Do look back – A true indication of a company’s progress is often to be found in its small print
While we love a subject we can really get our teeth into, here on The Value Perspective, we are rather less keen when the subject starts getting its teeth into itself. Take B&M, a fast-growing discount retailer, which opened some 80 new locations last year and in so doing took the total number of stores it operates in the UK up towards the 500 mark.
Investors can become very excited about these sorts of roll-out stories, where revenues can grow 20% or more a year – and so it is proving with B&M, with the market’s high hopes reflected in a valuation of 20x earnings before interest and tax. To be clear, we are not debating B&M’s growth profile here or even its current target of 850 stores – but we are uneasy about some small print in its latest results.
This is where we pick up on our opening line and the marketing strategy term ‘cannibalisation’, which refers to a reduction in a company’s sales volume, sales revenue or market share that results from the introduction of a new product – or, in B&M’s case, the opening of new stores – by the company itself. Yes, truly the only good cannibals are the fine young ones who had a string of hits in the late 1980s.
Now, should you refer back to the prospectus B&M published ahead of its IPO in 2013, you will find the company saying it did not expect “any significant adverse changes to store payback or profitability” from the store roll-out programme it was planning and indeed that it could “sustain multiple B&M stores in individual markets and regions with little to no cannibalisation” of existing stores.
In short, B&M’s directors were not expecting any ill-effects from the company’s very aggressive growth strategy – and, to begin with at least, they appeared to be right. Like-for-like growth was an impressive 6.6% in 2013, 6.5% the next year and a still very respectable 4.4% in 2015. Even for the year ended March 2016, underlying growth was an acceptable 2.4%. But did you spot the red flag?
Whenever you see the term “underlying” in a corporate document, the best course of action is to translate it as “company-adjusted” and then head straight to the footnotes. In this instance, they reveal B&M made two adjustments to its 2016 growth, the first of which added 0.6% as a result of using a 14-month period after a new store opened rather than 12 in order to cut out the ‘halo effect’ that can occur.
For apparently there are few things people like better than visiting a B&M store in the weeks after it opens and so the company deemed it necessary to strip out the first couple of months to avoid any distortions. If we sound surprised, it is not because B&M chose to make this adjustment but because it had never seen any reason to do so in previous years.
The second adjustment was made to take account of – you guessed it – cannibalisation. We should quickly add that stripping out the negative impact the opening of a company’s store can have on an existing one as if it never happened is not unheard of – Poundland and Next have both done this in the past. Don’t forget, though, at its IPO only three years ago, B&M expected no such ill-effects.
What is more, the adjustment was worth 1.5% of that 2.4% growth – meaning, if you strip out both that and the 0.6% we mentioned earlier, you end up with like-for-like growth of just 0.3%. No doubt B&M had perfectly good reasons for doing this – after all, the number of stores it opened last year was well above the average – but, still, it represents quite a change in attitude.
Furthermore, once you work it through, it represents quite a change in the company’s numbers. By our maths, those two adjustments are worth roughly £32m, which equates to about 13% of B&M’s new revenue. How many people, when they look at the company’s roll-out programme would be assuming more than a tenth of new revenue and probably a similar level of profitability is being given away?
It is all too easy for a business to say it is going to grow very attractively but sometimes the reality can prove rather different and be only suggested by terms such as “underlying”. You should take these as your cue to examine the small print and understand what the company is really talking about. Is it, as those Fine Young Cannibals might put it, a good thing or something that could drive you crazy?
Fund Manager, Equity Value
I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst.
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