Small Cap Value Report (Mon 17 Dec 2018) - ASC, BOO, SOS, PHTM

Good morning, it’s Paul here.

I knew it was going to be a bad day today, at approximately 06:52, when I knocked a tumbler of water all over my iPhone, trying to turn off the alarm. My late grandmother always told me that bad things happen in threes – which is not the most soothing thing you can say to someone who has just experienced their first bad thing of the day.

Thankfully, I have since accidentally poured cold water into my cafetiere, and spilt a carton of milk all over the kitchen floor. Therefore my quota of 3 bad things is now complete, and today should just get better from here.

Or so I thought, until looking at my share prices. Let’s hope that doesn’t constitute the start of a second batch of 3.

A profit warning from perennially over-priced Asos seems to have caused some problems this morning. Therefore, despite being a larger cap, I’ll check out what Asos is saying, looking for sector read-across. I’ll also later look at the update this morning from Boohoo (LON:BOO) .

There seems to be a pattern emerging of (some) clothing retailers saying that November trading was poor – e.g. Sports Direct said that trading was “unbelievably bad” in Nov. Bonmarche Holdings (LON:BON) put out a horrible profit warning recently. As did Superdry (LON:SDRY) .

Therefore it seems likely that others will be following suit with profit warnings. Hence why it’s carnage in the whole sector at the moment, re share prices. The market tends to shoot first, and ask questions later. 

Share price: 2539p (down 39% today, at 11:27)
No. shares: 83.87m
Market cap: £2,129.5m

Trading update (profit warning)

This online fashion retailer announces a slowdown in Q1 (Sep-Nov 2018) sales growth.

Last year (ending 08/2018) Asos achieved +24% revenue growth. This growth rate has slowed to +13% (at constant currency, or +14% as reported) in Q1. Note that;

• November was particularly difficult (as others have reported) – not helped by unseasonably  mild weather (which does genuinely have an impact, as people don’t buy higher value outerwear)
• Conventional retailers would die for revenue growth of +14%, so this is still a good performance, just not as good as the market was expecting – hence the share price being clobbered, as expectations are lowered
• The UK is actually the strongest market segment, with +19% revenue growth. So nobody can blame this on Brexit! (although no doubt some people still will, as generally I find that people tend to believe what they want to believe)
• EU sales growth is +14% (at CC), with France amp; Germany being difficult, but the rest  of Europe better (at +24%)
• Margins also down, by 160 bps – which is often the case (revenue growth amp; gross margins tend to move in tandem, because lower sales then require price discounting to shift slow-moving inventories)

Asos has a relatively low gross margin to start with, as it shifts a lot of third party inventories (lower than own-buy product). 

Higher costs

Put that lot together, and the EBIT margin (which wasn’t good to start with) has halved. Revised guidance for this year;

Other points;

• Capex is being reduced – but is still enormous, at £200m this year – being warehouse automation mainly
• Significant headroom on banking facilities – the fact this is mentioned at all is a worry
• H1/H2 profit weighting is usually 30%/70% – will be even more pronounced this year (thus increasing risk H2 could disappoint further)

My opinion – Asos doesn’t generate any free cashflow, and has never paid dividends. So what exactly is the point of it? Mind you, people have been saying that about Amazon’s cashflow for years too, and that hasn’t held it back.

At this size, the business should be highly cash generative, but isn’t. That’s concerned me for a long time. The market didn’t worry about this, whilst growth was stellar, but it’s coming more info focus now that growth is slowing down.

The key question is whether this is a temporary dip, or whether online sales growth has now peaked? I saw an article recently which suggested that online is levelling off in Germany, as everyone who wants to buy online is possibly now doing so. Whereas in the UK, consumer appetite for online purchases shows no signs of abating.

In the past, a pre-Xmas wobble in retailing shares has, selectively, been a buying opportunity. My experience (admittedly now becoming historic) was that Xmas sales always happen, they just get later amp; later every year. I think Black Friday has been a terrible American cultural import (aren’t they all?!) – it just incentivises customers to hold back on spending in Oct amp; Nov, to anticipate Black Friday discounts.

Large eCommerce companies like Asos (and increasingly BooHoo) become so large, that their warehouses become inefficient. Therefore both are spending lots of capex on automation. Whilst expensive short term, that should give considerable efficiency and cost savings, once up amp; running. So there should be upside to come through in due course for both companies.

With slower growth at Asos, it is likely that investors will focus more on conventional valuation measures, principally PER. That could see Asos shares potentially tumble a lot further.

Are the problems closer to home with Asos, as opposed to industry-wide, or a bit of both? An update from BooHoo this morning seems to indicate that Asos could be making some of its own problems, or just isn’t competitive enough any more, maybe?

Share price: 156.6p (down 14.4% today)
No. shares: 1,149.5m
Market cap: £1,800m

Update

This is another online fashion retailer, with 3 brands: BooHoo, PrettyLittleThing, and Nasty Gal.

No doubt in response to Asos’s profit warning, BooHoo rushed out at 8:08 this morning a brief update on its own trading. Everything’s fine basically;

Boohoo group plc (AIM: BOO), a leading online fashion group, is pleased to confirm that the group’s trading performance remains strong, with record Black Friday sales across the group and continues to trade comfortably in line with market expectations.

The group will provide an update for the four month trading period to December 31st on January 15th 2019.

 So why on earth is its share price down over 14% today? That doesn’t seem to make sense to me.

Why is BooHoo not being affected by the sector slowdown? Probably because it’s so aggressive on price. BooHoo’s strategy has always been to lead the charge against conventional retailers, by under-cutting them on price, and achieving better speed to market, with the test amp; repeat business model.

Hence I can see why BooHoo would weather the current storm better than others.

This is very difficult to determine. The share price of Marks and Spencer (LON:MKS) is plumbing new lows, so my previous enthusiasm for the turnaround story there has obviously waned somewhat. There’s no point standing in front of an express train, hoping that it will stop before it hits you, so I’ve had to bow to market forces and close my long position there, for now. Although the (I believe safe) dividend yield is now highly attractive.

Similarly, and as mentioned at Mello, I’ve been looking for a point to re-enter Next (LON:NXT) but it really doesn’t feel like the right time there either.

As regards Sosandar (LON:SOS) the share price fall today of 15% to 29p doesn’t make any sense at all. We’ve heard from management very recently (in interim results amp; presentations) that business is booming, across all product sectors. They’re very upbeat about how things are going, and broker revenue forecast have been raised recently from £3.9m to £4.15m for y/e 03/2019.

Given the incorrect market read-across, I think it would make sense for SOS to follow the example of BOO, and also put out a brief update. Crunching the numbers myself, and looking at how quickly many lines sell out on Sosandar’s website at full price, I reckon they should be on track for a substantial beat against broker forecast revenues of £4.15m. They achieved £1.85m revenues in H1, and the H2 seasonal uplift should be huge. Therefore I’d be surprised if anything under £5m revenues for the full year are reported.

SOS is achieving these big sales increases on 55% gross margins, way ahead of the 48.4% gross margin being achieved by Asos. That’s because SOS product sells through very fast, at full price – an extremely bullish indicator that the company is designing products which are highly attractive to its core customer, and that demand exceeds supply.

Another point to bear in mind, is that a tiny eCommerce fashion business like SOS can carve out a niche in a gigantic market, irrespective of market conditions, if the product is right. Whereas it’s more difficult for bigger players to buck macro trends.

Incidentally, if you’ve not seen it, there is an excellent video here from 3 Dec 2018, briefing private investors on the recent interim results. This is well worth a look, for people interested in deepening your understanding of the company. I had a more detailed meeting with management a couple of weeks earlier, which was also very upbeat in tone. There’s no read-across at all to Sosandar, from today’s Asos profit warning, in my opinion.

Therefore overall, my view is that I’ll be avoiding Asos, even after this big plunge. Whereas both BOO and Sosandar (in which I have a long position) look like buying opportunities to me. I’m also minded to avoid all conventional retailers for now. There might well be some bargains out there, but we just don’t really know which ones are bargains, and which ones are disasters waiting to happen.

So much business is leaking away online, that conventional retailers with a small/poor online offering are looking very vulnerable indeed.

Whereas niche amp; online retailers continue to do well. Joules (LON:JOUL) was an example of a business that is bucking the trend, with a positive recent update.

I’ll write some more later, or tomorrow. 

Right now I need to stretch my legs amp; forget about the markets for a little while!

Photo-Me International (LON:PHTM)

Share price: 90.7p
No. shares: 377.7m
Market cap: £342.6m

Interim results

Photo-Me International plc (PHTM.L), the instant-service equipment group, announces its results for the six months ended 31 October 2018.

I’ll try to catch up on interim results from this company, a week ago, which slipped through the net at the time.

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