Halfords share price has been under pressure for some time. At £3.31, it is 40% below their peak and currently trades at a three-year low.
Looking at their interim results.
Share price: £3.12 (down 6%)
Market Capitalisation: £621m.
Halfords overall results saw group revenue increased by 3.8% and +1.5% LFL (like-for-like sales). Each segment of LFL is broken down as follows:
– Motoring +1.9%;
– Cycling +2.0%;
– Autocentres sales -1.3% LFL, lower than expected;
– Group online sales saw +4.8% LFL.
Overall, Halfords Underlying Profit Before Tax for the year was down 9.8% at £36.8m (H1 FY17: £40.8m). The weakness in earnings came from the additional £15m to cost of sales, due to the weaker pound representing the peak FX impact. The company thinks the total impact for FY 2018 will total £25m (so expect another £10m for H2).
Halfords Group PLC operates in two broad markets: motoring and cycling. In the first half, 65% of Group revenues were generated from motoring and 35% of Group revenues generated from cycling.
Management continues to state that profit before tax is operating in-line with market expectation, but didn’t give a forecast. Going off their interim results, I expect profit before tax to fall between 7% and 11%.
Now moving on the company full-year results.
My issue with older cars equal more repairs
Management at Halfords made an interesting observation, that is the older the car the more repairs it requires! That’s is pretty obvious.
They stated that the average age of cars in the UK has increased from 6.7 years in 2006 to 8.0 years in 2016. And Halfords says this an opportunity. My problem with this assessment is normalised EPS has been declining since 2008! If this was a big opportunity, then business in Halfords would be buzzing as their motor division generates 65% of revenue.
The problem isn’t about the age of the average car, but the new ways of purchasing leasing a car, which doesn’t include car ownership.
This is the PCP car financing model which has been in place for some time. It means people don’t necessarily own the cars outright but lease it for a period. After the period, they could buy the car outright or enter into another leasing transaction.
With this model widely available to ordinary car consumers, then it means the likelihood of repairs goes down because, after two to three years, they are likely to lease another car. Whether the old leased car gets pass down the car chain or not it requires more research.
However, Halfords is right when car sales fall it means the consumers are likely to buy the leased car outright instead of signing a newly leased car. So, the opportunity is when car sales fall it means more car ownership and the likelihood of repairs increases.
Let’s take a look at Halfords Group PLC historical performance.
Over a 12-year period, Halfords PE ratio ranges from 7 times to 17 times. It currently stands at 11.5 times.
There is a reason why Halfords is registering low multiples. It’s because operating margin is under pressure and struggle to move above double-digits. In the past four years, OPM has hovered around 8%. The period before 2012 sees Halfords enjoying margins between 12% to 14%.
Falling margins put pressure on normalised EPS, and since it peaked in 2011 at 45 pence, it has been declining ever since. The 27% increase in revenue since 2011 has slowed the decline in EPS amidst collapsing margins.
Chart one: Halfords Operating margin, PE Ratio and Normalised EPS
Onto the balance sheet:
Halfords continues to grow its equity, despite margin issues. However, the level of shareholders’ equity looks legitimate because asset turnover has increased from 1.2 times to 1.4 times. A declining asset turnover would raise suspicions of high valuation attached to its assets. Therefore, creating an “illusion” of company’s value.
Chart two: Halfords Shareholders Equity and Asset Turnover
You would normally associate rising asset turnover on businesses spending very little (compared to depreciation) on capital expenditure.
And Halfords is one of these businesses.
It requires very little “extra” capital to grow turnover. You can test this by using the
“Capital employed/Revenue” ratio.
If Capital Employed is growing faster than Revenue, then it needs to spend more money to acquire profit which leads to diseconomies of scale.
The decline in Halford’s capital employed/Turnover ratio means it requires less capital to churn out more sales. Another way of increasing sales is by cutting prices, which isn’t reflected in the ratio.
Other historical data
Businesses that spend little requires less borrowing to finance their purchases. Halfords net borrowing is at £85m and below their 12-year average of £146m. It has no pension deficit to worry about.
Net cash profit is at their lowest level since 2004 at £73m, which is below their historical 12-year average of £96.5m.
The fall in Halfords Group PLC operating margin is down to increasing competition. This latest decline could cause Halfords to report their lowest profit before tax since 2004.
If one was to look back at Halfords share price history. The shares did fall below £2 per share. So, the risk of another leg down is possible. But management has said that there could be a recovery in 2019 as they don’t expect the British Pound to fall further.
At £3.14 per share, I don’t expect the share price to move to upside anytime soon until investors see improving EPS numbers.
Right now, Shares at Halfords has been moving sideways for some time. It is struggling to break past £3.45, which is the 50-day moving average. Another intermediate price level is £4, or Halfords 200-day moving average.
In the short-term, I feel Halfords shares will come under pressure and push the share price towards £2.50 or lower, as investors realise that profit will be lower for the full-year. Anything beyond 2019 will depend on the UK economy remains robust.
CALL TO ACTION
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The above analysis is based on my opinion and nobody else. It does not constitute professional investment advice. Data is correct on at the time of availability. I don’t hold the company’s shares unless stated.