Halfords Group Plc (GB00B102TP20) – UK Retail contrarian opportunity ?

I have been looking at only a few UK stocks so far in more detail, mainly Creston PlC, Colefax and Home Retail Group.

So far, the results have always been rather dissapointing. Nevertheless I still find depressesd sectors such as UK retail interesting from a contrarian point of view. Also from a portfolio risk point of view, I could afford some UK exposure as with the exeption of Total Produce, I have virtually no exposure to UK stocks or markets.

Let’s look at Halfords Group Plc:

According to the website,

Halfords is the UK’s leading retailer of automotive and leisure products and leading independent operator in garage servicing and auto repair

The Halfords Group comprises two strategic business units — “Retail” in the United Kingdom (UK) and the Republic of Ireland (ROI) and “Autocentres” in the UK.

Halfords Retail operates through a national network of stores and an innovative online offer. The product ranges are divided into three categories: Car Maintenance, Car Enhancement and Leisure (Travel Solutions & Cycling).

Halfords Autocentres offers MOTs, car servicing, repairs and tyres to both private motorists and fleet clients throughout the UK. It provides customers with dealership quality service at more affordable prices backed by the guarantee of Halfords’ trusted brand.

Fundamental overview:

As always, let’s start with a quick overview of traditional valuation metrics:

P/E: 7.0
P/B: 1.67
P/B tangible: neg.
EV/EBITDA (12m): 4.8
Div. Yield: 10.2%

A quick look into the history (since the IPO in 2004) shows relatively consistent and high profitability and cash flow generation:

EPS FCF ROIC dvd Net margin
31.12.04 0.24 0.29 16.3 4.11 8.1
30.12.05 0.24 0.17 16.4 13.67 7.9
29.12.06 0.26 0.25 16.8 14.56 7.7
31.12.07 0.29 0.23 17.5 15.83 8.0
31.12.08 0.27 0.27 17.7 17.06 6.9
31.12.09 0.37 0.63 19.4 18.78 9.3
31.12.10 0.41 0.47 21.3 24.44 9.8
30.12.11 0.34 0.36 17.1 24.44 7.9

So clearly, Halford’s is not an asset play but a cashflow play. Which is not a surprise as before its IPO, Halford was owned by PE inevstor CVC.

A quick look at the stock chart shows some serious negative momentum:

Potential issues to look at

For A UK retail Group, I would like to look first if anything is lurking in both, Operating Leases and pensions. As a reference, I use the PDF version of the 2011 annual report.

Pensions

The only reference to pension I could find was this statement:

24. Pensions
Employees are offered membership of the Halfords Pension, which is a contract based plan, where each member has their own individual
pension policy, which they monitor independently. The costs of contributions to the scheme are charged to the income statement in the period
that they arise. The contributions to the scheme for the period amounted to £2.8m (2010: £3.2m).

So I assume that they only have defined contribution plans and no DBO’s (defined benefit obligations), which is VERY GOOD.

Operating Leases

One of the big issues for retailers in a declining market are often the leases which represent to a certain extent fixed liabilities but do not show up on the balance sheet under current accunting rules.

Halford’s as well doesn’t own its retail outlets but leases them.

For 2011 they state 87 mn GBP property rent payments and income of 7 mn GBP from subleases. In the notes they show around 740 mn GBP total lease commitments on a gross basis which translates into a ~8.5 year average duration.

As future lease commitments include interest and pricipal, one should try to adjust for this by a factor. If we assume for instance an implicit interest cost of 5%, then we would have basically 8 x 5% “coupons” include in the obligation. So to derive a “real” liability”, we would need to deduct the interest.

With a very simple calculation and assuming 5% interest on 8 years, we would get =740/1.4 ~ 530 mn GBP “on balance sheet” liability.

We can then recalculate EV/EBITDA by adding net rent income 80 mn GBP to EBITDA and add 530 mn GBP to EV.

Current EV is stated by Bloomberg at 618 mn GBP, EBITDA at 618/4.8= 129 mn GBP.

Restated EV/EBITDA would then be (618+530)/(129+80)= 5.45 . So not as cheap anymore as before (4.8) but still Ok.

A quick look at other factors:

Share buy backs: Additionally to dividends, the company has a history of significant share buy back programs since 2007. Total share count has been reduced from 227 mn shares to currently 190 mn shares.

Management & Compensation: At a first glance positive. Moderate salaries howver ongoing share option programs which slightly increase sharecounts.

Shareholders structure

Company is widely held by investment management companies (Capital Research, Artemis, Blackrock). So a take over could happen and should protect the stock to the extreme down side, on the other hand maybe long term investments are not popular. So far I would say the company is very shareholder friendly which is good.

Analyst sentiment

Stock is covered pretty well by analysts, but sentiment is pretty bad, some analysts (JP Morgan,HSBC, Deutsche) just downgraded the stock. From a contrarian point of view, bad sentiment is good.

Known Problems

The biggest problem for Halfords is the shrinkage in its core Retail segment (they acquired the auto repair segment only in 2010).

In the 2011/2012 statement, retail shrank like for like by -2.7%, which is still better then the -5.5% decrease in 2010/2011. If one considers the relatively high inflation rate in the UK, the decrease in real term is even more significant.

Especially in car audio and sat nav systems, Halfords is clearly suffering thorugh the disintermediation of Amazon and Co. Howver, management seems to have reacted to the trend and seems to concentrate now on services and “i need them now” items and services.

For me how ever it is really difficult to evaluate how much of the “retail segment” is stil exposed to the structural shift and how succesful Halfords own online sales will be.

Quick view at valuation

The question is of course what could Halford be worth ? A very rough indicator would be the average 5 year free cashflow of 39 cent and a discount rate of 10% which would indicate a´”going concern” value of 390 pence or a healthy 63% upside.

The simplified 7 year Boss Score would be 2.74 which is very good and would also imply signifcant upside, howver assuming constant profits.

Momentum / relative strength

So now we come back to relative strength and momentum. The following table shows the relative performance against the index over the last relevant periods:

REL_5D REL_1M REL_3M REL_6M REL_1YR
hfd ln equity -14.0% -5.5% -11.2% -21.2% -34.2%

We see negative relative performance over the last 12 months in every period. Under my current leanring experience regarding momentum, this is a clear warning sign that despite the big repurchase program, the performance is so bad.

Summary:

+ Halford is very shareholder friendly and cash generative
+ valuation on looks quite attractive for a “FCF play”
+ no hidden pension liabilities etc.
+ very transparent reporting, clear communication

– due to private equity pasts no significant assets to protect downside
– business model is in a transition phase, main business line still deteriorating and shrinking
– negative stock price momentum

I could live either with a shrinking core business or negative momentum but not with both. So for the time being, I will put Halford on “watch” only and wait for either a turn around in sales in their core business or at least “neutral” relative price momentum before investing here.

11 comments

  • thanks for the update, UK percentage used to be bigger in the past.

    Retail: Let’s wait and see.Don’t forget that Tesco is under attack in the UK as well. Hard discount (Aldi, Lidl) is gaining market share:

    http://www.guardian.co.uk/business/2012/apr/24/tesco-loses-market-share-kantar-worldpanel

  • mmi,

    total produce revenue:
    Eurozone Fresh Produce 1,205
    Scandinavian Fresh Produce 595
    UK Fresh Produce 486
    Other Fresh Produce 171
    Inter-segment revenue (29)
    Total Fresh Produce 2,428
    Consumer Goods and Healthfoods 99
    Unallocated costs (2.9)
    Total Group 2,527

    I agree that retail is about local markets. Maybe the internet will play a bigger role in the future and the international retailers can better utilize their intangible assets like software. Economies of scale can matter in procurement and they have blueprints for buildings and best practices to roll out in other countrys.

    • tom,

      thanks for the link, but pages are empty. However, I have read “competition demystified” where he has a chapter on local moats.

      mmi

      • hm.. when i click the link it works. sorry

        maybe try google with ‘all strategy is local, bruce greenwald, judd kahn’ or something like that.

  • martin,

    i know that Total produce is from ireland, but a significant part of theri business is in the UK. For my stocks, I try to identify where they do business, not where they are listed.

    About tesco: In my opinion, competitive advantages are local. So being number #2 in the world means nothing. If tesco is great in all its local markets then OK.

    MMI

    • memyselfandi007 :
      martin,
      i know that Total produce is from ireland, but a significant part of theri business is in the UK. For my stocks, I try to identify where they do business, not where they are listed.
      About tesco: In my opinion, competitive advantages are local. So being number #2 in the world means nothing. If tesco is great in all its local markets then OK.
      MMI

      this has nothing to do with the topic, but on local advantages, this is a nice paper from greenwald & kahn:
      http://www.capatcolumbia.com/Articles/FoStrategy/All%20Strategy%20is%20Local.pdf

      maybe someone is interested,

      tom

  • total produce is from Ireland. I have looked into them because they are one of the cheapest food&bevereage stock I know (which earn money).
    Tesco has much capex this year and is complicated to understand. But I am quite confident for 2013. I dont like that they spend so much capex in the uk where they are not growing. However they invest into their internet activities, too. The have exposure to growing economies. Wal-mart has the better profitability (but fair priced). tesco is #2 world-wide and they have a new ceo.
    halford is cheap, maybe this can become a bargain.

  • hope_to_survive

    One of my friends used to be a customer of Halfords until he found out that they do a relatively poor job and charge higher fees then independent repair shops. I would stay away from the stock

  • tom,

    Tesco is on my research piule. I used to have in the portfolio but sold it. Its a very complicated big company, so I am not sure when I will be able to analyze it.

    mmi

  • could be interesting, maybe i will take a look at the company for myself if i find the time.

    to your thoughts on uk exposure: did you ever look at tesco plc (GB0008847096)?

    because the stock looks interesting to me at a price of about 300 pence, and i like reading your blog. would be nice if you could take a look at it (and post your thoughts).

    best
    tom

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