Kingfisher (LSE:KGF) has a board containing names of the great and the good from the European business world. When I analysed the company back in 2019 I found that there is no one on the board who learnt his/her trade through Kingfisher trading. No one who had worked in home improvement or DIY retailing. How, I wondered, are they supposed to know what it’s like to serve customers on the shop floor, drive the vans or share lunch with the lowest employees?
Even now the non-executive part of the board consists of people who are busy running other companies, with keen interests in other industrial sectors, or are the semi-retired. But they each receive a large remuneration package.
I wondered in 2019 what it must be like for middle and senior managers - having gone through the Kingfisher graduate programme and working their way up - to find that none of their own is considered worthy of adding their voice to boardroom discussion?
A firm needs a managerial cohort in depth. It needs experienced, wily executives at all levels drawn from a pool of talent that continuously being developed.
When a handful of these “home-grown” people reach the highest levels in the organisation they are far more likely to benefit from the respect of those they work with at lower levels in the organisation.
They know the subtle tricks of the retail game; they know the characters up and down the hierarchy; they know when a plan is feasible or pie in the sky; they know how to play one supplier against another.
Surely, this implicit knowledge and this respect of colleagues is to be valued? If there are no experienced insiders at or near the top it sends a clear message to aspiring younger managers. That message is: take your talent elsewhere, the chairman of the board is only interested in those picked from talent pool outside of your industry.
So I was sceptical in 2019 that the newly appointed CEO, Thierry Garnier, could handle this company. His claim to fame is the building of Carrefour’s Asian business in China, having spent 22 years in Carrefour’s retail empire. The other fresh executive board member, Bernard Bot, brought in to be CFO, had worked in tech, McKinsey and an airline.
However, the turnaround in the last three years has proved my scepticism ill-founded. They have greatly improved the company’s profits, and steadily grown the business. I’m particularly impressed by their stick-to-the knitting attitude.
They are not coming up with fancy schemes to take over other companies in search of “synergies” or growth. Rather, they keep doubling down on numerous incremental improvements to operations, and as they put it “consistent execution”. For example:
Conventional earnings numbers do not generally adequately allow for the fact that with some companies profits cannot be taken out if it is to maintain its unit volume of output, spend enough to maintain its economic franchise (e.g. on working capital, new machinery, marketing, service quality, employee training, etc.) and invest in all value enhancing projects.
Some firms need to invest so heavily in these items that little of the conventional earnings can be given to shareholders.
Owner earnings is more useful than conventional earnings for getting to the amount shareholders can take after allowing for necessary investment to maintain the quality of the business.
Kingfisher has an impressive history of conventional earnings relative to the current share price. Here I’d like to see how it shapes up under the owner earnings approach.
With owner earnings we’re trying to obtain the earnings that, in future, would be left for shareholders after the managers’ use of the cash generated to pay for items of expenditure to maintain the strength of the economic franchise, maintain unit volume and to invest in all value-generating projects available.
Depending on circumstances, the owner earnings figure may be the same for every future year or on a steadily rising (or falling) trend.
Naturally, owner earnings are impossible to obtain with any degree of precision because many of the input numbers are merely educated guesses about the future. Despite this imprecision it remains an important method for thinking through valuations.
Owner earnings analysis is about future cash available for shareholders to take out of the business. But the only evidence we have available is past data. We start with that, and then use qualitative analysis to judge whether to simply project forward the past pattern or modify the previous trend for future orientated thinking.
In the following we use what the company actually invested in new working capital items and in new fixed capital items, and what they spent on marketing, R&D and staff training etc. already deducted from the P&L.
What the analysis really requires is the amount necessary to maintain the quality of the economic franchise, unit volume and invest in value generating projects. To start with we make the bold assumption that what was spent by the managers was also the necessary amount.
When we move to forward-looking analysis to value the firm we need to make another bold assumption on the real amount needed to invest in new WC, fixed capital items, etc., in the future. The historical analysis helps us make that judgment.
Owner earnings in the past........
Kingfisher’s shares (LSE:KGF) have fallen from 440p in 2014 to 237p. But average earnings per share over the last thirteen years have been 22.2p, giving a cyclically adjusted price earning ratio of 10.7. Dividend yield is 5.2%.
Why has Mr Market pushed the share down so much? Here are some common justifications for dramatic share price declines, even for those companies with a history of high EPS and dividends:
My judgement: I see the strategic positioning of Kingfisher’s main businesses as reasonably strong. True, they were hit by problems a few years ago, but, as Warren Buffett once observed of companies, these are local excisable cancers rather than needing a Pygmalion transformation. Indeed, many cancers have been excised, it seems.
The full quote related to short-term problems at GEICO and American Express which permitted Buffett to buy them when cheap: “The GEICO and American Express situations, extraordinary business franchises with a localized excisable cancer (needing, to be sure, a skilled surgeon), should be distinguished from the true “turnaround” situation in which the managers expect - and need - to pull off a corporate Pygmalion.” (1980 Letter to BH shareholders).
While I’m not saying that Kingfisher has “extraordinary franchises” it does have some strong businesses.
The rewards realised by shifting the firm to having common product lines, new IT and operational cost savings were more limited than originally thought; while the costs of change, in terms of managerial distraction, staff redundancy and compensation, were all too evident.
The French businesses seems to have been run for short-term target numbers aimed for by pushing up prices, thus damaging the low-price consumer franchise.
But since 2019 things have been turned around by new senior managers, most notably in France.
Piotroski factor analysis
I’ll start by using Joseph Piotroski’s nine variables. These, when taken as a whole, are useful to indicate whether financial distress risk has risen in the last year or so. A low score – say 3 or 4 – would suggest a deterioration in the firm’s ability to withstand shock.
The indicators fall under three headings: (1) Profitability; (2) Leverage, liquidity, and source of funds, and; (3) Operating efficiency
If the firm is profitable and produces positive cash flow it has a capacity to generate funds internally. A positive earnings trend suggests an improvement in the firm’s ability to generate positive future cash flows.
2022: £737m/£12.4bn = 5.9%.
Third Piotroski point.
The last two newsletters described the strong market positions held by Kingfisher (LSE:KGF) in the UK and Ireland with its B&Q and Screwfix brands ("banners"). Today I turn to its other businesses ranging from Poland to Iberia.
Castorama Poland has grown gradually from sales of just over £1bn in 2011 to £1.5bn today. There are 90 stores, putting it in first place with about 30% market share.
The Polish team is currently expanding its urban park small-store concepts (800 – 2,000 sq m) under the Castorama Smart banner
Profits are a respectable £135m before deducting tax and central costs. Allowing for say £20m of central overhead allocation and about 20% for tax, we might estimate after-tax profits to be £92m.
If this was our estimated earnings power perpetuity then present value would £1.15bn at a discount rate of 8%.
As well as showing great strength in operations Poland has the virtue of owning 80% of its stores. This property was valued at about £700m recently.
France is where Kingfisher has made serious blunders, taking its eye off serving the customer, while focusing on its “transformation programme”. It also employed local managers who seemed to push up prices to the point where consumers decided to shop elsewhere.
If you look at the facts, it is not as bad as some would have us believe. Profits did fall but still profits were made, even in the bad years – over £160m. And now they have risen to over £220m.
Turnover is the same as it was eleven years ago, and higher than in 2016 so customers are starting to come back to the stores (93 Castorama's with an average store of 12,376 sq metres; 123 Brico Dépôt with an average store with 6,910 sq metres).
And the managers in France have already implemented the plan of “Every Day Low Prices” to compete more effectively. And cut staff numbers by 5%
Taking the numbers from the table: if we make the bold assumption that profit after-tax, after-central cost and after-exceptional deductions in future years is around £130m (based roughly on 2022 and 2021’s total retail profit minus one-third), then this division’s value might be £1.6m using an 8% discount rate.
Seventy-five percentage of the French sites are owned by Kingfisher, which were recently valued at £1.3bn.
The repair work is advancing
As well as increasing LFL sales by 14.8% over the last two years the company has ....
It is frequently said of the Kingfiaher Group (LSE:KGF) that “a sum of the parts” valuation would total to much more than the current market capitalisation. What then usually follows is a statement to the effect that the company should be broken up, with a particular focus on liberating the “jewel in the crown” Screwfix.
I question that logic, especially given the much greater degree of integration painfully forged across its markets in the UK, Ireland, France, Iberia, Romania and Poland in the last four years. It will be costly to split it now (redundancies, new IT, new senior teams, logistics networks, etc.), and many of the hard fought-for buying synergies will disappear.
Far better to do something much more mundane and long term: concentrate on doing the ordinary extraordinarily well. Don’t go dashing off looking for growth with dramatic sounding strategic moves, just get on with day to day improvements in every aspect of the business, from product selection to keeping a close eye on competitor pricing and tactics.
This has been a slow-growth company over the last thirteen years, with turnover not even keeping pace with inflation, and earnings per share much the same in the most recent five years as in the five years before that.
The question is: if the past thirteen years is representative of the future in terms of earnings power, would we be content to buy these shares at 250p (MCap £5.04bn)?
Average EPS is 22.2p, giving a cyclically adjusted price earnings ratio of 250p/22.2p = 11.3. (That is an earnings yield of 8.9%)
The CAPE is less than the average for UK shares which is good, but it is not in single digit territory, so is not well and truly a bargain.
We’ll have a look at owner earning numbers later, but my preliminary impression is that little additional investment is needed in working capital and capex if the company maintains its no-growth trajectory, so we could, perhaps, imagine all of the reported earnings flow coming to shareholders.
An 8.9% earnings yield these days is not to be sniffed at. More than half of that is already coming from the 5% dividend yield; the remainder is likely to come from dividend growth and using future surplus cash to repurchase shares.
Note the total paid out in dividends and buybacks has averaged £329m in the last five years, that is 15.7p per share or 6.3% of the current share price.
Of course, if the directors can identify projects able to generate goodly rates of return shareholders will support the investment required, lowering near term cash flow to shareholders, but shifting the company to positive growth in earnings and a more rapidly rising dividend.
But, in judging whether these shares are good value much depends on the strategic positioning of the various operations – are they strong businesses, or even franchises? Is there some pricing power?
To shed some light in this area I’ll look at each market in turn:
United Kingdom and Ireland.........
I’m sorely tempted to invest in Kingfisher (LSE:KGF) despite the fear of a major downturn in the home improvement market. It’s a company that's been forced to cope with some serious problems in recent years – many of which were self-inflicted But the fairly new (appointed 2017-19) management team seem to have revived the company by concentrating on continuous improvement within Kingfisher’s circle of competence and competitive advantage.
Despite the recent jump in underlying profits its market capitalisation has fallen from £10bn to £5.2bn.
Kingfisher remains the strongest player in big-box general DIY sheds (B&Q in the UK & Ireland, Castorama in France and Poland, Brico Depot in Romania).
It is also a very significant retailer of building tools and materials to professional tradespeople, especially through its fast-growing Screwfix and the B&Q TradePoint (and similar schemes in other countries).
The third area is the supply of home improvement products at discount prices – Brico Depot France, Brico Depot Iberia.
These banners hold either the number one market position in their respective countries, or number two. We in the UK are familiar with Screwfix dominating the capital-light trade counter service and B&Q dominating the consumer home improvement market in towns up and down the country.
Kingfisher’s average earnings per share over the last thirteen years are 22.2p. With its current share price of 250p this gives a cyclically adjusted price earnings ratio of 11.3.
Dividend yield is 12.4p/250p = 5%, which, it seems to me, is unthreatened by the risk of financial distress. The directors are committed to a “progressive, sustainable dividend policy” (2022 Report)
In addition to the £254m to be paid out in dividends in respect of trading for the year to the end of January 2022 the group has bought £300m of its own shares.
Thus we see that this £5.2bn MCap company is so cash generative and has so much cash in the bank that it can hand over £554m to shareholders via proposed dividends and the ongoing share buyback programme in one year.
Kingfisher has no borrowings alongside £823m of cash, combined with a history of cash flow from operations north of £700m year after year.
It also has £2.8bn of freehold property on the books.
Being a (fairly) fast stock-turn retailer, inventories are covered by credit obtained from suppliers.
Is it reliant on DIY?
In the past, in addition to selecting shares, I’ve invested in properties for re-development, and so I’m familiar with using B&Q’s TradePoint: I (or an employee) can pitch-up at a B&Q outlet, select goods and take them away after showing the card.
I get “trade prices”, and up to 60 day’s credit, with a neat monthly bill. TradePoint customers pay the same as ordinary shoppers until they reach the threshold of £250 in a month. After that, a 5% discount is applied. Reach £1,000 and 10% is knocked off for the rest of that month and the next three months.
Admittedly, for many items e.g. a truck load of bricks, prices are often lower elsewhere. Why, you might ask did I spend so much at B&Q and Screwfix when builders merchants can be cheaper? I also had accounts with three builder’s merchants and bought a lot from them.
Firstly, builder’s merchants are not always cheaper – Kingfisher can be competitive on some things.
Second, builder’s merchants are great for buying a truck load of heavy items – blocks, insulation, plasterboard, etc. Play one off against the other and prices can fall significantly. But builder’s merchants cannot stock a wide range of the less heavy items – dozens of different light fittings, kitchens, doors, paints, baths, tiles, flooring, etc. That is where B&Q and Screwfix really come into their own. They stock thousands of items to choose from. Thus, Kingfisher has a loyal customer base in tradesmen of all descriptions. It is certainly not for DIY enthusiasts only.
Last year TradePoint sales were £834m, which was a mere 20% of B&Q’s overall turnover. But it is growing fast - over the last two years TradePoint increased sales by 33% LFL, and has a target to reach £1bn. Screwfix does however put it in the shade; it already sells £2.3bn pa.
So, why did the shares fall?
In 2016 the newly appointed CEO, Ms Véronique Laury, launched her big strategic idea to transform the group from one where product ranges and sourcing varied from one country to another. The plan was to have a common set of product lines in France, Ireland, Poland, etc.
As well as having “unified” products, the company would have “unique” products that competitors did not stock. There was also to be a one IT system across the Group, and some operational cost savings.
The promise was that the company could reap a benefit amounting to £500m per year, raising profits from the £700m range to more like £1.2bn. It would cost up to £800m to implement all the changes, but it would be worth it in the end.
Making the short-term sacrifice more palatable was the offer of over £600m returned to shareholders over three years by way of share buybacks. This was on top of the annual dividend of around £230m.
True to her word, £630m was spent on share repurchases – and the balance sheet remained strong. At the same time dividends per share rose from 10p to 10.82p. So that is all good.
What was not so good was the poor performance in some parts of the empire. In particular, both Castorama and Brico in France suffered from poor management. French sales flatlined for ten years, not even keeping pace with inflation. And operating profits from France fell from over £400m in 2012 to just £164m in the year to January 31, 2020.
It was even worse in the, much smaller, Russian and German operations, which were closed.
But things have perked up in France under the new management after Laury’s resignation in 2019. Sales there are now up to £4.5bn, and profits £221m.
In the UK sales overall ha.......
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