Interactive Investor

Stockwatch: Reasons to keep buying this share

15th April 2016 10:22

Edmond Jackson from interactive investor

Is Halfords shaping up as a sustainable turnaround? Since I drew attention to the bikes and car parts retailer last December at 322p the price has risen nearly a third to 420p, and you also had the chance to lock in a yield over 5% - twice covered by forecast earnings. It shows how dividend yields can be pivotal to re-ratings even when trading statements are lacklustre.

I suggested Halfords had fallen too far following lower bike sales due to the last wet summer. However, this was a temporary factor in the overall positive outlook for cycling and the group's car parts retail and servicing operations offer solid steady growth.

A dilemma has been capital growth prospects reducing such that the stock de-rated in order to attract a new constituency of income-seekers. Like most trends, this fall got over-extended in the second half of 2015, but I suggested the attractive yield implied upside to at least the 350-400p region if the new chief executive sharpens up marketing.

Stock rises despite worries for UK general retail

Two decent trading updates covering Halfords' second half to 1 April have affirmed this scenario as bike sales recovered. A 21 January third-quarter statement was a key trigger, albeit with a mixed message operationally, including a fall in cycling parts, accessories and clothing.

There's been good progress in car parts, although car maintenance was affected by warm weather and Autocentres' increasing service revenue yet impacted by lower tyre prices.

The stock advanced to about 420p as the chief executive reassured full-year profits in line with expectations. But on 21 March the price dropped back below 400p after UBS issued a bearish note on the UK general retail sector - for the next 12 months - given uncertainties over "Brexit", wage inflation being compounded by a weak pound/dollar exchange rate (retailers are significant net importers) and Amazon continuing to grow.

UBS specified Halfords on the exchange rate issue, downgrading from 'neutral' to 'sell' and claiming it will have to raise prices to sustain margins. However, there is less scope for this as competition increases. Minimum wages are also constraining earnings growth.

Buyers sense firmer underlying trend

Yet investors have rather brushed aside the macro warning, the stock jumping to 422p after a 13 April fourth-quarter update cited 3.2% group revenue growth or 2.6% like-for-like (LFL).

So, do two quarters of progress comprise the early stage of a trend, as a new chief executive since last May settles in? Within LFL retail fourth-quarter sales, cycling edged up 1.9% as bike sales offset those lower in parts, accessories and clothing (items potentially cheaper online) and motoring sales rose 3.5% amid the current fashion for in-car cameras or "dash cams" (useful for evidence in road accidents).

Autocentres rose 2.8% or 1.7% like-for-like - a tenth consecutive quarter of LFL growth - which may reflect people keeping older cars while wage growth remains slow, hence the need for more servicing.

And is this mixed/modest growth profile enough to offset the various headwinds? It also emphasises the new chief executive's "Moving Up A Gear" strategy, to be further clarified with prelims on 1 June.

This was first cited at last November's interims along a theme of "leveraging customer data and analytics, relentless innovation, a better shopping experience, enhanced customer services and modern infrastructure" - effectively the next stage of marketing push after Halfords' three-year investment programme.

The hope factor likely explains some profit taking currently, with loose talk of a 320p to 420p trading range. Broker price targets range from 300p (Liberum, who are persistent sellers) to HSBC, who have raised theirs from 460p to 470p after the latest update.

CFO buys £185,550 worth of stock

Amid the mixed evidence and sentiment, Halford's finance boss has struck out boldly - buying 50,000 shares at an average price of 371p at end-January, taking his stake to 75,000 shares.

It's tempting to draw a line between this strong cash commitment and (even the sellers at) Liberum conceding "clear positives" such as a 4%+ dividend yield and the potential for near-term special cash returns.

But special dividends look a marginal prospect, given the interim cash flow statement showed £37.1 million net cash generated from operations offset by £17.5 million used for investing and £21.4 million paid out as dividends (the 2014/15 year showing £28.4 million total dividends).

At 2 October 2015, the balance sheet had £23.2 million cash. So it's a healthy cash flow and balance sheet profile, if not one exuding scope for special payouts. Much will depend on the extent of ongoing investment to "move up a gear", so best note an off-chance and revisit the issue in June.

Traders may lock in gains, but rating offers fair value

Halfords' 2016 re-rating puts it on a forward price/earnings (PE) ratio close to 13 times - high enough, given signs of a challenge to achieve even low single-figure growth.

The ordinary dividend profile has leeway in its earnings cover (and note the cash flow trend significantly in excess of earnings) to keep growing even if the UK retail context gets tougher. So the stock should continue to interest income-seekers, offering a rather high-quality yield despite price-volatility lately.

A hefty £358.1 million intangible assets as of October 2015 means no support by way of net tangibles (see table below), hence the valuation focus on earnings and dividends. But, marketing-wise, the group is well-positioned in cycling and car support, two areas of consumer spending that are likely long-term resilient.

Halfords is the UK's leading retailer of automotive and cycling products, with a 20-25% share of the cycle market and 15% of the parts, accessories and clothing market - altogether a circa £1.5 billion market that's been growing at 5% a year.

2016 is an Olympic year; British cyclists could prompt more people out on Halfords' Boardman Performance Series bikes. Even with just a 1% share of the £9 billion car aftercare market, the group owns the UK's largest car service network. So, share price volatility and a clearly-detailed strategy in June offer scope to continue accumulating stock.

For more information see their website.

Halfords Group - financial summaryConsensus estimates
year ended 3 Apr2011201220132014201520162017
Turnover (£ million)8708638719401025  
IFRS3 pre-tax profit (£m)11894.17172.683.8  
Normalised pre-tax profit (£m)12693.473.871.783.279.580.8
Operating margin (%)13.811.28.27.47.9  
IFRS3 earnings/share (p)40.23426.928.233.3  
Normalised earnings/share (p)42.834.128.327.73332.333
Earnings per share growth (%)1.5-20.3-16.9-2.1192.12.2
Price/earnings multiple (x)    12.712.912.7
Cash flow/share (p)56.344.948.134.861.9  
Capex/share (p)10.59.710.513.820.4  
Dividends per share (p)22222214.314.616.917.4
Yield (%)    3.544.5
Covered by earnings (x)21.61.322.31.91.9
Net tangible assets per share (p)-11.5-28.5-21.9-8.15.5  
Source: Company REFS

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