The Topps Tiles share price (LON:TPT) fell over 25% in early trade today as a trading update covering the start of the year brought bad news. On a day where the FTSE 100 index looks like it may fall 3% or more (again), this was unfortunate timing.
The share price may seem bad, but in fact 60p is a key region for Topps Tiles. The price has tested this region in all of 2017, 2018 and 2019 and all times it has rebounded. The prognosis this time looks quite poor, what with the coronavirus also lurking around.
Topps have been listed a long time (1997) and they may be a familiar name to people in the UK. Specialising in tiling mainly for domestic housing they trade via stores and more recently online. Over time, it has developed a huge store network with over 350 stores in the UK alone.
Topps may be seen as a broader tracker of the economy. In the run-up to the global financial crash of 2008 the shares were very highly rated. A price of over 270p was seen in 2007. By 2009 the share had declined to under 20p and the future did not look great with the company having taken on a large amount of debt. The Topps Tiles share price has recovered since this low but has never regained the previous highs.
What’s gone wrong at Topps Tiles?
We had an inkling this may happen as the Q1 update in January already said that like-for-like sales were behind by some 5.4% but no guidance on profit was given. Today there is confirmation that this trend did not improve:
Trading in the first eight weeks of the second quarter has remained challenging against a backdrop of continued weak home improvement spending. Retail like-for-like sales in the eight weeks to 22 February 2020 decreased by 5.5%.
We also now get a profit warning:
With most of the period complete, the Group now expects that first half profit will be significantly below the prior year level. As a result, management expect adjusted profit before tax for the 53 weeks ended 3 October 2020 will be materially below the bottom end of the current range of market expectations1.
Thankfully, there is a footnote which also details what these expectations are:
1 The current range of market expectations for adjusted profit before tax for the 53 weeks ended 3 October 2020 is £13.5m to £14.5m
A broker note (available on Research Tree) gives a guess a this figure: £7.0m. What’s worse, it seems that these new margins also stretch into 2021 and 2022. No improvement is seen.
Topps Tiles: Stagnation or Biding Time?
One thing about Topps Tiles is that if we are to slide into a recession, it is better prepared for it. In 2009 when the share price was last at 20p it had a large debt of over £90m. Profits were much bigger at this time but the share price reflected a large insolvency risk.
Lessons have been learned and the debt pile is much smaller: £11.3m was the figure at the last set of results. The company have consistently put their profits to reducing this figure over the years and Liberum estimate that by 2021 it will be just £5.5m. Whilst not as good as SCS (which went bust in the last recession), this certainly aids matters this time.
The debt reduction has come at an expense of business expansion. Only small business have been acquired, and net store openings have been very slow. In 2009 there were 340 Topps Tiles stores, today there are 361. The reason for this seems clear: after paying out dividends and money to maintain stores, there was nothing left without either taking on debt or issuing equity.
This has resulted in a stagnant top-end:
As we can see, revenues have barely increased since 2015. And net profits ends up falling, presumably because costs such as wages increase. With a very large retail operation, a decrease in sales is quick to drop to the bottom line. The Liberum research note alludes to this, and operating profits are slashed by 50%.
Clearly Topps are doing something right though. These figures are a world away from those companies which have rapidly chased expansion and then had to impair investments. Their margins were relatively solid at almost 10%, and whilst not being the cheapest are well regarded by customers. The decade long (and counting) property boom in the UK has been good for their business.
Today’s warning states that they are cash generative. This is true enough and to be expected as most customers pay up front for their items. But capital expenditures have been falling in the past couple of years.
This may be unsustainable, depending on how much branches need refreshing or simply maintaining them to be up to standard. All stores improvements last year came to £1.8m, which does not sound a lot considering the number of stores.
The balance sheet looks mixed. There is a very low level of intangibles left and the net asset position is positive. Current assets are almost much bigger than their liabilities, and inventory levels are relatively low (£30m vs £220m turnover). Tiles do not spoil, or go out of fashion.
Borrowings may be more pressing. £30m was outstanding which is repayable after three years. This is at a low rate – 2.27%, although increased from the 1.78% the year before. There is £5m headroom on this left, plus a £15m accordion. The annual report mentions that there are covenants tested on a biannual basis. Whilst Net Debt/EBITDA does not seem very high even on reduced profits (assuming depreciation will still be £7m+) it is clear that without a move in debt the covenant result (which is not defined) will be much worse at the next test.
Is the Topps Tiles share price good value?
This may have a familiar feel to 2009 for longer-term holders: the market is declining and prospects of a recovery seem uncertain. Perhaps there may be a temporary pick-up, if the coronavirus sees people invest what would have been holiday money into home improvements instead.
However, the tile market may be structurally a little different this time around. There are plenty of other places to get tiles nowadays. At the standard residential end it is virtually commoditised. Profits in 2006 were £39.1m on turnover of £180m for example. These kind of margins have not been maintained and are much worse today and I believe that competition has been the biggest factor.
The market capitalisation at current prices is £117m. That still strikes me as quite pricy considering that normalised profits may be of the order of 50% less for the foreseeable future. In real terms, the value proposition has actually gotten worse today than it was yesterday as the share price has not gone down commensurately. If trading deteriorates even further then there may be further problems down the line.
Lease liabilities look rather large:
In context this is not much less than Card Factory. This is understandable in some ways, as Card Factory has many more locations but their average store size is a lot smaller. But crucially, Card Factory are earning a lot more money to be able to pay off their lease liabilities.
Dividends may have been a reason to hold. But these cost the company £6.6m last year, and the projected decrease in profits would see them all but wiped out.
I would not go so far as putting the case as terminal. The economy may rebound (housing market activity picked up in January). And there may be still opportunities (acquisitions via equity raise, for instance). But at the current price I wouldn’t like to hold. 2/5.