Stockwatch: does share slump offer another bite of the cherry?

The extent of share price spikes lately has got me thinking about whether these are justified by company fundamentals. Should you beware of irrational exuberance or are bulls right to exploit the “Trump always chickens out” (TACO) trade since his various changes of position on tariffs?

Mid-cap B&M European Value Retail SA (LSE:BME) exemplifies how a recent spike in share price is suddenly seen has being unjustified.

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In February I was intrigued by its fall from over 500p in May 2024 to around 280p, despite a cash-generative business model having enabled 15p special dividends alongside similar ordinary payouts. Even if specials were cancelled, a yield above 5% looked supportive alongside a forward price/earnings (PE) ratio around 8x, yet the balance sheet hardly offered comfort. Annual results to 29 March now confirm £2,350 million net debt (including leases) in a context of £752 million negative net assets before £1,040 million intangibles.

Of chief concern is like-for-like revenue declines in the main UK stores since around a year ago. The March 2024 year had achieved 3.7% growth in this respect, but this has slid to 3.1% negative. Despite the French stores growing 8% this last year they constitute only 10% of total revenue. A 4.0% overall growth rate is being achieved by vigorous new store openings.

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The trend was already manifested when I wrote last, and I could not see it as value-enhancing to expand stores if the retail proposition was declining. Might B&M need a more radical re-set and, given the board had decided to change CEO, could that follow from a new boss calling a strategic review? I could but muster a “hold” rating given the business’s still strong and cash-generative profile.

Ironically it was after these numbers were affirmed in a 15 April update that the shares began to soar consistently - by 25% to over 340p – although it’s unclear if this is related at all to the 15 May confirmation of a capable new CEO effective from 16 June. That was a big re-rate if simply “because the market is going up”, and showing perhaps a lack of pricing efficiency. The share price has slumped back to around 280p after annual results gave the market a reminder of its issues rather than any new information.

Source: TradingView. Past performance is not a guide to future performance.

A curate’s egg of a financial and marketing mix

In fairness, a 1.8% fall in adjusted operating profit to £591 million implies a 10.6% margin versus 4.9% for Tesco (LSE:TSCO) on a similar basis and ex-fuel sales last year. That is very good for retail, showing B&M is adept with its occasional big purchases and promotions at low prices that pull shoppers in.

Marketing seems the trickiest yet most vital aspect to judge about whether B&M is a potential turnaround, or becoming squeezed in a tough market for “value” retail as the lower-income clientele is itself pressured.

There is a similar “Home Bargains” chain, and also the Costco membership warehouse club, which has faced similar challenges; and of course Poundland is currently being sold – yes, for a pound – as its owners see UK retail as too challenging.

Online reports suggest Home Bargains may be more competitive on everyday essentials and food items, whereas B&M tends to have a wider range of household items and seasonal products.

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It has been easy to assume hard times would partly aid value retailers, with people trading down from major supermarkets. That was a key reason Aldi and Lidl achieved huge expansion in the UK, and which continues today. The likes of Marks & Spencer Group (LSE:MKS) and Sainsbury (J) (LSE:SBRY) lost share but more recently have fought back with more varied produce and price-matching on key items.

Yet the cheapest retailers appear to be victims lately as lower-income households are compromised by a mix of low real wages growth, benefit cuts, rising tax thresholds and inflation.

B&M cites its fast-moving consumer goods as a chief source of sales weakness, which would follow from this social segment cutting discretionary spend. However, I suspect Aldi and Lidl’s “middle aisles” of cheap goods may also be a factor.

There is no specific update on trading since the 29 March financial year-end beyond reiterating headwinds such as “heightened consumer caution and limited real wage growth in lower-income customers”. This does not sound great versus cost headwinds of “higher minimum wage and employee national insurance costs, other taxes and inflation on input costs”.

Can a new CEO make a real difference here?

Tjeerd Jegen “brings broad international retail experience having worked in leadership roles at Ahold Delhaize, Metro, Tesco, Woolworths, HEMSA and Takko Fashion”. He is described by the chair of the board as the “stand-out candidate” with a track record of “driving growth and transformation”.

Against this possibly is Warren Buffett’s cold-water adage: “When a manager with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

The current state of UK value retail might worryingly qualify B&M in this instance, yet its longer-term financial record has shown, for example, very respectable returns on total capital – from 12.8% to 21.5% since 2016, and free cash flow up from £8 million to over £60 million. Does the new CEO therefore inherit a business able to be honed for better like-for-like returns?

B&M European Value Retail SA
Year end 29 Mar

Source: historic company REFS and company accounts.

Latest prelims also assert an adjusted return on capital of 30.4% in the last financial year, in a context of “£2.1 billion returned to shareholders over the last five years”. But it seems to me, not wholly dissimilar to how water utilities have been criticised for “dividend stripping” only to find themselves behind the curve as to industry positioning and carrying too much debt.

B&M’s income statement shows net finance costs of £136 million (inclusive of leases’ servicing) taking 24% of operating profit. That would hardly appear stressed but in terms say of the Altman Z-score, a classic measure of bankruptcy risk, B&M entertains “distress” at the far end of a “cautious” scale. For sure, near £2.4 billion net debt including the leases, is weighing on equity value.

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Meanwhile, the cash flow statement shows £300 million going out as dividends; virtually all £306 million reported net profit albeit only 44% of £675 million net cash from operations. Perhaps management would justify its aggressive expansion of stores by pointing to only £131 million spent on purchase of property, plant and equipment. But how is this value-creating if accumulating an estate with declining like-for-like sales?

Call me wary how the new CEI says he is “honoured to join one of Europe’s leading value retailers at such a pivotal time” (my italics). It accords with my sense of major change needed here. He still asserts the company’s “strong fundamentals” (contra Buffett) and “taking it to the next level”.

It is why I incline to keep B&M on-radar.

No commitment on maintaining special dividends

The financial review does still affirm “an agreed long-term capital allocation policy...(within which)...the dividend policy targets an ordinary dividend pay-out ratio of 40% to 50% of net income...”

A current share price around 280p effectively discounts an end to specials’ given an implied yield over 5% if the 15p ordinary dividend is at least maintained; with 10.7% seen as unrealistic with a further 15p special (as was paid only last February).

I incline to let this new CEO get settled in and see as and when a substantial share option grant is made, at what price. Call me cynical but the longer this takes the greater chance he prescribes tough medicine.

You could take a speculative position on the basis of a financial record this new CEO might go some way usefully to restore; that the market will again buy hope, any radical actions will yield desired results.  

But until we see what he does, whether sufficient in a tough “value” retail space, I retain “hold”.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.