Growth stocks in the FTSE 250 are slowly recovering as investor sentiment improves. However, there are still plenty of top-notch enterprises trading at exceptionally low valuations.
One stock that’s caught my attention this month is Howden Joinery Group (LSE:HWDN). Despite posting solid results, shares have been in a downward pattern as investors focus on the short-term headwinds. As such, the market capitalisation now sits below pre-pandemic levels, despite revenue and earnings sitting around 50% higher!
Let’s take a closer look at what’s going on.
A new bargain in the FTSE 250?
As a quick reminder, Howden Joinery is a vertically integrated designer and supplier of fitted kitchens. It works directly with tradesmen out of its network of 885 depots across the UK and Europe, selling primarily to the home renovation market.
With inflation tightening household budgets, it’s no surprise that investor sentiment around this business is currently weak. After all, renovating a kitchen isn’t cheap. And given we’re in the middle of a cost-of-living crisis, families are more likely to prioritise other less elective expenses.
This concern is valid. And it’s already being reflected in Howden’s results, with growth falling from double-digits to low single-digits. However, while inflation and rising interest rates are creating headwinds today, they may evolve into tailwinds later down the line.
Higher interest rates mean more expensive mortgages. As such, the trend of moving houses every couple of years by using dirt-cheap loans is starting to reverse. And families are now more likely to stay put for longer, making the idea of renovation more alluring after several years in a property.
Management seems to share this opinion since it’s still investing heavily in its expansion both in the UK and internationally. The firm is well on its way to hitting its goal of 1,000 depots. And despite the challenges of penetrating new markets, its international network has delivered 16.8% sales growth in the first four months of 2023.
Pairing this with a P/E ratio of just 9.9, the FTSE 250 stock looks cheap in my eyes. And it would appear Howden’s leadership agrees since it recently launched a £50m share buyback programme.
Nothing is risk-free
As encouraging as Howden Joinery’s performance and valuation look, there’s a glaring elephant in the room surrounding its lease liabilities.
International expansion isn’t cheap. And while the firm has been using organic cash flow to fund this project, the majority of its new depots are leased rather than owned. As such, the group currently has £665.3m of lease liabilities on its balance sheet, which behave similarly to debt incurring interest expenses.
This is the highest level of debt equivalent obligations the group has ever had, and consequently, financing expenses are on the rise. As things stand, the company generates more than enough free cash flow to cover its leases and interest incurred. But if management accidentally bites off more than it can chew, margins may get eroded.
Nevertheless, the track record of this FTSE 250 stock is impressive in my mind. Dividends have increased 275% over the last decade, the constant stream of incremental buybacks has shrunk outstanding shares by 10% since 2018, and the business model looks primed to keep delivering value to shareholders. Therefore, despite the risks, Howden Joinery is on my personal top stocks to buy list.
