Millets profits depend on the right kind of weather. Is this where you'd want to put your money?
Private equity investors are snapping up retailers at the moment. Icelandic operator Baugur is in the process of acquiring House of Fraser
(LSE: HOF)
, and Wyevale Garden Centres was recently bought out by West Coast Capital.
But why is this, when the outlook for retail spending is still uncertain? One answer may be that the buyers are taking a longer-term perspective than the stock market, and looking to the returns that will be made as spending inevitably increases over the years. Short-term concerns may result in a buying opportunity.
Another reason is that many retail earnings are strongly supported by cash flow. This allows the balance sheet to be geared up with relative safety, and cash returned to the investors. The more predictable these profits and cash flows, the more debt that can be taken on.
Over the summer, profit warnings by Blacks Leisure
(LSE: BSLA)
, owner of the Millets and Blacks chains, lead to a slump in the share price. This added fuel to the rumours that Mike Ashley, the entrepreneur behind Sports World, would make a bid for the company. Blacks has net cash on its books, has strong cash flow to back up any profits, but has the problem that both profits and cash flow are very hard to predict.
So not all the boxes are ticked, but add in the synergies with Ashley's other businesses and you can see why people are speculating. The box that's not ticked, predictability, is an important issue though. Interim results this morning show the company barely breaking even, versus a healthy profit in the same period last year. Consider the following:
- The World Cup meant people stayed close to their televisions rather than out in the woods, and spent more time looking at football than playing it;
- No Glastonbury Festival meant lower sales of camping gear;
- Unseasonably warm and dry weather meant no need to stock up on rainwear;
- Competition intensified in the camping sector.
Profitability may return to what it was, just as unpredictably as it fell. Admittedly the fall in profit was flagged up in the profit warnings, but in each of these announcements the outlook statements had to be revised.
On a forward PE of in the high teens, I'd want earnings to be based on more than the random chance of co-operative weather. As I see it, the possibility of a bid is the only reason to hold Blacks shares at the moment.
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