Dunelm Trading, Abrupt Share Price Moves and Volatility

It’s a good job I am not an emotional person. This morning Dunelm (DNLM) issued what I considered a very positive trading statement for the last quarter. The share price promptly dropped 6% after the market opened.

Total group sales were up 5.8%, with like-for-like sales up 6.4%. In addition this is a company that is clearly making a successful transition from being a retail store business to a hybrid on-line/store model. On-line business was up 34.7% while store business was still up 2.9%. On a prospective p/e of less than 15 and a yield of over 4% this is starting to look attractive. The company says year-end expectations remain unchanged as it continues to win market share. The only slight negative was that “September trading was mixed in part reflecting a softer homewares market”. But should a retailer be judged on one month’s trading alone?

This is the third of my holdings to suffer abrupt falls in the last couple of days. The others were 4Imprint (FOUR) and Telecom Plus (TEP), neither for any very obvious reason although there were some large trades put through on the former. But the UK market has been falling driven by the nervousness over resolution of the Brexit situation no doubt. That looks even more problematic at present with it being clear that the EU thinks they can force Brexit to be cancelled by sitting on their hands and dictating another referendum or general election before they will negotiate a withdrawal agreement. Conspiring with Speaker John Bercow is the latest attack on the democratic constitution of the UK by the EU in furtherance of this objective. What’s the motivation for the position of the EU Commission on all of this? I would suggest as usual it’s about money which always drives politics and the actions of individuals. The departure of the UK from the EU will leave a massive hole in the EU budget which they have not even attempted to solve as yet.

These events mean of course that foreign investors, who hold the majority of UK listed companies, are spooked and the risk of a future Labour Government rises as the leavers vote is split between Conservatives and Brexit party supporters. The only positive aspect is that the falling pound, driven by the same emotions, is improving the potential profits of many of my holdings which have large overseas revenues. 4Imprint comes into that category of course so the recent falls are difficult to explain except on the basis of recent past irrational exuberance. Smaller cap stocks are particularly vulnerable because just a few trades can move the share price substantially.

When markets and investors get nervous, volatility does increase and sharp share price falls can happen for no great reason. This is the time to pick up some bargains perhaps?

Postscript: Commentators on the Dunelm results after the share price fell further focused on the threat to margins from a falling pound, but the company announcement indicated that they expect gross margin for the full year to be consistent with last year despite currency headwinds towards the end of the year.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Victoria AGM, Dunelm Results and Brexit Impacts

I attended the Annual General Meeting of Victoria (VCP) in central London yesterday. I have held a few shares in this producer of carpets and tiles since the revolution that installed Geoff Wilding as Executive Chairman a few years ago. He did a great job of turning the business around but the share price fell back sharply last October over concerns about the level of debt and a failed bond issue to replace bank debt which cost £7.3 million As Mr Wilding says in the Annual Report: “There is no way to view the majority of these costs other than, with the benefit of hindsight, a waste of money”. The Annual Report is certainly worth reading as it is a good example of the Chairman and CEO revealing their thoughts on many issues rather than the polished and anodyne statements you see in most such reports.

The company has subsequently issued some loan notes with a five-year term and fixed rate of interest to replace some of the bank debt. These were described as “covenant light” in the meeting. The company has adopted the use of high debt levels (net debt/EBITDA ratio of 3.2) to finance acquisitions and to finance substantial restructuring of its operations. There is extensive justification of this policy in the Annual Report but there are clearly still concerns among investors.

Last year the company reported a loss of £7.9 million despite reporting an operating profit of £24 million because of the exceptional finance costs, restructuring costs and amortisation of acquired intangibles. This is one of those companies where it is best to look at the cash flow statement to see what is going on as the accounts are otherwise quite confusing. The company did generate £52 million in cash from operations last year.

An announcement from the company on the morning of the AGM contained positive comments and they expect to meet market expectations for the full year. They are also continuing to look at further acquisitions although it states “mindful of financial leverage levels, the Board is proceeding cautiously”. I would certainly like to see some reduction in debt levels with fewer exceptional costs for a period of time.

There were less than a dozen shareholders at the AGM. There were only a few questions. One was on the attributes of new non-executive director Zachary Sternberg, and what he will be contributing. Apparently he is the investment manager of a US fund who have a 15% stake in Victoria. It was said he is very good at financial analysis but is not a flooring expert.

I asked about the breakdown of sales. Turf (i.e. artificial grass) is now 4% and growing. Otherwise it’s about two thirds tiles to one third carpet. In Europe hard flooring (not just tiles but wood/laminates) is growing but the demand varies between countries. That surely is has been a long-term but slow trend in recent years in the UK for example. Even my wife wants to replace our hall carpet with something else because she is tired of cleaning it but other areas are likely to remain carpet.

I also asked about the impact of Brexit, hard or otherwise. Earlier in the year they built up stock in case of disruption and are now doing this again. But the CEO said they might be able to take advantage by increasing prices. He did not appear too concerned about the prospects.

In summary a useful meeting, but investing in this company is very much dependent on one’s trust in Geoff Wilding to manage the debt levels and its business operations wisely. Mr Wilding has a beneficial interest in 18% of the shares although he did dispose of some shares last year.

Another company I hold is Dunelm (DNLM). The company issued preliminary results this morning and at the time of writing the share price is down about 8%. That may be surprising because the earnings were slightly better than forecast and a special dividend was also declared. Like-for-like revenue was up 10.7% and market share is increasing in the homewares sector. The company appears to have been successful in moving into “multi-channel” operations with internet sales rapidly increasing. So why would shareholders be concerned about the announcement?

One comment in the announcement was “Whilst trading performance has continued to be strong, we remain cautious about the full year outlook due to ongoing Brexit uncertainty and specifically the impact it may have on consumer spending as we enter out peak period”. They go into more detail on the impact of Brexit, especially a “no-deal” version which might disrupt imports after the possible Oct 31st date. But if Boris Johnson loses his fight against the “remainers” this evening then it could be put off yet again, even into “never-never” land. Comment: What a shambles and the House of Commons is descending into anarchy. I hope Mr Johnson manages to call a General Election to get this matter settled finally. But at least a Scottish Court has rejected the challenge to the Government’s ability to prorogue Parliament which was surely misconceived. Legal cases driven by emotion are never a good idea.

As regards Dunelm, perhaps another issue that rattled investors was the adoption of IFRS16 which will apparently reduce group pre-tax profit by approximately £3 million (i.e. by about 2.3%) but with no impact on cash flows. However EBITDA will increase. IFRS16 concerns accounting for leases and has surely been well known about for some time so it is odd if this was the cause of the share price fall.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Debenhams PrePack, Dunelm Trading, ASOS and Privacy

Department store operator Debenhams (DEB) has been put through a pre-pack administration. It’s been bought by a new company formed by its secured lenders. Mike Ashley of Sports Direct is furious. His company invested £150 million in the shares of the company in the hope of taking it over, which will now be worthless. He had some choice words to say on the subject which included that it was an “underhand plan to steal from shareholders”, “as normal politicians and regulators fiddled while Rome burnt”, and that they “have proven to be as effective as a chocolate teapot”. I have much sympathy with Mike Ashley and the other shareholders as I have consistently criticised the use of pre-pack administrations in the past. It is an abuse of legal process. Why could it not have been put through an ordinary administration as the company appears to be a going concern, albeit with excessive debt, or Ashley’s offers considered?

Mike Ashley had previously made various offers to refinance the business including a pledge to underwrite a rights issue, but to no avail. It is not clear why his proposals were rejected, but as usual with pre-packs it is probably just a case of the lenders seeing the opportunity to make more money from a pre-pack. Ashley suggests he might try to challenge the pre-pack although that will be difficult now the deal is done.

What went wrong at Debenhams? Basically an old-fashioned retail format where sales were relatively stafic compounded by very high and onerous property leases and massive debt.

Contrast that with the trading statement from Dunelm (DNLM) this morning. This company sells home furnishings from out of town warehouse sites (not on the High Street like Debenhams) and have moved successfully into “multi-channel” operations with a growing on-line sales proportion. Overall like-for-like revenue in the third quarter is up by 9.8% with on-line sales up 32.1%.

Retailer ASOS (ASC) also announced their interim results this morning. Sales were up 14% but profits collapsed with margins declining and costs increasing while they invested heavily in technology and infrastructure. Competition in on-line fashion is increasing but you can see that such companies are taking a lot of business from High Street retailers, particularly in the younger customer age segment. The world has been changing and Debenhams has been an ex-growth business for many years. I do most of my clothes shopping, but not all, on the internet which shows even oldies are changing their shopping habits. I have never held Debenham shares although I do hold some Dunelm and have held ASOS in the past. But declining businesses with high debt are always ones to avoid however cheap the shares may appear.

Readers of my blog should be aware that after many years and growing amounts of spam I am changing all my email addresses. You can either contact me in future via the Contact page of my web site (see https://www.roliscon.com/contact.html ) or via the Contact tab on this blog.

It’s taking me some time to notify all the hundreds of organisations I am signed up with of my new email address. But that was almost frustrated when one of them sent out an email to all their clients using cc. rather than bcc. They have reported themselves to the Information Commissioner! But will they take any action? I doubt it. Thankfully the company in question used one of my older addresses which will soon be deleted. Such idiocy is not acceptable.

Another problem I am having of late is that if I mention a company or look at its web site, I then subsequently get bombarded with web advertising. So I am now seeing repeated advertisements for SuperDry products when I have absolutely no interest in such products. Despite removing cookies they still appeared. This is the kind of problem that is annoying people about the lack of privacy in the modern world and which needs tackling.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Autonomy, FRC Meeting, Retailers and Brexit Legal Advice

The big news last Friday (30/11/2018) was that former CEO Mike Lynch has been charged with fraud in the USA over the accounts of Autonomy. That company was purchased by Hewlett Packard who promptly proceeded to write off most of the cost – see this blog post for more information: https://roliscon.blog/2018/06/02/belated-action-by-frc-re-autonomy/. As this was a UK company, are we anywhere nearer a hearing in the UK over the alleged “creative accounting” that took place at the company and the failure of the auditors to identify anything amiss? That’s after 8 years since the events.

As I was attending a meeting held by the Financial Reporting Council (FRC) for ShareSoc and UKSA members yesterday, I thought to review the past actions by the FRC on this matter. In February 2013 they announced an investigation but it took until May 2018 to formally announce a complaint against auditors Deloitte and the former CFO of Autonomy Sushovan Hussain who has already been convicted of fraud in the USA. On the 27th November, the action against Hussain was suspended pending his appeal against that conviction, but other complaints were not. But why the delay on pursuing the auditors?

The FRC event was useful in many ways in that it gave a good overview of the role of the FRC – what they cover and what they do not cover which is not easy for the layman to understand. They also covered the progress on past and current enforcement actions which do seem to have been improving after previous complaints of ineffectiveness and excessive delays. For example PWC/BHS was resolved in two years and fines imposed are rising rapidly. But they still only have 10 case officers so are hoping the Kingman review of the FRC will argue for more resources.

It was clear though that audit quality is still a major problem with only 73% of FTSE-350 companies being rated as 1 or 2A in the annual reviews when the target is 90%. The FRC agreed they “might be falling short” on pursuing enforcement over poor quality audits. So at least they recognise the problems.

One useful titbit of information after the usual complaints about the problems of nominee accounts and shareholder rights were made (not really an FRC responsibility) was that a white paper on the “plumbing” of share ownership and transactions will be published on the 30th January.

There were lots of interesting stories on retailing companies yesterday. McColl’s Retail Group (MCLS) published a very negative trading update which caused the shares to fall 30% on the day. Supply chain issues after the collapse of Palmer & Harvey are the cause. Ted Baker (TED) fell 15% after a complaint of excessive hugging of staff by CEO Ray Kelvin. This may not have a sexual connotation as it seems he treats male and female staff similarly. Just one of the odd personal habits one sees in some CEOs it seems. Retail tycoon Mike Ashley appeared before a Commons Select Committee and said the High Street would be dead in a few years unless internet retailers were taxed more fairly. He alleged the internet was killing the High Street. But there was one bright spark among retailers in that Dunelm (DNLM) rose 14% after a Peel Hunt upgraded the company to a “buy” and suggested that they might be able to pay a special dividend next year. There was also some director buying of their shares.

Before the FRC meeting yesterday I dropped in on the demonstrations outside Parliament on College Green. It seemed to consist of three fairly equally balanced groups of “Leave Means Leave” campaigners, supporters of Brexit and those wishing to stay in the EU – that probably reflects the composition of the Members in the House across the road. You can guess which group I supported but I did not stay long as it was absolutely pelting down with rain. There is a limit to the sacrifices one can make for one’s country.

But in the evening I did read the legal advice given to Parliament by the attorney-general (see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/761153/EU_Exit_-_Legal_position_on_the_Withdrawal_Agreement.pdf

Everyone is looking very carefully at the terms of the Withdrawal Agreement that cover the Northern Ireland backstop arrangements. The attorney-general makes it clear that the deal does bind the UK to the risk of those arrangements continuing, although there is a clear commitment to them only lasting 2 years when they should be replaced by others. There is also an arbitration process if there is no agreement on what happens subsequently. However, he also makes it clear that the Withdrawal Agreement is a “treaty” between two sovereign powers – the UK and the EU.

Treaties between nations only stick so long as both parties are happy to abide by them, just like agreements between companies. But they often renege on them. For example, the German-Soviet non-aggression pact in 1939 was a notorious example – Hitler ignored it 2 years later and invaded Russia. Donald Trump has reneged on treaties, for example the intermediate nuclear weapons treaty last month. Similarly nations and companies can ignore arbitration decisions if they choose to do so.

What happens after 2 years if no agreement is reached and the UK insists on new proposals re Northern Ireland? Is the EU going to declare war on the UK? We have an army but they do not yet have one. Are they going to impose sanctions, close their borders or refuse a trade deal? I suspect they would not for sound commercial reasons.

Therefore my conclusion is that the deal that Theresa May has negotiated is not as bad as many make out. Yes it could be improved in some regards so as to ensure an amicable future agreement but I am warming to it just like the Editor of the Financial Times recently. He did publish a couple of letters criticising his volte-face when previously he has clearly opposed Brexit altogether, but changing one’s mind when one learns more is just being sensible.

Note: I have held or do hold some of the companies mentioned above, but never Autonomy. Never did like the look of their accounts.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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CAKE (Patisserie), Foresight 4 VCT AGM, Payment Companies and Dunelm

More bad news from Patisserie Holdings (CAKE) today – well at least you can’t say the directors are not keeping you informed about their dire situation which is not always the case in such circumstances.

Yesterday the company announced that its major operating company had received a winding-up petition from HMRC, of which the directors had only recently become aware. Today the company said after further investigation the board has reached the conclusion that without an “immediate injection of capital, the Directors are of the view that there is no scope for the business to continue trading in its current form”.

The directors could possibly try to do a quick placing at a deep discount no doubt, borrow a pile of cash at extortionate rates or they could put it into administration. The big risk is that Exec Chairman Luke Johnson will put it through a pre-pack administration. I hope he does not because that won’t do his reputation any good at all. He needs to try and engineer some sensible solution if his reputation in the financial world is to remain intact. That is particularly so after he wrote an article for the Times in September on “a beginner’s guide to tried and tested swindles” suggesting how you can spot them. Clearly he was not taking his own advice. Whatever happens, the outlook for existing shareholders does not look good.

As another commentator said, the Treasury should not reduce the generous tax reliefs on AIM companies because they need to realise that it is a risky market.

But there was some good news on cake yesterday when the Supreme Court decided after all in an appeal from the lower courts that a cakemaker can refuse to bake cakes where the proposed wording in the icing is objectionable to them. A victory for common sense and liberty.

Today I attended the Annual General Meeting of Foresight 4 VCT (FTF). There is one advantage to owning VCT shares. They barely move when the stock market is otherwise in panic mode. They are one of the few “counter-cyclical” investments to public companies as they invest in private equity. There are some disadvantages of course. Illiquidity in the shares, and often disappointing long-term performance as in Foresight 4. But it may be improving.

I won’t cover the meeting in detail but there were a couple of interesting items in fund manager Russell Healey’s presentation. He mentioned they are still having problems with long delays on HMRC pre-approval of new qualifying investments – can still delay deals for a few months it seems. More representations are being made on this.

He also covered the performance of their top few investments. Datapath, the largest, was valued down because EBITDA fell but revenue is still growing and the fall in profits arose from more product development costs. Ixaris, the second largest, is growing strongly (I knew this because I have a direct holding in it and had just read the December 2017 accounts they filed at Companies House). From my recollection that’s the first year they have made a profit since founding 16 years ago. Russell couldn’t remember how many funding rounds the company had launched – was it 6 or 7, and me neither. That’s venture capital in early stage companies for you – you have to be very patient.

However, in response to a question from VCT shareholder Tim Grattan it was disclosed that VISA are tightening up on the rules regarding pre-payment cards. This might affect a significant part of Ixaris’s business. I suspect it will also affect many other pre-payment card offerings by payment companies, some of whom are listed. Particularly those that are using them to enable payments into gaming companies which Visa does not like.

It was another bad day in the market today, although Dunelm (DNLM) picked up after a very positive trading statement with good like-for-like figures. They are moving aggressively into on-line sales but their physical stores also seem to be producing positive figures so perhaps big retail sheds are still viable. They are not in the High Street of course.

While the market is gyrating I am doing the usual in such circumstances having been through past crashes. Will the market continue to go down, or bounce back up? Nobody knows. So I tend to follow the trend. But I also clear out the duds from my portfolio when the market declines – at least that way I can realise some capital gains losses and reinvest the cash in other shares that are now cheaper. I also look carefully at those stocks that seem to be wildly over-valued on fundamentals – those I sell. But those that suddenly have become cheap on fundamentals I buy, or buy more of. In essence I am not of the “hide under the sheets” mentality in the circumstances of a market rout as some are. But neither do I panic and dump shares wholesale. This looks like a short-term market correction to me at present, after shares (particularly in the USA) became adrift from fundamentals and ended up looking very expensive. But we shall no doubt see whether that is so in the new few days or weeks.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Interesting AGMs, or not – Rosslyn and Dunelm

This morning I attended the AGM of Rosslyn Data Technologies (RDT) for the first time. I picked up some shares in a deeply discounted placing that qualified for EIS relief a few months back. One has limited time to research a company on offer when a placing comes up. It looked sound enough at the time although the historic financials did not impress. Prospects looked better after an acquisition although this company has been around a long time without becoming a shooting star. Bearing in mind the software sector it operates in – a somewhat niche area – I doubt it will show rapid growth either although the analyst forecasts I looked at before the meeting (from a single broker I gather) suggests a substantial rise in revenue and breakeven in the current financial year – partly from the merger no doubt.

Incidentally in case anyone from HMRC is reading this bearing in mind the current review of VCT/EIS tax reliefs, I would just like to say that I would certainly not have invested in the placing without the attraction of EIS tax relief. I considered the valuation at the placing price only “fair” and with the risks apparent, it would not have been attractive without the tax relief.

But at AGMs of small companies like this one, it is possible to learn a great deal. I will just mention a few things – there may be a more extensive report on ShareSoc’s web site later.

The Chairman was absent in the USA (not usually a good sign), so another of the directors, Barney Quinn chaired the meeting, and well. He read out a prepared statement (not issued in an RNS oddly), saying there had been good progress and they had been focussed on integration of the businesses since the start of the year. He mentioned the securing of a major partnership with D&B (see Annual Report).

I queried the very high debtors (accounts receiveable) which were about 6 months of revenue. Apparently this is due to work in progress on projects being recognised as revenue but not yet billed to clients (which tends to be on completion). To my mind, it’s still excessive though.

It seems to be taking some time to develop the market for the products/services and it seems their broker is currently reconsidering their forecasts and I suspect the existing ones are optimistic from what was said in the meeting – but we may soon see no doubt.

Anyway I learned quite a bit about the business and the management seemed to be competent on a brief acquaintence but a couple of long-standing shareholders turned up late for the meeting and said some negative things about the progress and valuation of the business. The company could really do with some more media coverage if they were to attract more investors and another shareholder suggested ways they could do so.

So it’s always good to attend AGMs, but one I will not be going to is that of Dunelm. This year it is Stoke at 9.30 am on the 21st November. Last year it was at a similar inconvenient and early time in Leicestershire.

A couple of year’s ago I attended their AGM in London (again at an early time), and complained about the remuneration arrangements. Have the more recent AGMs been deliberately arranged to avoid private shareholders like me from attending? I would not be surprised if that was the case. So I have voted against the Chairman, against the Remuneration resolutions, and against other directors also for that reason. It really is not acceptable for the directors of companies to pick inconvenient dates, times or locations for General Meetings.

I don’t object to going to Stoke but I do object to having to get up at 5 o’clock in the morning to be sure of getting there on time. But if anyone lives closer, and would like a proxy appointment from me to attend the AGM, let me know.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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