Walker Greenbank: Is there value in luxury interior furnishing?

Introduction – Walker Greenbank (LON:WGB) describes itself as an “international luxury interior furnishing groups that designs, manufactures and markets wallcoverings, fabrics and complementary products”. The majority of its revenues and profits is achieved through its “brands” division which includes Harlequin, Arthur Sanderson, Morris & Co and Zoffany. The “manufacturing” division includes Anstey and Standfast. The company’s sales, interestingly, aren’t overly concentrated in one section of the world. Western Europe produces the most sales but is only 10% of total sales.

The market cap is just under £30m, with sales of around £70m and profits of £3m in the last fiscal year. Looking at the summary above, we can see that the profits in the annual reports isn’t the number I have come up with. The reason for this is that WGB has a vast array of items below the operating line. Some of these aren’t too important but the company does have a fairly significant pension deficit of some £6m which it is being very proactive in charging off. The operating metrics below uses, what I think to be, the most effective measure of operating profit. Another factor to consider is that some amount of sales growth was achieved through marketing related to 150th anniversary for Sanderson which may prove to be one-time.

Operating Metrics – The company has a fairly rocky history with the company taking heavy losses between 2001 and 2005. This was driven partly by poor sales growth but more important was the increase in cost of goods which destroyed margins.

I couldn’t find a definition of COGS (the company’s breakdown of costs is quite confusing) but the vast majority appears as “raw materials and consumables used”. As we can see, the improvement in profit was driven by an improvement in COGS after 2002. More recently, the COGS have moved back into the danger zone matched with a continued rise in admin costs. In the previous five years, the CAGR of revenue was 4.33% against 9.86% for admin costs. Looking at how margins have changed with changes in sales (i.e fixed/variable costs), this picture gets worse as years of fast sales growth have been accompanied by even faster declines in margins. We would expect this, to some extent, as the company does have significant manufacturing operations (costs will move with revenues) however, it is mostly a retailer which should benefit from sales growth with fairly stable costs. One explanation for this could be increased marketing costs as a result of the marketing campaign mentioned earlier. Again we suffer from the lack of detail. Equally, we should recognize the improvement in S&D which is close to the 2004 lows. This is impressive as we can assume this was a period of particularly ruthless cuts in costs. Either way, this is a concerning trend. For example, if sales growth started declining from here the company could be jammed with these costs for a few years.

Financial Condition – As mentioned already, the company has a significant pension deficit and, as a retailer, operating leases. The deficit is obviously not a great situation as without improvement in markets (the fund is mostly equities), the £6m is, eventually, going to be charged off equity. Interestingly, the company shows firm resolve to tackling this problem by charging off some of this every year. The charge is often as financially significant as the cost of the company’s working capital facility. Operating leases appear to be handled quite well with the average length being around 8 years. In my experience, this is quite surprising as WGB is really a very small retailer which suggests a degree of faith in its durability from property owners. The company does carry about £4m of its own property. I expected that this might be undervalued as it appears to be in prime locations however, the director statements and its use as collateral on the loan facility suggest that this value is about right.

Recent Trends/Competitive Position – I am not going to pretend like I understand the economics of the wallpaper and fabrics industry and I certainly don’t have access to good information so I am going to try to focus on what seems sensible. The first thing that jumps out is the potential for the overseas operations. It appears some part of this business is outsourced to distributors but what stands out is really the breadth of the international sales. Every continent/region from Australia to South America makes at least some contribution. What this suggests to me is that there are considerable opportunities of scale. For example, it may cost a lot to sell £1m of wallpaper in East Asia but it probably doesn’t cost as much to sell the next £1m or the £1m after that. In addition, the company focuses on the high end of the market and holds significant brand value, Sanderson has a royal warrant. It also appears that the manufacturing division fits in quite well as it produces the “brands” as well as offering sophisticated printing technology on contracts. Despite the problems with costs the company appears to have focused well on working to its strengths. In particular, the combination of manufacturing and retailing seems quite important and the company has made effective use of expanding the manufacturing beyond its own products which results in really good use of its assets.

Valuation/Conclusions – The main factors in the valuation are sales growth and costs however, due to the volatility of the profit margin my current spreadsheet setup is pretty useless so I am going to take a slightly different approach projecting a constant margin around the historical average. In terms of debt and capex, I am projecting a continuation in trends. It should be mentioned though that given trend sales growth of 4% we need a margin of around 6% to be making decent returns. As usual, I am considering three scenarios:

1. Base Case – Projection of 7% average margins for the next five years and trend sales growth of 4.33%. The previous 5 year average margin was over 8% but I think some of these gains resulted from the one-time gains achieved in early 2000s cost cutting. Obviously, this also projects a considerable improvement from last year’s margin of 3% which is somewhat dubious. Sales growth is probably more conservative.
2. Worst Case – Projection of 4% average margins for the next five years and sales growth of 2%. For sales, I think this is quite an extreme scenario but for margins seems possible if the problems with COGS and admin get worse.
3. Best Case – 8% average margins for the next fie years and sales growth of 8%. Ambitious all round in projecting a return to previous margins which may prove difficult without a clear crisis but sales growth of 8% isn’t inconceivable.

 

Overall, I think it is quite tough to make a decision on this company. My projections have turned up an unusually wide range and the most conservative estimate is, as usual, in between base and worst case. My worry is that admin costs continue to cut returns down until the company starts taking losses and has to change. The company has made redundancies in the past few years so it is willing to make costs when stuff is going along quite well but it hasn’t been anywhere near enough. In addition, the company’s failures controlling admin costs  have been covered up by equally large improvements in S&D costs, unfortunately admin costs are bigger so this improvement has been made irrelevant. Of course, COGS have increased as well so the company is getting close to real trouble.

Analyst estimates assume an improvement back to roughly 7% margins but I think the market is pricing in closer to 5.50-6%. Framed that way, this isn’t really such an appealing bet. I don’t think I will buy around this price but if we see WGB get offered to 45p then I think this limits the downside far more effectively. Either way, I will continue to keep an eye on this company as it has massive potential. Its manufacturing operations are a fairly well defended niche, it has strong brands and good overseas opportuntites that it hasn’t capitalized on fully.

EDIT:

Historical Valuations -I forgot to include these tables when orginally posted. These should give some idea of how WGB has been valued in the past. The company took losses in 2004/05 so there is no P/E for those years.

See also a followup piece here, correcting some other issues in the piece above.