It’s never nice to wake up to a profit warning, particularly for a small-cap share. But that’s what happened to me this week with Moss Bros. Currently the market absolutely despises the retail sector and for good reason, a whole host of restaurants and clothing stores are struggling, and many of them make good news copy. Despite the projections that the economy is in good state it appears that customer confidence is on the wane.
As I suspected, having a stop loss in one of these events is like having a chocolate teapot: the price simply falls through it and your stop remains intact. At this point, your choice is simply whether to keep holding or whether to cut your losses. After my pain on Carillion (where I obstinately held on), and after reading the relevant reports, I decided to go. The share price action was as follows:
I first entered the share at around 60p after the first profit warning, and we had almost an immediate rally to 70p, but since then the drift downwards has been consistent.
I think it may be worth asking the question: why buy in the first place? I think (and I still do) that there are quite a few good things about Moss:
- Debt-free; and are still carrying £17.1m in cash – that’s particularly relevant due to their market cap.
- A continual track record (6 years) of revenue, operating margin and profit increases.
- A progressive dividend policy.
- Cash generative and as they receive payment up front for their goods, no liquidity worries.
To be fair, this isn’t a business in any immediate danger, unlike the several others that are seeking administration or a CVA. But the bad news is enough for me to leave. If we take the belief that the company seeks to paint the best picture of the information given (a fair assumption) then it could be that further pain is yet to come.
The timing of this profit warning seems odd for me. Moss Bros already warned on profits in their update in January, so this represents the second warning in the space of a couple of months. Considering that these projections are for the year ending January 2019, there must be some fairly good reasons to be making these projections. And these are not small, as they say:
Following a review of projections for the year ending 26 January 2019, the Board now anticipates that the Group will deliver profit at a level materially lower than current market expectations.
One really annoying thing about this is that no numbers are included – would it have hurt to include some guidance? This is a mature business with rather stable demand, so I would theorise that financial projections are not included because either they want to avoid spooking the market with a low figure or that they have no confidence in hitting a revised figure. Both of which are bad.
To be fair, there are several specific reasons given for their projections:
· Following the consolidation of the Group’s supplier base in response to Sterling weakness, there have been material short-term issues with the resulting availability of stock. This stock shortfall across all categories has had a negative effect on sales in all retail channels and will continue to do so until late Spring.
· Hire sales continue to be challenging, although the peak trading period for Hire is still to come. As such the Group has remained prudent in its outlook.
· The reduction in store footfall that was experienced towards the latter part of December, has continued, reflecting a more cautious consumer environment.
I can’t say I’m particularly impressed with the first reason. If you’re going to cut a supplier, at least make sure there are substitutes in there somewhere.
The questions about the second and third reasons will be whether they are temporary, or part of a longer-term trend. Having reflected on this I do believe that the upside in recovery for these particular reasons are limited. Suit hire was perhaps common a generation ago, but the value for money is questionable nowadays. For example, on their web-site you could hire a suit for the sum of £59 – marketed at ‘race day’ goers. But with the cost of a suit rapidly dropping, the decision to hire rather than purchase makes little sense, particularly for the individual that can afford to spend several hundred pounds attending such a race meeting. The suit in question isn’t even a great suit, and could be picked up fairly cheaply in their sale.
Hire for weddings is a different animal and certainly a viable market, although it seems that this too faces an uncertain future. The trend for weddings appears to be downwards, and the trend for lavish weddings also seemingly downward. There is also potential for price competition in this sector as the profits on hire are tremendous.
Footfall is a genuine challenge, and only likely to be more pronounced if lack of stock is available. A store like Moss doesn’t really appeal to men simply dropping in for a look around; people go there with something in mind. As far as the competition goes, I would place them at the ‘low-cost’ category, but with a solid brand name and no implied affiliation to any brand this offers a few different strategies for the future.
Perhaps the biggest kicker was the dividends may be on the wane:
As a consequence of this revised view on FY18/19 results, the Board has reviewed its approach to dividend. The Group has a strong balance sheet but, given the more challenging trading environment, the Board is taking a prudent approach to capital management and has decided to modify the existing dividend policy to ensure that we are able to fully cover our future dividends with profits in FY20/21 and onwards. The Board will therefore be recommending a final dividend of 1.97p, meaning a total FY dividend of 4p per share for FY17/18 (5.89p FY16/17).
This is actually quite sensible, as dividend cover in previous years was below 1, meaning they paid out more than they made. The share still trades on an extremely high yield, but with the dividend policy changing, future cuts cannot be ruled out particularly if more bad news happens.
So for some of these reasons, I am out. It is quite difficult to put a valuation on them at the moment because it is yet to be seen what ‘material’ means in terms of their profits, and the obvious route to improving them and margins is not a price war as implied here:
We do believe continued investment is essential to ensure we retain a sustainable point of differentiation and that we leverage our distinct position on the high street.”
I do believe that Moss has a few advantages over the competition; many of their stores are much larger and spacious than competitors such as TM Lewin, and their perception for suits is a lot higher than Burton, Top Man, Next (even if the product may not be necessarily that much better). The made-to-measure market appears ripe for them; they could replicate a price point of the pure internet players and offer an in-store service that would be difficult to match for others.
That said, such a move would likely decimate their cash pile and in the past this is something they have been very keen to protect. And leaving themselves short of cash would also increase risk quite a lot. In this sector, one poor season might be enough to put a company in real trouble.
I had thought about moving to other retail companies (for the sake of diversification in my portfolio). Bonmarche is another company that I liked, and are trading at 20% less than when I acquired Moss Bros. Currently their market cap is actually even less than Moss, and similarly they are a company with a track record of profits, are debt free with a cash cushion and their dividend is well covered by profit. But with bad news being severely punished at present in this sector, I’m inclined to invest elsewhere.
Pure Passive Investor. Always looking for ways to make money (but not myself) work harder.