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I’ve bought N Brown shares (LSE:BWNG) at £1.42 for my Modified cyclically adjusted price earnings ratio portfolio. This online retailer – with some legacy paper catalogue business – has seen its shares fall from around £6 four and half years ago to £1.42 today.
Outline of what they do
They specialise in fashion for the underserved groups of the size 20 plus or the over fifties. They are overwhelmingly UK focused, but with some operations in Ireland and tentative steps in the US and an “anywhere in the world” website.
They are the “experts in fashion that fits and flatters”. Long recognised for expertise in the target markets of “fashion that fits and flatters”as well as breadth and depth of range: “We have an industry-leading fit specialism and market leading position in our plus-size niche.”
At one time, most of the business was catalogue-based with a few shops. Now it is three-quarters online (57% of sales through smartphones). Ladies fashion is the largest source of revenue using several brand names, followed by homeware and gifts, followed by menswear. In last place is footwear and accessories.
In the year to end March 2018 the company had 4.45m active customer accounts, i.e. those that made at least one purchase in the 12 months – a substantial percentage of the UK adult population.
Explanations advanced for the share fall
It would seem that Mr Market is upset. Included in the list of issues worrying Mr Market are:
- The fall in underlying earnings, down to 4.41p in 2018 from 29.28p in 2012.
- The habit of finding that past profits (pre-2011) we’re artificially inflated by recording earnings for selling insurance policies to credit-taking customers in a PPI-type scandal. Now the company is taking the benefit away from its profits through “exceptional” deductions because it has to pay compensatory payments to the customers it hurt. While the directors do this they steer investor’s attention to the “underlying earnings” which ignore these payments. The current fear is that there may be more PPI-style reparations to be made which will knacker profit and the balance in the years to come. Also, there could be a large exceptional cost (about the same as a year’s profit) if a tax dispute goes against the company.
- The company’s buyers are not good at selecting dresses etc., for sale, as exemplified by the decision to close all high street shops (and take a closure cost of over £31m – £35m as an “exceptional”).
- The general malaise around retailing. Clothing retailers, in particular, are sacrificing margin to attract sales.
- The managers are going to waste money on international expansion beyond the few countries where they have established customer recognition and habit-formation.
- Debt is £405m for a company with a market capitalisation of 283.6 shares x £1.42 = £402m and a profit last year of only £12.5m.
- The dividend (which costs £40m pa) will be cut or eliminated to pay down debt.
- The FCA might withdraw/restrict their licence to lend due to excess interest charge.
These are all legitimate concerns, and it may well be that one or more of them will cause the share to fall further. But I have to play the probabilities, and in my estimation the probabilities of these negatives causing serious issues in the long-run future are smaller than the probabilities of good things happening.
These good scenarios are derived from the evidence of the past, which I’ll outline in a series of newsletters this week. The evidence feeds into a range of valuations.
(Previous newsletters on N Brown: 4th – 12th May 2017, 30th June 2017, 28th Nov – 1st Dec 2017)
Let’s start with the facts on earnings and dividends
| Pence per share | Earnings (basic) | Earnings (adjusted) | Dividends | ||
| 2018 | 4.41 | 23.06 | 14.23 | ||
| 2017 | 15.67 | 22.74 | 14.23 | ||
| 2016 | 19.23 | 24.02 | 14.23 | ||
| 2015 | 18.15 | 24.61 | 14.23 | ||
| 2014 | 27.09 | 27.74 | 14.23 | ||
| 2013 | 28.51 | 28.04 | 13.68 | ||
| 2012 | 29.28 | 28.84 | 13.03 | ||
| 2011 | 26.04 | 26.88 | 12.41 | ||
| 2010 | 22.83 | 24.77 | 10.79 | ||
| 2009 | 22.88 | 21.96 | 9.19 | ||
| 2008 | 21.16 | 20.27 | 9.06 | ||
| AVERAGE OVER 11 YEARS | 21.4 | 24.8 |
Dividend yield is 14.23p/142p = 10.2 %. That is exceptionally high. If the share price only holds steady for the next few years, I’ll be content if I’m compensated with a 10.2% return per year from the dividend. In other newsletters I’ll consider the threats to earnings and thus the dividend.
Average earnings per share “basic”: 21.4p. Cyclically adjusted price earnings ratio “basic”: 142p/21.4p = 6.6
Average earnings per share “adjusted”: 24.8p. Cyclically adjusted price earnings ratio “adjusted”: 142p/24.8p = 5.7.
The CAPEs are less than half that of the average for the London market, so the share certainly passes the first test for the Modified cyclically adjusted price earning ratio portfolio.
Where do the earnings come from?
The way I see the business is, that it sells clothes etc., to people at below cost as a deliberate strategy. That is, it makes a gross margin on the items it sells of around 52% (i.e. if it buys a dress from China for £28.80 it sells it to a Brit for £60), but the costs of warehousing, logistics, website maintenance and promotion amount to more than the gross profit.
This pattern is apparent in the last six years. Take 2018 as an example. It sold £653m to its customers. From this it had to pay suppliers £312m, leaving £341m in gross profit to pay for warehousing, admin etc. But these costs came to £387m so it made a loss on selling dresses etc., of £46m.
And it produces this sort of loss year after year. A disastrous pattern, you might think, for a retailer. But this is no ordinary retailer. There is an alternative lens: it can be looked at as an
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