Greggs, Aeropostale and a bit of history

Greggs has already been included into the “generals” part of the portfolio but I decided to do a more thorough look into what is going on. As usual, this will be largely quantitative however, my original decision was to do with news that its same-store sales was strong (interim statment), a fairly good sign considering the weakening outlook for consumers.

As with JD Sports, I should highlight that GRG have done their prelims for FY11 (prelims) but not published their annual report (FY10 annual report) so there is a basic outlook of FY11 but without data on operating leases we can’t really tell whats going on. So, as usual, the first thing to look at is the return on operations.

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Looking first to turns we see a few interesting trends. The company’s cash cycle has begun slowing down on both sides, the bottom appears around the mid-2000s however, it still remains negative by about a month or so. Revenues have also been slowing in comparison to growth in operating assets. I have fairly solid data going back to 1993 and GRG appears to be pretty pro-cyclical. This is something I didn’t really expect and I don’t know how to interpret it in the context of GRG’s business. Margins is, of course, where the interesting stuff is happening at the moment. GRG mentions its latest view on commodity costs in the prelims and states it is working to improve efficiency to prevent any need to pass costs on. Looking at FY11, we see that top line growth is fairly stagnant at 0.63% whilst net income growth is 10.36% so the company appears to be fighting inflation although I would suspect it is raising prices as well. So there are a few things to keep an eye but I was suprised how well the company was performing and how strong its historical record is. In fact, since 1993 there doesn’t appear to have been a year where the company has returned less than 27% to shareholders. It is true the company hasn’t returned over 33% since then either but I also think its consistency is pretty attractive too.

In terms of cash flow, we get the same positive picture. OCF (before WC changes) is consistently 200%+ of net income and so accurals are consistently positive. Free cash flow has been just as healthy averaging around £30m for the past 5 years. Capex has been steady but the company is forecasting slightly heavier capex for the current fiscal year at around £60m (up from £45) with most of the new investment going to store refits and supply chain capacity. Compared to other companies, GRG has been pretty agressive in returning cash to shareholders through dividends and buybacks, in the last fiscal year these were around £30m (£17m in dividends and £13m in buybacks) however, although the share buyback program was approved it appears the company will largely stick to the dividend going forward as it invests more in the business. At returns of around 12.5% for refits and 20+% for new stores this seems like it could work out well. GRG’s cash management appears encouraging particularly, its willingness to return cash.

In all, I am pretty bullish on GRG as it appears to be a well-managed company in a good position with a clear strategy going forward of supply chain improvements and store refits. I am planning to build the position in GRG in the coming weeks as I read through the annual reports in more detail but at the moment, I think the current price presents a good oppurtunity and although the margin of safety is quite tight I believe this is remedied by the stability of the business overall.

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Aeropostale reported Q1 earnings after the close on Friday and the response was a complete rout of around 15%. The stock is trading around $18.30 although it will probablly have another tough day today. Other retail stocks have been reporting, Abercrombie has had pretty good results, and I think that this is where the money is heading, if anywhere, in retail apparel, whilst Gap had pretty weak results and got taken down around the same as ARO.

Results for ARO were in line with the adjusted guidance of 20c and same-store sales decreased 7% in Q1. The new information was guidance of $0.11-$0.16 for Q2 which is pretty terrible. Last year Q2 was $0.46 and $0.38 the year before that. The company also purchased around $100m of stock in the first quarter. The cited reason for ARO’s underperformance was the heavily promotional market. At this price, I am going to add to ARO as I have some room left with position sizes but I am not completely convinced by what is happening. The continued heavy share repurchase, the apparent loss of market share and the clear overcapacity in this sector obviously make this a tough pick. However, the company remains in a strong position financially with good cover over interest expenses and a fairly good record of management. The concern is though that the only way out is through a pickup of US consumer spending which, at the moment, isn’t in the foreseeable future.

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Finally, I was looking at historical US market yearly returns since the 1870s and came up with this interesting table. Basically, it tracks the realized CAGR of annual yearly returns over 3 periods. The green line is 5 year CAGR annual yearly returns, blue is 10 year and red is 20 year. In other words, the graphs shows you what the return going forward by holding period had you bought on a certain date (so why it ends in 2007). There are obviously several quite interesting things about this table but I am going to only talk about two. The first is the volatility in possible returns that we see around the late 1920s period and then in the late 1990s. For me, this highlights the problem with virtually any development of knowledge or idea in markets. Something is a good idea, until everyone thinks its a good idea and then its not. Likewise, buy and hold was a good idea in the early 1920s (briefly) and for a 5-7 year period in the early 1990s but after that is wasn’t so good. The very acceptance of an idea changes the nature of its application and so ideas may change but, it seems, valuation/price is permanently important. The second regards the distinct change in the 20yr yearly returns after 1931 and, prompted by following Hugh Hendry’s writings, was the reason why I got round to looking at these returns in more detail. Since 1931, they have barely been below 5% which, seems to me, extraordinary. Look at the late 19th cenutry, 10yr/20yr annual returns were barely above 5%. Perhaps more extraordinary is that they never turned up in the 1920s suggesting the fleeting (and artificial) nature of the massive bump in 5yr annual returns in that period. Either way, it suggests to me that the way the market behaves now is heavily influenced by this idea (always buy dips/size-weight indexes) and that there is no logical reason why this should be. The way the market behaves now hasn’t always been and there is no rule saying it should.

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