IG Design Profit Warning: Shares Slump on Cost Headwinds

IG Design Profit Warning: Shares in international accessory manufacturer IG Design Group (LON:IGR) were hit by 35% today as a trading update revealed that cost pressures would wipe out profits this year. It has been the case that rising costs have been known in the market for some time. Much like yesterday’s warning with James Fisher, the share price action here is interesting. Todays drop has sent it to a lower level than it was at the pandemic sell-off, although longer term holders may be in profit as the share was much cheaper a few years back.

What did the IG Design profit warning say? 

This comes as a trading update released this morning for the six months to 30 September. We start with good news: like-for-like revenues up 11% this year – this was constrained by the well-publicised supply issues. We get the bad news next:

In addition to the logistical disruption within the Company’s global supply chain, partially related to the impact of Covid-19, the business has experienced worsening cost headwinds during the period, with sea freight costs up significantly across all regions, alongside raw material and labour inflation as well as supply availability issues. The business has responded quickly to mitigate much of the impact of these challenges through commercial negotiation, earlier stock commitments and other initiatives, while working with both suppliers and customers to ensure the Group maintains its high level of customer service across all its operations.

This sounds like a perfect storm for a company such as IG: it needs raw materials to make its product, and it also needs freight to move them to the final markets. They may claim they can mitigate the impact, but the next line sounds like not much has been done:

However, as a result of the disruption and these cost increases, operating margins in the first half have been negatively impacted and it is expected that the challenges will continue into the second half of the current financial year and also into FY23, although it remains difficult, at this time, to estimate the impact. As such, the Group now expects FY22 full year operating margins to be 175-225 basis points lower year on year resulting in full year earnings being significantly below current market expectations, with the cost and supply chain headwinds continuing for an as yet unknown period in FY23.

This seems like a mealy-mouthed way of trying not to say what will be obvious after a quick look. Last year’s operating margins were 2.25%, so it seems that these cost increases potentially could send the company to a small loss for this year. Even worse is that nobody really knows where this may end; the problems could get worse, or better.

IG Design Group: The Business

IG Design are an interesting business, one of those whom you may have used their products without realising. They design and manufacture wrapping paper, gift cards, packaging, craft items and stationery. At almost $1bn of turnover for the last year, the scope of their business is vast and their products are sold all over the world.

A listed company since 1989, the model here has been one to follow for the growing smaller companies today. Originally DG plc, the company have over the years grown by acquiring other companies and integrating them into their setup. Recently there have been very large acquisitions: the last being CSS Industries, a greeting cards manufacturer and retailer. This had a headline price of $88m.

This growth has been self-financing in that equity was raised in order to pay for them: there are almost 100m shares in issue today, which is up 50% from 5 years ago. This means that the company runs not completely debt free, but does not have large borrowings. One aspect of the business here is the large scale of capital outflows: it could be imagined that the latter half of the year is much more popular for wrapping paper. Their accounts report at 31 March and report a positive cash position, however by the time it gets to September this has swung to a net debt; the size of the swing around $100m.

As we can see from Stocko there is not a massive operating margin in making cards:

Obviously 2020 was an anomalous year; the company’s figures flattered by a tax rebate. However, relatively modest margins had pushed this into quite an expensive share. Many companies of this ilk are similar, to be fair. There is a prospect of them being continually acquisitive, for if the share price remains high these can be efficient add-ons. In terms of liquidity, the forecast here is still for profit this year, so short of input costs getting way out of control this should not provide too many issues.

Another thing to like is that the company are cash generative and capital light. They have quite a stable and short capital cycle – doing business with many larger customers such as big retailers allows for a pretty reliable source of incomes. Capex expenditure is low as well as the spend on intangibles, with the larger spend being on acquisitions. With this knocked out in 2021, this should allow the cash balances to repair, giving a further level of safety.

A red flag here is the director deals:

Virtually all sells – including some very heavy ones. No purchases since 2019 is a pretty sorry state of affairs. To make it worse, the CEO has no holdings at all. If he isn’t going to have skin in the game, why should anyone else?

Is the IG Design profit warning a buying opportunity?

The director share dealings is enough to put me off. But there are also other small things which I dislike. The trading update was presented in quite vague terms; presenting the profit hit in basis points not really cutting the mustard. Additionally in retrospect valuing the share based on their year-end financials may be misleading, as the cash snapshot there provides a very flattering view of the company.

Another question may be whether the effects have been successfully mitigated. Supply chain issues are nothing new. Recently Unilever reported issues but its response was to increase prices. With some of IG Designs products, it may not be known whether the prices can be raised without the customer going elsewhere. After all, something like a greeting card or a wrapping paper is ubitquitous. A customer may happily get a cheaper substitute. The trading update makes no mention of raising prices, however.

The growth plan the company announced in June, which targets $1.5bn revenues also seems a little off now. This would have been a major factor in the share price, but 70% of this gap was anticipated through M&A. The share price now makes this less efficient, and means more dilution for existing holders – perhaps a reason for the director selling.

On the positive side however, there does not appear to be any immediate risk to solvency. And despite the directors sales, the business does boast an excellent track record of growing and integrating the business, and the CEO has been with the business from the beginning.

In my own opinion I don’t think this is far off from becoming good value, but still a tad pricy, also would like to see how the supply issues resolve themselves. 2/5.

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