One size fits all - The underlying dynamics of retail apply no matter what you sell
The recent travails of Mulberry, which culminated in the UK-based luxury goods company issuing a profit warning on 14 October, led us to revisit Spot the difference, an article written by The Value Perspective back in June 2012, which compared and contrasted the attractions of the then market darling with electrical retailer Kesa, now known as Darty.
In the piece, we noted: “The stockmarket does not like electrical retailing these days for a number of reasons – not least because the internet has posed some awkward questions for the sector and because we are in a recession. What the stockmarket does love, however, is luxury goods companies that are growing quickly and Mulberry certainly ticks both those boxes.”
It ticked other boxes too – fashionable brand names that create high barriers to entry, high margins and exposure to some exciting emerging markets, such as China and Russia – to the extent that many investors began to view Mulberry and some of its peers as ‘perfect’ businesses. They paid multiples to match for them too, convincing themselves there was no environment in which these companies could not thrive.
Well, now they are not thriving. Undoubtedly they could point to external factors – slowdowns in some exciting emerging markets, such as China and Russia, for example – but it seems improbable there are not some company-specific issues too. Either way, no company is so good it will never make mistakes or be hurt by external trends – and luxury goods businesses are no different.
On the subject of internal issues, Mulberry admitted in its profit warning that, over the 26 weeks to 30 September 2014, group retails sales were down 13% overall and 17% in the UK. It also noted it is maintaining tight cost controls across the business “albeit with a large proportion of costs being fixed”. If your sales are going down, of course, then the maths is fixed costs = bad and variable costs = good.
The statement continued: “The opening of the Paris flagship store, planned for late spring 2015, will mark the end of a period of accelerated investment in new stores, establishing the foundation for the next phase of growth in Europe and North America. This investment has involved significant capital investment and increased the fixed costs of the business substantially.”
While these projects may go on to have a very high-returning future, expansion that occurs towards the end of a boom is often the more marginal in profit terms and companies can end up regretting it. Many of the costs that go into the expansion of any ‘retail footprint’ may well relate to long-term leases in expensive locations that are hard to get out of – Paris being an obvious example. It is a classic retail trap – good times encourage a business to expand and often its plans become too ambitious.
In that sense, some of the issues Mulberry may now have to confront will sound very familiar to management and shareholders of a number of the UK’s much more low-market high street retailers, such as Home Retail Group and, more recently, Tesco. Just because you are selling handbags for £1,000 rather than groceries to go in your 1p plastic bags, it does not mean the underlying dynamics of retail – or indeed prudent corporate capital allocation – cease to apply.
And what about Kesa/Darty? Well, it can hardly be said to have thrived in the two and a half years since we made that comparison with Mulberry – indeed, with hindsight, we should have used Dixons to illustrate our point as its share price performance since then speaks for itself. However such has been the decline in Mulberry’s share price, as the market has begun to value it more rationally, that you would still have been much better off owning the apparently outmoded, eurozone-focused electrical retailer than the more fashionable option. As we suggested at the time, Kesa/Darty’s valuation was considerable more favourable and, as ever, the price you pay is the most important determinant of future returns. As you may be able to tell from our photos, here at The Value Perspective we will take value over glamour every time.
Fund Manager, Equity Value
I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.
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