Carpetright - An Inflated Bubble

http://www.carpetright.plc.uk/


Carpetright (LSE:CPR) is probably one of the most overvalued UK listed companies at the moment, from a financial perspective. I have described the situation as being similar to an inflated bubble, but in reality that bubble has been inflated for years now, and the company seems to defy gravity. Against an unfavourable economic backdrop over the past five years, Carpetright's share price has been unexpectedly resilient. After being founded in 1988 by Lord Harris of Peckham, the company listed on the LSE in 1993 where its share price has ranged from sub 200p to highs over 1300p. Valued at circa £369m through trading at a share price of 545.5p and having 67.59m shares in issue, the company is being priced at a staggering premium to its retail peers, and that premium appears to be unjustifiable.


From a technical perspective, Carpetright's outlook is weakening. There is overhead declining resistance that has come into action after the shares broke down through their previous 600p-700p consolidation range. The length of that consolidation means that the breakdown should be fairly substantial, although in the short-term there is 500p providing support. However, heading upwards there is massive resistance. There is 50-day MA resistance at around 545p, 200-day MA resistance that is falling from just above 600p levels, previous 600p support that is now resistance and declining trend line resistance around 650p. Therefore a significant rise on volume would be necessary to create a positive outlook. A breach of the red resistance trend line would ultimately mark a turning point in Carpetright's share price, but the chances of that happening are slim.

As will become clearer later, Carpetright's current rating is stretched to say the least. However, it has been stretched over the last few years and there is an obvious question to ask: "Why has the share price not reacted accordingly?" There are probably a couple of reasons. The first is that Carpetright has been heavily shorted by both institutions and retail investors. For example, GMT Capital has recently been increasing its short position to 3%. This increase in shorts over the past few years has a catch. Whilst it indicates bearishness, it actually provides support. The fact that Carpetright hasn't moved downwards as quickly as expected, many shorters would have come to the realisation that they don't want their cash tied up, not making profits during a period of economic upturn. Therefore they would close their shorts as the share price falls a little (none of the falls, until recent, have been convincing enough to signal a real downtrend is starting. As they close their shorts they have to purchase shares, and that props up the share price, thus any minor declines are bought back into. That is backed up by a short-tracker for institutions (only). It shows that, despite a worsening financial performance, Carpetright shorts have declined from over 8% of the stock, to ~5.5% currently.

The second reason for the price resilience has probably been that there have been several large shareholders who hold a major percentage of the stock. The majority are held by institutions, although Lord Harris, and Martin Harris (his son) hold a fairly substantial amount of shares. That means, that in the absence of institutional selling, the share price has been fairly stable. There has been some interesting movement on this front. In December 2013, Martin Harris (who is also the Group Development Director) sold £1.05m worth of his shares. Furthermore, Harris Ventures (a company in which Martin and Lord Harris are involved) sold down a further £12.19m of shares citing 'personal wealth reasons'. Director sales are always worth keeping an eye on, and considering the scale of these sales, it is a bearish signal that carries a lot of weight. The shares were taken up by a number of institutions including BNY Mellon and JP Morgan. That will increase market liquidity making the shares more prone to large movements - after all, institutions are far more likely to move shares around compared to directors.

That worry is exacerbated as the sell came after a poor financial performance. What's even more concerning is that the Darren Shapland resigned (was not dismissed) from his role of CEO in October 2013, just 17 months after taking on the role. He was previously the Finance Director of Sainsbury's. As is usual, no reason was given for the resignation, but I don't imagine he resigned due to the company being on the cusp of a brighter future. The share price dropped sharply upon this announcement. In the interim Lord Harris (now 71) stepped back into the frame as Executive Chairman.

Carpetright is a leading specialist floor covering retailer through its primary brands CarpetRight and Storey Carpets. These coverings include carpets, rugs, vinyls and laminates which are made through their cutting and distribution factory in Purfleet. To maintain customer footfall, the company has deviated slightly from that path, selling beds through their brand SleepRight beds. Therefore there is some discussion to be had whether the company more closely follows that of a retailer, or that of the home construction sector. I'd argue the latter and that has probably been helping support the share price. The hosuing market has been recovering strongly over the past year and some of that strength is likely to have rubbed off on Carpetright, although it shouldn't have as past results demonstrate the company is yet to track that recovery.

Note: The 2013 profit figures were negatively impacted by a substantial amount of exceptional costs.  Without these, the decline from 2012 would appear more gradual
The historical results above show that the company has really struggled since the pre-crisis years. In 2006, whilst revenues were lower than in 2010, the underlying pre-tax profit was excellent at £56.7m and net debt was at comfortable levels around £29m. However, since 2006, the initial increase in revenues only masked the declining state of the business with underlying pre-tax profit plummeting and net debt rising sharply. In recent years, revenues have re-entered a downward trend, pre-tax profits have continued to fall, and whilst net debt has fallen pretty significantly, the business is certainly not a growth prospect and the underlying performance has been weak.

The H1 2014 results came after the company warned that profits would be significantly below market expectations during a trade update. Looking more closely at the H1 2014 results, these were the key points:
- UK revenues down 2.2% and other European revenues down 2.4%. Around 83% of the revenues were from the UK
- Underlying operating profit in UK of £5.5m (vs. £5.2m), but a £1.4m loss in the Rest of Europe [ROE] (vs. £0.2m profit)
- Underlying EPS of 3.2p and Basic EPS of 2.8p
- No dividend

On the UK front, the company commented that 'self-help initiatives' continued to show growth, like-for-like (L4L) revenues were down 0.8%, gross profit rose to 63.1% and the number of stores fell to 474. In the ROE, L4L sales fell 8.6% and there were difficult conditions in the Netherlands. The fact that the European operations as a whole are not generating an operating profit is quite worrying, especially when conditions are unlikely to recover in the short or medium-term.

You can probably see why a £369m valuation is ridiculous. Carpetright have said that they expect a better H2 result, so assume 11.5p FY EPS as per forecasts - that is a PER of 47.4. That is the sort of PE ratio that you would expect of a technology firm that is growing extremely quickly. It is certainly not the sort of valuation that should be given to a firm like Carpetright. There is also strong chance that the debt level of £14.3m could start to rise back up in light of the poor trading conditions. 1 year borrowings total £11.7m, although most of these are overdrafts so won't carry the same repayment terms as commercial loans. Cash declined from £7.9m to £6.0m over the period although debt facilities of £62.0m are available and run through to July 2015.

What is a fair valuation? These sorts of companies are generally valued at a PE ratio of 12-18 in normal circumstances, and that only equates to a share price of 138p - 207p at EPS of 11.5p. That valuation is backed by property owned by the group has been valued at circa £79.2m. At 207p Carpetright would be valued at £140m or £154.3m when adding back the debt pile. That would equate to a share price of ~228p. Even factoring in higher future earnings, there is a huge disparity between the current share price and what should be fairer value. I certainly would not want to be paying on the assumption of future growth given the company's track record.

Consequently, it genuinely startles me that N+1 Singer can put a 710p target price on Carpetright. That target surely includes a significant turnaround of the business and factors in all of that reward without factoring in the risk. To put it into perspective, to be trading on a current PER of 18, the company needs to make 30.30p EPS and that would require a Post-tax profit of around £20.5m.  Elsewhere in the results, the company had a small £4.7m pensions deficit and there is a large amount of net payables. However, that net payables figure has been in place for several years so arguably is not a massive issue. When factoring out receivables and inventories, that figure runs at £40.4m. The balance sheet is fairly weak with a current ratio of only approximately 0.60 although that is skewed downwards by the dormant payables.

Executive Chairman Lord Harris said: "While we anticipate trading conditions will remain challenging, we expect these self-help initiatives will underpin an improvement in Group performance in [H2] and our [revised] expectations for the year remain unchanged." Elsewhere in the results he commented, "Although UK economic data has begun to indicate improved prospects, this has yet to impact consumer spending in our categories".

To try and counter-act the operational decline, they are modernising the profitable estate, rationalising the portfolio of estate, increasing their internet presence and increasing their sales of beds (which amounted to 7.1% of total UK revenues during H1 2014). Whether that is enough remains to be seen.

There are a wide range of price targets from brokers as follows:
- Liberum Capital: Sell. Target = 400p
- Deutsche Bank: Hold. Target = 565p
- N+1 Singer: Buy. Target = 710p
- Numis: Sell. Target = 400p
- Cantor Fitzgerald. Sell. Target = 500p

Carpetright is set to release its Q3 IMS on Tuesday 28th January. That is expected to outline a slight improvement as the company have hinted at, but it is likely that the overall performance will still have been pretty dismal. If there has not been an improvement, there is the chance that another profit warning will be released. Ultimately there is little to dispute in terms of Carpetrights valuation. The underlying business is declining, and the current valuation is exceptionally high. Technically there is plenty of resistance that should limit upside, and few support zones to the downside. Several supports as outlined at the start of the article have been removed and that could contribute to further price weakness. For those reasons, I am putting a Sell tag on Carpetright. It is probably unrealistic to expect a quick decline, but once there is a significant downward movement, I expect it will lead to a much larger fall. There have been plenty of warning signals over the past year to suggest that this inflated bubble will continue to deflate.

UPDATE (26/04/14) - I have moved CarpetRight from Sell to No Rating after a second profit warning this morning. The company remains ludicrously overvalued, and I intend to re-open a sell position in the future, but I am also aware that there are many good buying opportunities opening up, and don't believe the current leg down will be sustained. I have therefore freed up this position in the short term

7 comments:

  1. Thanks for the interesting piece and the chart

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  2. God i hate this company!

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  3. Check the short interest.... its one of the most shorted stocks on the LSE (hence the high price)

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  4. Fantastic call el1te. They issued a profit warning today

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  5. God I hate this company more and more!

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  6. I can not wait for this company to fall! They are the worst company in the world to work for and their down fall will be how they treat people, their debtors and mainly their staff. Over the years they have some how managed to recruit highly skilled people but then walk all over them with total disrespect.
    there fore they will have soon exhausted the life blood and will only be able to keep hold of the desperate seeking work. The best has already gone and now the constant staff turnover will result in their further downfall. Cat Stephens made a song about them called Mathew & Son. This company is the modern version of that song. They are ruthless bullies who lead by intimidation and bending all the rules to suit them selves. All the toys come out the pram when any one fights back and they are sore losers. Like most bullies they are week. They will fall and the sooner the better.

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    1. Fair comment. A shame that I was unable to re-open a short position after various resistance levels held. Clearly the share price has collapsed since!

      Best,
      El1te

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