phil oakley’s weekly round-up · campuses and hospitals – often through franchising is...

www.investorschronicle.co.uktelephone: +44 (0)20 7873 3000 email: [email protected]© The Financial Times Limited 2018. Investors Chronicle is a trademark of The Financial Times Limited. Registered office: Number One, Southwark Bridge, London SE1 9HL

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In this first weekly round-up of the New Year I look at some potential pockets of value created by the market turmoil at the end of 2018

The companies mentioned this week are:n Ted Bakern Greggsn Taylor Wimpeyn MJ Gleesonn Nicholsn Greene Kingn Dunelm

Happy New Year to all readers!The year 2018 was a tough one for stock market inves-

tors, which has raised the obvious question as to whether the near decade long bull market is over?

If I look around the world and try to fathom what’s going on in the economy, I think there’s quite a lot to worry about. Consumer debt in the UK and US looks too high to me as do house prices, while the buying power of people’s wages struggles to improve. China looks like a debt-fuelled bubble economy, rather like the West a decade ago or Japan in the early 1990s.

In the UK, If I look at the housing market, the new car market and the state of the high street and consumer- facing businesses, I could make a case for thinking that we are close to a recession.

However, I find myself feeling surprisingly optimistic about certain sections of the UK stock market. My preferred high-quality shares (growing businesses with high profit margins, returns on capital and strong free cash flows) look overpriced and a very crowded trade. I can, however, see pockets of value in shares that were heavily beaten up in 2018 where a lot of pessimism has been baked into their share prices.

11 January 2019

Alpha Editor: James Norrington

Alpha Production Editor: Sameera Hai Baig

Phil Oakley’s Weekly Round-Up

Household debt as % of GDP

20062007

20082009

20102011

20122013

20142015

20162017

0

20

40

60

80

100

120

Source: IMF

ChinaGermany

JapanUKUSA


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Ted Baker, discussed below, is a classic case in point of this. The shares have been savagely derated on growth concerns and allegations of misconduct levelled at its chief executive officer (CEO). The underlying business has continued to perform quite well and this week’s trading update has seen a significant re-rating of the shares. I think there are other unloved companies out there that could do the same, provided that their sales and profits can continue to grow.

Could 2019 be a year for contrarian value investors?

Ted BakerShares of global fashion brand Ted Baker (TED) have had a tough time over the past year after halving in price. The fact that trading in clothing and fashion accessories is challenging is not news to most investors, but Ted Baker’s trading performance has been holding up reasonably well. In recent weeks, the shares were given a further kick-ing due to allegations of misconduct against its founder and CEO.

Worries about trading and the allegations against the CEO have seen Ted Baker go from what was arguably quite an expensive share to quite a cheap one. I have picked it as one of my shares in the popular online UK stock challenge game for 2019 (I do not own any shares in the business), as I think there has been too much pessimism baked into the share price.

Wednesday’s trading update for the five weeks to 5 January was very reassuring: Total sales were up by 12.2 per cent, with online sales (which account for a quarter of total sales) up by 18.7 per cent. Despite widespread discounting, gross margins have held up well and the company expects to end the year (the end of January) with a clean stock position, which means it will not have to cut prices – and reduce profits –at the start of its next financial year.

Source: SharePad


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Consequently, profits for the year to January 2019 are expected to be in line with expectations. Current forecasts for the year to 2020 is for growth in EPS of 6.4 per cent to 138.5p, which would put the shares on a forecast PE of 12.9 times the share price at the time of writing this note (1,780p), which does not look desperately expensive.

While not wishing to dismiss or condone the serious-ness of the allegations against the company’s CEO, I see them of something of a side issue as far as the long-term prospects of the business are concerned. I say this as from what I can see, the business model seems sensible, which does not need to change even if there is a change of CEO.

Ted Baker is slightly different to many of its sector peers. It is a global fashion brand and does not seem to have a burdensome bricks and mortar presence on the UK high street. It has a decent and growing online business and is a wholesaler as well. Its expansion into new territories by granting licences is at an early stage, but has the potential to add a decent amount of incremental sales and profits.

I think the risk-reward trade-off for investors in this share are more favourable than they have been for some time.

GreggsI have admired Greggs (GRG) and its business model for a long time. By making a lot of its own food products and selling them to customers at very cheap prices, it has a very competitive offer that is difficult to match.

It has had to cope with the declining high-street footfall and changing consumer tastes towards healthier products which have made for a rocky ride in recent years, but it is now doing well. A strategy of moving towards areas of higher footfall – in particular transport hubs, university campuses and hospitals – often through franchising is positioning the business towards more profitable areas.

In my experience, Gregg’s pricing is very compelling and hard for customers to ignore. It is much cheaper to buy coffee and food from Greggs than Costa or Pret a Manger. The food quality is pretty decent as well. Greggs has long since moved on from a narrow range of pasties and sausage rolls and now offers plenty of healthy options.

The year 2018 finished well for Greggs. Its managed shops saw like-for-like sales (LFL) increase by 2.9 per cent for the year as a whole, with 4.2 per cent growth in the second half and 5.2 per cent growth in the fourth quar-ter. The growth has not just come from healthy sales of mince pies but from the continued growth of hot drinks and breakfasts. Pre-tax profits are expected to be at least £88m, compared with a current consensus of £86.7m.


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It’s reasonable to assume that forecasts for 2019 will be upgraded given the strong LFL sales momentum in the business. Maturation benefits from the net 99 shops opened in 2018 should boost growth and receive an additional boost from a net 90-100 shops to be opened this year.

On the current consensus forecast 2019 EPS of 70.4p, which is likely to be upgraded, Greggs’ shares trade on a forecast PE of 20.9 times. The healthy outlook therefore looks to be priced in.

Taylor WimpeyTaylor Wimpey (TW.) shares had a tough 2018 as in-vestors became more cautious on its prospects due to tougher trading conditions and uncertainty on how long the government’s Help to Buy scheme – which has been so beneficial to builders’ profits – would last. Its shares had fallen to lows not seen since the aftermath of the EU referendum result in June 2016.

This week’s 2018 full-year trading update highlighted that Taylor Wimpey is performing satisfactorily, but no more than that in my view. Completions were up by 3 per cent with private average selling prices up by 2 per cent. After experiencing build cost inflation of 3-4 per cent, profits for 2018 are expected to be in line with current consensus analysts’ forecasts. This implies a pre-tax profit of just under £858m and EPS of 21.2p. The company’s net cash position of £644m was slightly better than expected due to the timing of land purchases and this underpins its very strong financial position.

The key uncertainty is what happens in 2019 and beyond. Based on current analysts’ forecasts out to 2020, there is little expectation of profits growth at all. Taylor Wimpey itself is guiding towards stable selling volumes in 2019. Its order book is currently higher than a year ago, but this is largely due to higher levels of social housing which tend to be less profitable.

Source: SharePad


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I am a big bear on the UK housing market. I believe that houses are too expensive in relation to wages and rents and that the profits of housebuilders would be a lot lower if it were not for the subsidised mortgages provided by the Help to Buy scheme.

It seems that the market in London and the South East is cooling rapidly as Taylor Wimpey alludes to. Based on my frequent observations of the mid to north Essex market – a key area for London overspill – houses are taking a lot longer to sell, while the price premium of new builds compared with similar existing properties looks to be un-sustainably high. Many four bedroom family houses have asking prices above the £600,000 Help to Buy threshold and could be difficult to sell for that price.

The problem I see for Taylor Wimpey and most of its peers is that selling price inflation is likely to be less than build cost inflation and this is likely to reduce profit mar-gins. Like all builders, it is exposed to a changes in selling prices and the feed through this has to the value of its landbank. I think that the risk on selling prices and asset values is now firmly on the downside.

That said, I feel that Taylor Wimpey’s land bank is something of a mixed bag. It has 76,000 short-term plots – around five years’ supply at current build rates – which are subject to price risks. This is offset by the flexibility of 121,000 strategic land plots.

Despite my cautious view on the company’s prospects, I do not think the shares are expensive. The company should make a return on equity of over 20 per cent this year, which could be sustained for a while as long as sell-ing prices and profits are reasonably stable. The price-to-book value of 1.5 times suggests that the market is already pricing in a reasonable fall in profits at some time in the near future. This is also confirmed by a low one-year fore-cast rolling PE of less than seven times.

A downturn in the housing market will probably happen in the future, but Taylor Wimpey looks well

Source: SharePad


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placed to withstand it. A £600m dividend payment in 2019 and growing net cash position offers shareholders a lot of reasons to stay invested.

MJ GleesonFor me, MJ Gleeson (GLE) probably has the most attrac-tive business model in the UK house-building sector. Its focus is on selling low cost homes (average selling price is c £125,000) on brownfield sites in the north of England and the Midlands means that it is operating in favourable markets. It then tries to make extra profits by selling strategic land in the south of England.

Its relatively low selling prices and the backing of the Help to Buy scheme have allowed it to build and sell lots of houses over the past few years with a healthy increase in profits. This trend has continued during the first half of its financial year to the end of December.

Gleeson has sold 691 units – 16.5 per cent more than during the first half of the previous year – and is making bullish comments about the health of its markets by say-ing that it sees “no signs of customer caution.”

It has an ambitious strategy to sell 2,000 homes by 2022, compared with 1,225 last year. If it can do this with a be-nign selling price environment then this is a company that looks to still have plenty of upward profit momentum.

Half-year profits are expected to be much higher than a year ago, with full-year profits at least in line with current expectations which suggest forecast upgrades are very possible.

Gleeson’s rude health is reflected in its shares trading on a premium to its peers on a one year forecast rolling PE of 11.3 times and a prospective price to net asset value (NAV) of 1.9 times. This looks to be well deserved.

Source: SharePad


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NicholsNichols (NICL), the owner of the iconic Vimto soft drink brand is a very high-quality business in my opinion. It has been able to consistently grow its sales of Vimto over the years by developing new products across fizzy drinks, still drinks, flavoured sweets and recently frozen beverages.

Vimto dominates the sales of the company, but it is backed up by decent brands in the form of Feel Good natu-ral drinks, Sunkist, Starslush and Frappe Chiquo frozen drinks and the licence to produce and sell Levi Roots in the UK. The bulk of its sales are made in the UK, but Vimto is also a very popular drink in Africa and the Middle East.

As well as having growing sales, the success of the business has been boosted by the decision to outsource the production and distribution of its products to third parties, leaving it to concentrate on drinks recipes and marketing. This makes Nichols an asset-light business that has been able to earn very high profit margins (over 20 per cent) and returns on capital employed (nearly 30 per cent). Its business model has been copied with great success by upmarket tonic water brand Fevertree (FEVR).

Despite a shortage of carbon dioxide and the introduc-tion of a sugar tax, 2018 was a good year for sellers of soft drinks in the UK. A scorching hot summer has seen the value of soft drinks sold increased by 7.4 per cent, accord-ing to Nielsen. Against that backdrop, Nichols has gained market share with sales growth of 12.6 per cent with Vimto growing by 12.9 per cent. Nichols has adopted a policy of not price discounting Vimto in recent years and has still been able to grow sales and maintain high profit margins – a sign of its significant brand strength.

Sales to Africa picked up during the second half of 2018, but the well-flagged conflict in Yemen and delays in shipments to Saudi Arabia saw sales to the Middle East fall significantly.

That said, total sales increased by 6.9 per cent to £142m which is ahead of current consensus forecasts and suggests that full-year forecasts will be met.

Source: SharePad


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The high quality of Nichols’ business has meant that its shares have not been cheap for many years now. At 1,550p, the shares trade on a one-year forecast rolling PE of 21.5 times, falling to 19.7 times if the net cash balance is adjust-ed for. I don’t think that’s excessive for a business of proven quality, but without material forecast upgrades it’s difficult to see the shares moving significantly higher for a while.

Greene KingWith a few notable exceptions, many large pub groups have been in a very difficult place for a while now. No-one wants to be running a business where their costs are growing faster than their revenues, but this has been the experience of Greene King (GNK) in recent years.

Christmas trading has brought some respite from this trend and has been much stronger than last year. The two weeks covering Christmas and New Year saw LFL sales increase by 10.9 per cent in its core pub business (+1.6 per cent last year), but trading in tenanted pubs and revenue from brewing was more lacklustre.

Total pub LFL sales growth for the 36 weeks to 6 January was up by 3.2 per cent, which is unlikely to have outpaced the rate of growth in costs. After cost saving measures, Greene King has said that it remains on track to limit the impact of cost inflation on its annual profits to between £10 and £20m, which means that overall trading profits for the group as a whole look unlikely to grow much.

The company is making some progress in selling off underperforming pubs and the cash raised will continue to support the current level of dividend payout.

However, I continue to see little attraction in Greene King shares and most of the pub sector – perhaps with the exception of JD Wetherspoon – in general. They continue to swim against a strong tide, with expensive drinks and uninspiring food comparing unfavourably with the option of staying home. Furthermore, pub businesses remain hampered by high cost bases.

Source: SharePad


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While many UK pubs continue to close on a weekly basis, the country still has too many pubs and restaurants chasing too few customers. The high capital requirements of providing attractive places to eat means that it is very difficult for pub companies to make acceptable returns on capital employed. You can see that Greene King’s performance on this metric has been very modest.

The returns figures quoted by many companies for returns on capital associated with refurbishments are mis-leading in my opinion, as the capex cycle is very short and the benefits of money spent do not last long before you have to spend money gain. Mitchells & Butlers (MAB) has been very open in explaining the capex cycle on its pubs has come down from 11 years to six years.

On that basis, I believe that many pub companies are under-depreciating their pub assets and overstating their profits. This is evidenced in their generally weak free cash flow performances. Greene King’s free cash flow margin performance has been very poor.

Greene King also has far too much debt for my liking (about the same as its market capitalisation) and while the shares look inexpensive on a one-year forecast rolling

Source: SharePad

Source: SharePad


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PE of 9.4 times and a forecast yield of 5.6 per cent, I struggle to see much upside.

DunelmIt’s been a tough few years for homewares retailer Dunelm (DNLM). It has exhibited many of the classic signs of a retail rollout strategy that has run out of steam until surprising investors with a very encouraging trading update this week.

The important thing to note is that Dunelm’s trading performance was up against very weak comparatives from a year ago when store LFL sales were up by just over 1 per cent. LFL sales growth of 5.7 per cent for the 13 weeks until the end of December represents a good improvement and has been backed up by another period of strong growth online.

Profits are being helped by the improvement in gross margins that have come from the closure of Worldstore stores and the absence of the significant losses that they contributed last year. On top of this, there’s seems to be a sharper focus on selling more profitable items and getting the business back on track.

I think Dunelm is a reasonable business that is making pretty decent returns on its stores.

Source: SharePad

Source: Company report


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I’m just not convinced that there is a significant amount of growth in this business. There’s certainly more potential to grow online sales and click and collect which account for just over 16 per cent of total sales, but sig-nificantly and sustainably growing sales from its stores is likely to prove more challenging. It currently has 169 stores in the UK and has not opened any more this year which is probably a wise decision.

Dunelm has a good supply chain and has proven to be able to earn very decent profit margins. Whether it can hang on to 10 per cent profit margins remains to be seen. Competition in homewares is intense, but the closure of Homebase stores has probably been helpful. Continued weakness in the UK housing market remains a source of downside risk.

Profit forecasts will be moved upwards on the back of this week’s update, but with the shares trading on a one year forecast rolling PE of around 15 times, the shares may not bounce much more in the short term.

Source: SharePad


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phil oakley’s weekly round-up · campuses and hospitals – often through franchising is...

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