“No Ordinary Designer Label”, is the motto sewed into the Ted Baker brand, as described on their official Twitter account.
Fishing for Ideas
Ray Kelvin founded the company in 1987 whilst fishing. The “extraordinary designer” opened their first store in Glasgow in 1988 and it expanded to other major cities in the UK.
And in ten years it became a publicly-listed designer with an IPO price of £1 per share. 20 years later, the shares are worth £24 each, which gives it a 17.2% average return. That makes Ted Baker one successful retailing success.
Now, can this continue? Or, will the fashion gods deny Ted Baker long-term success?
A more reasonable angle to take is to ask if Ted Baker’s valuation has overtaken its fundamentals?
To answer these questions and more, the best way (if not the only way) is to do our homework.
Here is what I’ve learned from the financials of Ted Baker.
Ted Baker growing profit
In the last six years, Ted Baker has made great strides in growing their business, but more importantly, it has garnered the taste of increasing their profits.
Will earnings growth continue?
In 2017, Ted Baker’s adjusted diluted earnings came in at £1.126 per share. According to eight analysts (who are following the firm), they are projecting earnings in 2018 to be £1.28 and 2019 to be £1.46. That is a 13.7% increase in 2018 and 14% in 2019, which is reasonable growth, but it is below Ted Baker’s 17.2% average shareholder returns. It means earnings haven’t kept up with long-term share price growth, and this leads to a more expensive valuation.
However, Ted Baker’s shares did peak at £35 per share in late 2015. And, now trades on £24, and despite the correction, the average is above earnings growth.
Does slow revenue growth mean maturity?
The word “maturity” means different things to different companies. In the technology firms, maturity could mean 10% growth, while others see it to mean zero growth.
But, for Ted Baker, we don’t know.
Looking at the chart below, Ted Baker’s extra revenue ranges between £7m and £19m during 2002 to 2010. But the sales growth over this period got slower and slower because the same level of revenue increase isn’t keeping up with the size of the company.
By 2011, Ted Baker manage to increase incremental revenue from £25m to the £60m-£75m range.
The annual sales growth went from 8% in 2011 to 25% by 2014. And from there, sales growth has been declining. The forecast revenue of 2018 and 2019 means sales growth will slow to 11%.
Does this mean Ted Baker will mature as a business?
If you believe that incremental revenue going to stay at around £60m forever, then sales growth will continue to fall into single digits within three years.
But, if Ted Baker manage to increase revenue at a rate of £80m, £100m and £120m, etc. Then revenue growth will be at double-digit rates.
What is more realistic for Ted Baker, big revenue increases or maturity?
Falling capital returns
One measure to suggest maturity is from return on total capital.
This pattern can suggest that as the company gets bigger the rate of returns will decline. And it is a sign for a maturing business.
Now, we see some interesting observations/facts you may want to know. One observation is their cash cycle.
Ted Baker Strange Cash Cycle Pattern
Here’s what I mean by strange is: In 2002, the retailer reported cash cycle of 114 days. By 2017, that rose to 239 days.
A longer cash cycle means it takes longer for sales to convert into cash and leads to two things: –
- A drawdown from cash balance, or
- It needs to raise external financings.
With Ted Baker, that extra financing was needed when it breaches past 170 days in 2012. Debt began to resurface on their balance sheet. Today, it totals £116m, although £58.25m went to purchasing their headquarters.
Longer Cash Cycle Culprit
The cash cycle was longer because of high inventories levels. The inventory period rose from 165 days to 279 days. Meanwhile, Inventory Turnover collapsed from 2.21X to 1.31X.
With lower inventory and longer inventory cash conversion. The designer begins to write down inventory values as expenses.
£8m may not seem a lot, but that’s a big jump from £1.7m in four years! Although, Ted Baker would find costs savings to negate this it won’t do so for long if write-downs get bigger.
The Growth in Ted Baker Debt
We mentioned earlier the return of debt on Ted Baker’s balance sheet. Well, that debt is having some impact on its financial leverage. The chart below sees the total debt to annual net income rose from 0.5 times to 2.5 times, meaning net profit used to cover the debt in six months. Now, it takes 30 months.
The cash debt coverage, (deducting dividends from operating cash flow) before dividing by total debt has fallen from 0.4 times to 0.27 times.
And, BTW, before 2012, Ted Baker has no debt on its balance sheet.
Analyst’s Tip: Ted Baker’s debt levels are very reasonable, but the rate of debt growth can be concerning if profits growth doesn’t keep up.
Ted Baker’s Capital Investment Analysis
Ted Baker capital investment was subdued, until the last few years. But the purpose is to analyse the dynamic between capex spending and incremental sales. To make this more reliable, you should deduct depreciation from capex because companies make capex to maintain the size of business, but you want to measure how extra capex would lead to extra revenue. Also, use last year capex figure to measure current year incremental sales because it allows for capital investment to take effect.
That (orange line) ratio looks very volatile but measured over the course of 15 years, it averages six times meaning for every £1 of capex it generates £6 in “new sales”.
What if you invested in Ted Baker during the Financial Crisis?
First, let’s look at Ted Baker’s dividend policies. Then, we look at what you would have gained if you invested in the designer, since the financial crisis.
Ted Baker has been forking out 4% of sales towards paying shareholders a return in the last 15 years. That means the amounts of dividends returned every year has been going up because sales growth has been averaging 15.4% per year.
Now, let’s say you bought £10,000 worth of Ted Baker shares at the beginning of 2009 for the average price of £3.47 per share, giving you 2,882 shares. The dividend was yielding close to 5%. So, how much would your shares yield today?
The last full year dividends come to 47.8 pence per share and would yield you 13.77%.
Making this adjustment would bring the real yield on cost down to 12.83%, which is 1% lower. It is still much better than the negative saving rates from the banks (inflation-adjusted, of course).
Macro Observations: – Another interesting, but unrelated observation is since the financial crisis, those who bought into stocks and property has benefitted from enormous capital gains, along with double-digit yields.
Ted Baker’s Valuation Levels
Since the shares peaked at late 2015 and corrected by 30%, Ted Baker’s valuation has come down.
Although EV/EBIT is currently trading at 20 times operating profit, it is still fairly overvalued when we compared future earnings growth of 14%.
However, if operating profits mirrored the rise in adjusted diluted earnings per share of 13.7% and 14% for 2018 and 2019, respectively, then that multiple will fall to 16.67 times and 14.6 times if enterprise value stays where it is today.
Share price forecast
Now you have read my analysis of Ted Baker, so you would want to know where the shares will be headed in the next two years?
No one knows where a company’s share price is heading because of future uncertainties. Therefore, you have to use the power of probability in your forecast.
Best-Case Scenario: After the June results, Ted Baker will resume its uptrend and make new highs – 25% probability.
While this can happen, I don’t think it is probably because sales growth will slow. Secondly, I don’t believe Ted Baker is going to become the next Burberry meaning I don’t see Ted Baker valuation jumping from £1bn to £3bn and to £7bn. (Burberry is valued at £7.1bn.)
N.B.: That is a similar pattern of achievement since the financial crisis.
Base-Case Scenario: Ted Baker will make an interim low, before recovering – 45% probability. The momentum of its shares is negative and could force the shares below £20 in the next six months. By then, valuation is at a fair value or 14 times EV/EBIT. Next, the shares will rise again as fundamental caught up with valuation.
And after two years, Ted Baker would trade around £28 to £30 per share.
Worse-Case Scenario: Ted Baker’s shares could fall below £16 per share, due to high inflation and the business cycle turning downwards. – 30% probability.
In this scenario, Ted Baker will enter maturity and no longer grows at double-digits. The company can maintain its size with stable and steady profits. At the end of two years, the shares would trade at around £20 to £22 per share.
But there is an “off-chance”, the stock market corrects leading to a recession. In this special scenario, Ted Baker will perform poorly with reported decline in sales and profits. It will put the shares in an unknown negative trajectory, as the rest of the share market takes a tumble.
How big or how long the correct will be, is anybody guess?
Thanks for reading this Ted Baker’s analysis and I hoped you have gained some interesting insights.
If you have any thoughts, please comment below.
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The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.