Interactive Investor

Can Safestyle bounce after latest profit warning?

8th September 2017 13:50

David Brenchley from interactive investor

Profits warnings come in threes, they say, and investors are already keeping a keen eye on Provident Financial to see if they complete the hat trick. They're giving Safestyle the once-over too after it reported a second warning in the space of two months Friday. Include a warning on first-half performance in May and that's the three. Is that it then, or could it be more?

Safestyle shares hurtled lower Friday, with the price very briefly halving to a record low of 112.85p, as the double-glazing firm said its order intake had "declined beyond... expectations" due to increasing consumer caution accelerating weakness in the market.

Full-year revenue is now expected to be flat year-on-year, with efforts to drive order intake incurring additional costs, "thereby adversely affecting the group's margin performance and leading to a material impact on full-year profits".

Broker Liberum adds it understands take up of promotional finance, offered by a third party and subsidised by Safestyle, has increased. This is likely to hit gross margins, which it expects to fall to 32%, from 34% in 2016.

Having bounced to trade at 167p currently, Safestyle shares have still halved in market value since making an all-time high at 325p on 17 May. It was the following day that troubles first surfaced.

A troubled year

Chairman Steve Halbert first disappointed investors at the AGM on 18 May, telling them that, after a robust first-quarter, subsequent trading had been weaker than expected and first-half profits would be lower than H1 2016. He countered an improved performance in the second half was expected, but investors took fright and the shares fell 13%.

But the recovery never materialised. In fact, two months later things were no better and full-year profit guidance was revised to be "broadly in line with 2016". And it's clearly got worse in the intervening seven weeks.

Safestyle says it remains well positioned in the event of a market recovery, with a significant cash balance and robust balance sheet. However, when that recovery comes is anyone's guess.

In August, peer Epwin also warned on profits and Safestyle cites figures from double-glazing regulator FENSA showing installations were down by 18% in June and July compared to 2016, confirming it's a market-wide issue. Today, Epwin fell a further 8% in response.

Liberum has revised its full-year forecasts for Safestyle, with pressure on margins the big take away. The full £3.3 million (-2%) in lost sales fall through to the bottom line, with earnings per share (EPS) estimates now 19% lower at 19.3p.

Downgrades also carry through to both 2018 and 2019. Sales will be 5% lower than previously expected, with EPS falling by 19% and 17% respectively. Margin will now be 203 basis points less in 2017, -182bps in 2018 and -171bps in 2019.

Can management turn things around?

Charlie Campbell, analyst at Liberum, reckons there's scope for self-help. It has a cost advantage over others and its use of promotional finance allows it to target a wider audience, we're told. An expanded manufacturing site should allow it to reduce unit costs in future, potentially facilitating margin recovery down the line.

"We would also expect management to keep a sharp focus on costs and we expect some overhead reduction measures to be used to offset slower volumes, driving expected profit progression in 2018 over 2017."

Liberum only cuts dividend per share forecasts for 2017 by 2% to 11.3p, reflecting the firm's strong cash position – year-end net cash of £13.2 million at December 2017 is around 10% of current market cap.

That gives the stock a forward yield of 7%. With scope to pay another special dividend this year, the payout should support shares going forward. "We see 8% free cash flow yield as extremely attractive for a market leader with strong cash flow characteristics," says Campbell.

It's why he keeps his 'buy' recommendation on the stock, albeit with a much-reduced target price of 215p – down 35% since May – based on FCF yield of 8%, rather than 7.5% previously.

Still, investors will be rightly cautious. It's not only a double-glazing industry problem. We've heard from other big-ticket item sellers that consumers are putting off forking out large amounts for non-essential purchases. The likes of Dunelm (-3.8%) and Kingfisher (-2.8%) were some of the biggest losers on the FTSE All-Share Friday.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.