Stockwatch: a rare income stock capable of capital growth

Is it time to get more emphatically in favour of Halfords Group (LSE:HFD)? Whether it is playing catch-up in the wake of many other London small-caps rallying since April, and/or its latest annual results to 31 March 2024 are going down well, the stock is rising from a 26 June low of 136p to around 145p as the figures are digested.

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The share price chart remains at a long-term low if you ignore the 50p print at the start of the pandemic in March 2020, after which the Covid-inspired cycling boom had sent the stock way above 400p by June 2021:

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

A dilemma with cycling, however, is that bikes are a long-term purchase and the cycling market was flooded with product after manufacturers responded to the spike in demand, hence the market needing time to clear. Aside from affluent “middle-aged men in Lycra” splurging £5,000 upwards on a bike (they would typically shop from specialists) the kind of fair-weather occasional cyclists likely to shop at Halfords (which could be me) have got what they want.

There is also a national dilemma about motorists not replacing tyres given they are a relatively expensive item, amid constraints on discretionary spending, which impacted Halfords last year. Otherwise, Halfords’ “Autocentres” service and repair facilities are doing well.

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The stock’s risk/reward profile is interesting. If UK consumer spending recovers on a two-year view and, given management cost-cutting, a possible 6% yield could be seen as generous market pricing.

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Despite around £1.7 billion of annual revenue, Halfords’ market capitalisation is barely over £300 million, which means its price/sales ratio is under 0.2x – hence, if operating margins can recover from 3% to nearer the 5% we saw in 2019 (disregarding those higher levels during Covid) more serious profit can kick in.

The outlook statement is guarded, however, so you are taking a similar view here as in the voting booths this Thursday. Can Labour be trusted to deliver wider benefits of economic growth to people, or might there be little change beyond taxes rising if they do get power?

It’s unclear what extent it is justified to cite Halfords’ history, but it suggests a rare income stock that is able to rally, if your timing is broadly right. In mid-2010 and 2015, the price broke above 500p and, while this looks a tough repeat on valuation measures, a recovery simply to the circa 200p level last year would constitute upside of more than 35%, while securing 6% income.

Mixed messaging within respectable mid-single digit revenue growth

Annual revenue growth has been 8% at the group level, or 5% like-for-like, achieving £36 million underlying pre-tax profit – which includes a downward adjustment for the cost of running (now disposed) tyre supply operations, to be outsourced at implicitly higher cost.

I should have liked to see better explanation of acquisitions/disposals within this revenue differentiation. It’s unclear what mileage remains for Halfords’ proven development formula of “consolidating a fragmented industry” by way of buying vehicle repair/servicing/MoT businesses.

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Re-branded as “Autocentres”, these delivered nearly 17% revenue growth constituting 41% of the total. Otherwise, you are significantly left guessing about the UK consumer spending outlook as regards majority retail. Autocentres gross margins is only slightly better though, at 49% versus 47% for retail.

Weather is blamed – not unreasonably – for extending weak consumer demand. High rainfall both last summer and winter hit demand for cycling and car cleaning, with the weather also blamed for reduced footfall in stores, yet a relatively mild winter curbed demand for batteries and winter products.

There were market share gains in all four core markets, albeit insufficient to offset a 30% slump in bike sales and 14% in vehicle tyres, which together represent 32% of group revenue. This should, however, put Halfords in a stronger position as and when demand does recover. Cost savings of £35 million were achieved last year versus £30 million budgeted, for a total £70 million over three years.

Re-organisation of tyre supply substantially created near-£11 million of “non-underlying items”, and you take your view as to how fair to normalise profit. You want to see through to underlying business performance, but costs have to be borne, hence impact value.

Halfords’ definition of adjusted net profit was thus £27.6 million versus £16.9 million reported. Scope to vary this may explain published consensus for an 18% decline in adjusted net profit this current financial year to £22.7 million, followed by a recovery near £35 million in 2026.

If that is indeed reasonable, then it implies earnings per share (EPS) of 10.4p rising to near 16p, hence a forward price/earnings of 14x easing to 9x.

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Management says the new financial year has been affected by low consumer confidence for larger spending, and poor spring weather. Even for the year to 31 March 2025, their expectation is for cycling and tyres’ market volumes to decline and only remain broadly flat in vehicle servicing and motor products.

Moreover, inflation remains “a material headwind” for example the 10% hike in national minimum wage. For importing, sea freight spot rates have more than doubled since the start of the new financial year, although Halfords is securing well below them hence a forecast rise of £4-7 million.

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I would therefore be surprised to see the stock run a lot higher in the short term given the market is likely to exact a 5-6% yield for its medium-term holding risks.

Yet the company says “we do not expect these headwinds to persist in the long term” given consumer price inflation is starting to ease and as bicycle stock clears and drivers are overdue replacing tyres.

Are there risks to sustaining the 8p a share dividend?

This is probably the key downside risk to determine, given such a payout should be supportive, patience chiefly being required for capital upside.

Consensus is for 8p to be maintained this financial year albeit a pretty full payout of earnings. A retailer’s cash-generative model does however mean Halfords’ record of free cash flow generation substantially exceeds earnings, so I would think this dividend reasonably safe:

Halfords - financial summary
Year-end 31 Mar

Source: historic company REFS and company accounts.

Mind that in a worst-case scenario of further consumer retrenchment, last March’s balance sheet showed cash down from £42 million to £13 million versus an 8p dividend costing £17.5 million. 

The ratio of current assets to current liabilities was a somewhat concerning 0.9 - due chiefly to £368 million trade payables versus £161 million trade receivables. I dislike such an imbalance given it can imply profit is being enhanced by late-paying suppliers, although in Halfords’ case such payables did not even rise 2% in a year when turnover advanced 8%.

I cite this as why one should not assume another 8p dividend is certain, although it strikes me as a fair expectation.

Over £300 million leases despite only £21 million bank debt, meant £13 million interest costs last year – albeit not onerous. Mind that while the table shows net assets per share of 257p, this constitutes 87% of intangibles.

Enough to upgrade to ‘buy’ from ‘hold’

My past assessment of Halfords has been “hold” at 234p in September 2020 justified by a subsequent rally to 435p, although it slumped after the Covid boom.

I last examined the business at 154p in September 2022 with a “hold” stance. The shares subsequently bottomed at around 130p and traded volatile-sideways until rallying to 230p last November, then suffered a slide.

Buyers should be steeled for further mixed updates, but I think it is justified to consider averaging in. Ignoring a reasonable prospect of recovering to 200p-plus with a 6% yield would be harsh. Buy.

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