casualty.
Are Card Factory shares good value?
The shares have dropped to quite a tempting price. The company shows some good points but also some bad ones. There are plenty of cost pressures facing it, which are detailed in the statement today and are fairly concrete.
Given this, the company cannot afford to stand still, otherwise it will face declining profits on a longer scale as costs rise. We have seen some efforts to mitigate this in that the average basket price has increased: it is yet to be seen whether this is sustainable or not. There are also some quite exciting plans: an expansion into Australia, and an agreement with Aldi to supply its 440 stores in the UK. This is important, as at over 1,000 stores in the UK this must be close to the natural limit.
Personally I do believe that there could be some great expansion opportunities in other countries, but the current dividend policy impedes a decisive move into other markets. I do think even at present the shares are good value, with even a heavy dividend cut offering an excellent yield for investors and freeing up money for the business. With its core market perhaps in slight decline I would like to see more in the way of innovation. 4/5.