Victoria - Acquiring Momentum

http://www.victoriaplc.com/


When a group of major shareholders attempts to oust an incumbent management team, it is not always a move that ends up positively for smaller shareholders. In many cases their interests are subsequently overlooked, especially if their collective interests represent a low percentage of the company's share capital. Consequently, when a group of shareholders managed to force out the management team of flooring company Victoria, you could have been excused for steering clear of the company. However, a new management team headed up by former Non-Executive Geoff Wilding has revitalised the company over the past two years, and that is reflected in the triple digit one-year price performance.

Technicals


Given the sheer speed at which the share price has recovered from the 145p low and current position well above long-term resistance, there is little technical analysis that can be done that is not on a very short-term basis. Victoria is currently in a situation very similar to that of Character Group where there is little immediate downside support (except for round-number), yet where the fundamentals are clearly strong (otherwise the share price would not have risen so dramatically). That is even more so the case given the market cap of Victoria (now £100m), and the relatively boring sector of operation.

In fact, the rise has been so steep that Cantor Fitzgerald has been caught in a loop whereby their target prices have been met very quickly, and appear outdated despite being issued recently. That loop has seen Cantor upgrade their target price from 420p in October to 650p in early January; that target is comfortably below the current price.

The standout move on the chart was the decline from 250p to 200p that occurred in H2 2014. That move was part of a complex deal that saw Camden Holdings (Executive Chair of Victoria, Geoff Wilding is the settlor) take a 50% stake in Victoria with a 292p/share special dividend being issued to investors. The drop was therefore the result of the special dividend payment, and is reflective that the money had been paid out of the business; the special dividend was of significant size, as reflected in the chart. Importantly, the deal leaves Wilding well aligned with shareholders, and the incredible recovery from those lows is the result of positive operational movements. Equally positively at the time, managers of a previously acquired company purchased £323.5k of shares at 323.5p, although the read-through to a share price of almost 700p is limited. Following small-scale dilution Wilding holds 49% of the shares in issue

The spread on Victoria currently spans 685p - 700p, hence is relatively narrow, even though Victoria is not particularly liquid.

Operations

Victoria Carpets was founded in 1895 in Kirkcaldy, Scotland, and has since grown into the wider UK scene, Ireland, and across the other side of the world in Australia. Indeed, it was the move into Australia around 60 years after establishment that kick-started the more significant growth of the company and has seen the share price appreciate more than tenfold from 63p in 1998 and a stream of dividend payments.

Victoria's business model is vertically integrated in that the company not only owns the spinning mills associated with carpets, but it manufactures them and distributes them under brands such as Victoria Carpets, Munster Carpets (in Ireland), and Flooring at Home. Taking the UK operations as an example, the creation process starts at a spinning mill located in West Yorkshire, and ends with delivery by Victoria's own liveried fleet. The product list does stretch to not only include woven & tufted broadloom carpets, but tiles and rugs. Once the products are made, they are sold through a range of channels including major retailers (such as John Lewis), independent retailers, insurance replacement specialists, wholesalers, under contracts, and for export.

The sector is cyclical around the state of the housing markets in the UK, Ireland and Australia, and the improvements that the housing market has seen over the past couple of years has led to a positive backdrop for Victoria. New housing starts in the UK are forecast to exceed 150,000 in 2015 and it remains the case that the UK has a shortage of housing and in my opinion that the housing sector will continue to perform steadily over the next couple of years, especially given the continued pushing back of UK interest rate rises.

That should assist in gradual underlying improvements in Victoria's top line, with companies in adjacent sectors such as windows and building products (including SafeStyle and Epwin) commenting as such.

However, that gradual growth is not a particularly attractive investment proposition from the low level that Victoria was standing at, hence with the injection of the new management, that strategy has changed and acquisitive growth been relatively rapid. To fund the step-change in growth, Victoria completed a sale and leaseback agreement on their Kidderminster factory for £5.8m in exchange for annual rental costs just £0.5m, and with the later backing of £10m of long-term capital from the Business Growth Fund, embarked along the acquisition trail.

Since 2013 there have been three notable acquisitions, all which carry material deferred consideration (DC) payments:
    -  November 2013: Purchase of Westex Carpets for £16m upfront + DC
    -  September 2014: Purchase of Abingdon Flooring for £7.66m upfront + DC
    -  January 2015: Purchase of Whitestone Weavers for £5.75m upfront + DC
These acquisitions have enabled Victoria to build and benefit from economies of scale.

Commenting on the Whitestone Weavers acquisition, Geoff Wilding, Executive Chairman of Victoria, commented: 

"We are delighted Victoria has been able to acquire the Whitestone group.  It is extremely well regarded within the industry and there are significant opportunities for operational synergies, which will improve the service to our customers and enhance the returns to shareholders. This is Victoria's third major acquisition in just over a year following the acquisition of Westex and Abingdon Flooring.
 
"Overall, when added to our existing operations the three acquisitions have together substantially increased the scale, breadth and reach of Victoria's offering and all are expected to be immediately earnings enhancing.  Our focus is on integrating Whitestone and delivering the synergies and growth we have identified."

The strategy for Victoria remains to acquire complementary businesses within the sector, given the tendency for these factories to have spare capacity and for duplicated costs to be stripped out, thus boosting the operating margins and the benefits dropping to Victoria's bottom line. The flooring (and in particular, carpets) supply market is highly fragmented with several hundred operators within Europe alone; as a result, companies can be picked up at prices that represent low premiums to their net asset value. The focus will remain on providing flooring to the mid and upper end markets.

Financials

To generate the sharp rise in the share price, it would be sensible - and correct - to assume that the financial outlook for Victoria has improve substantially as a result of the acquisitions; the turnover run-rate has increased to over £200m, and the company now operates from 6 manufacturing sites in the UK and 2 in Australia. The acquisitions of Abingdon and Whitestone Weavers alone should contribute £109m in turnover and incremental £3.9m of pre-tax profits, prior to the removal of any duplication costs that should run well into 7 digits.

However, one point to check when a company operates overseas is the exchange rate exposure. In FY14 £38.3m of revenues were derived from Australia with £33m from the UK; as a result of the recent acquisitions, that split has shifted significantly towards the UK side such that, assuming the AUD:GBP rate does not change sharply, it is not something to be focused upon despite the recent move from ~1.85 AUD:GBP to ~1.96 AUD:GBP.

The latest set of results reported for the half-year prior to the acquisition of Whitestone Weavers and did not largely include the acquisition of Abingdon as Victoria's half-year ends 27th September. These are a few key points:
    -  Revenues up to £40.51m vs. £34.53m courtesy of the Westex Carpets acquisition
    -  Pre-tax profits before exceptionals totalled £2.40m vs. £0.51m
    -  Net debt of £20.2m vs. £2.97m following the complex CFD deal. The special dividend was funded out of that debt
    -  Basic adjusted EPS of 19.31p vs. 6.16p
    -  Net cash inflow of £1.68m. This should improve with the acquisitions integrated

Interestingly, when breaking down revenue figures, the Australian performance weakened with revenues and operating profits down 10% and 9% respectively (for the half-year), but the strength of UK operations plus the performance of acquisitions drove the overlying improvements. It's hard to get excited about the financials if you take a static point of view, and that is reflected in a peer comparison with other UK listed flooring companies.


Of the companies shown, Victoria has the second lowest gross margin (excluding Airea) and the second weakest balance sheet, next to CarpetRight. Although that is down to the payment of the special dividend, it doesn't provide a huge amount of financial flexibility until free cash flows filter through from the acquisitions, and further acquisitions would only increase gearing in the near-term. However, that's not really an issue given that the TA/TL figure is still sound at 1.35 and the acquisition trail should be relatively straightforward, given the sector. Victoria does not have a dividend forecast for 2015 (by virtue of the debt pile, which would probably be better spent on acquisitions), and the FY15 forward PE Ratio adjusted for net debt is high at 26.

Whilst those numbers do not paint an attractive picture for a company operating in the household goods and home construction sector - which trades on an average PER of around 15 once outliers are excluded - there are a couple of further points to consider. United Carpets and Airea are also very small companies, hence should trade at a sector discount.

The first is the operating margin; that allows you to work out how lean the business is in terms of overheads, when compared to the gross margin. Between 2009 and 2012, Victoria made an operating margin of just 3 to 4% compared to between 6 and 7% before the financial crisis. A strong operational performance and a positive backdrop in the core markets has meant the operating margin has climbed back up to nearly 6.9%. That compares favourably to the comparator companies who average just shy of 4% (excluding James Halstead, which has robust double digit operating margins by virtue of scale and business model).

The second point is that forecasts for Victoria are key to understanding the current valuation. £6.5m in pre-tax profits on revenues of £129.6m, giving EPS of 33.6p are forecast for 2015. The EPS line is forecast to jump by 38% in 2016 as a result of the acquisitions and generate 46.5p EPS, which is then expected to rise a further ~13% to 52.7p in 2017. Throughout that period, net debt should trend down (albeit at a slower rate than operational cash flow), unless further acquisitions are completed, which would only assist in increasing earnings further. That places Victoria on a 2017 PER of just over 13, albeit closer to 16 when adjusted for cash. The premium to the sector is as a result of the market buying into the acquisition story, which has been executed well thus far.

Commenting in the latest results, Geoff Wilding, Chairman of Victoria PLC commented:

"Progress continues at Victoria, with a record H1 profit of £2.4m before exceptional items. Although Victoria has grown significantly in the last 12 months, the Group's revenues still represents only a tiny fraction of the markets in which it trades. There is both potential for sales to increase in line with the market and the opportunity to grow market share.
 
"The board believes it has an appropriate strategy to further improve the Group's performance and is focussed on its execution."

Laying Foundations for Growth

The acquisitions that Victoria has undertaken, starting with Westex, has enabled Victoria to transform its outlook to one where there is acquisition growth filtering through into both profit and cash flow
improvements. However, at 692.5p, the share price is already factoring in profits for the year until 2017 and is expectant of further acquisitions over the next twelve months. Although the balance sheet is strong enough to cater for at least a further £10m of debt, deferred consideration payments from previous acquisitions and integration costs are likely to slow the cash flow profile of the business, such that the absolute net debt level stays high (barring any fundraise). Therefore, although the profit figures are likely to be attractive looking beyond 2017 and could support a valuation up towards 900p if the market continues to support the growth trend, the three acquisitions made since 2013 alone appear to have been completed on low valuations and carry potentially over £20.5m in deferred consideration payable by February 2018, which could prove an obstacle. I have therefore put a No Rating tag on Victoria at 692.5p.

3 comments:

  1. Hi El1te - excellent analysis as ever.

    So the company's products are sold through insurance companies?
    A typo possibly?

    Regards, Ram

    ReplyDelete
    Replies
    1. I appreciate that was not clear, hence have altered to read "insurance replacement specialists". Many Thanks

      Delete
  2. Very gd call on CCT : ).

    ReplyDelete