Disclaimer: This newsletter is not financial advice this is for educational purposes only so please DON’T take this newsletter as a buy or sell signal.
What is special situation Investing?
For new readers who aren’t familiar with the term “special situation investing” I will give you a brief overview of what “special situation investing” is then I will get into the breakdown of Wickes Group. Special situation investing is value investing with a clear catalyst. When talking about special situations there are several ways the smaller investor can benefit from this by looking at merger arbitrage, spin-offs, liquidation play and even cash payout via a special dividend or share buybacks. For more information on what special situation investing is check out the book “You Can Be A Stock Market Genius” by Joel Greenblatt.
In this particular investment opportunity, Wickes Group is a compelling spin-off play as the stock is down 48.39% since it got spun off in April 2021 by Travis-Perkins. Spin-offs are a compelling investment for the smaller retail investor because the company that is getting spun off sometimes can’t be held by fund managers because the parent company might be part of a major index fund and the new company might not be which means you will get selling pressure from fund managers as a result of this. Another reason why a spin-off company might get sold off is that the company might be too small in size and if a company is too small in size this particular investment might not be enough to move the needle for fund managers. You also get selling pressure from retail investors who only want to invest in the parent company and not the new entity and when the new entity is given out to the retail investors who invest in the parent company they will usually sell it off because they might not want to be exposed to similar business risk and they sell it without doing any research on the company. When you get selling pressure from fund managers and retail investors this causes an avalanche of constant selling pressure which for value investors is a dream because we can buy these companies that can give us outsize returns as spin-offs tend to outperform the market over a long period as shown by the image below.
Wickes Group PLC Fundamentals:
Below is a table I normally use in my process when looking at the health of a company to see if they pass the screening test. If the company meets my criteria it will be colour-coded in green and if they don’t meet that criteria it will be colour-coded in red which means we need to investigate further and ask ourselves why this is the case. As you can see we have 3 red boxes and I am going to explain each one below.
5-Year Profit Margin- When looking at a company I ideally want a company to have a 5-year average profit margin above 10% but because this is a retail company I am not going to penalise them for having such a low-profit margin. I do praise Wickes because they have signally improved their profit margins over the years where it was as low as 2% and now their profit margin is hovering around 4% and 5%. This margin increase was due to them cutting costs and pivoting toward a digital lead business model.
Free Cash Flow- When Looking at a company I ideally want my free cash flow to be growing over time just like their profit and revenue. Wickes on the other hand is somewhat a cyclical business and they aren’t always going to be generating steady free cash flow growth. Some years they will generate a lot of cash flow and some years they won’t but the main point is they will always generate a lot of free cash flow.
Debt To Equity Ratio-If you were to look at Wickes’s balance sheet you would think this company is in a terrible financial state because it is highly “leveraged” when that isn’t the case. When it comes to retail it is important to understand what type of debt Wickes has and most of Wickes’s debt is tied up in long-term lease obligations. Out of Wickes’s £559 Million in long-term liability £225 Million is in long-term lease obligations. Long-term lease obligation isn’t something I am worried about since it isn’t interest-paid debt it is essentially rent for the properties so it is fixed. Wickes is a highly profitable business that generates a lot of cash flow and they have a lot of cash on the balance sheet so they should be fine.
Business Overview:
Founded in 1854 by Henry Wickes, Wickes is a DIY and Home Improvement company founded in Michigan, United States. It wasn’t until 1972 when Wickes, along with British builders merchant, Sankey’s, opened up its first store in the United Kingdom. By 1987, Wickes was trading from 41 locations and was floated on the London Stock Exchange under the leadership of CEO, Henry Sweetbaum. In 1996 Wickes went through a scandal where they were accused of accounting irregularities, involving the overstatement of their profits. To oversee this scandal Wickes fired Henry Sweetbaum and appointed Bill Grimsey as the new CEO. This was the turning point for Wickes because they were able to turn their business around and put the scandal behind them. Wickes turned their business around that in 2000 they were bought out by Focus DIY and since then they have managed to grow to the point where they had 131 stores located across the UK by the year 2000 and 172 by the year 2004. In 2004 Focus DIY sold Wickes to Travis Perkins which is the largest merchant in the UK as of 2022 and by 2021 Wickes was spun off by Travis Perkins which will enable both companies to operate as a separate entity and focus on growth strategies without having to share resources.
Business Segments:
As shown below Wickes has 3 business segments that drive growth.
Source: Wickes 2021 Annual Report
Local Trade- This segment of Wickes helps with home improvement projects such as home extensions, and kitchen and bathroom renovations. The typical customer for this part of the business is small businesses and if you signed up for their TradePro membership you get a 10% discount. The TradePro membership programme has significantly grown since it was launched in 2018 where the userbase has grown from 192,000 accounts in 2014 to 492,000 in 2019.
Source: Wickes Quarterly Report
Do It For Me- This segment of Wickes is Wickes’s in-house design and installation team. Wickes has 620 in-house design consultants available for an appointment either in-store or virtually. These design services are available for free and come with a home consultation and an itemised quote with no obligation to buy. If the customer decides to go ahead with the project Wickes has an installation team that will help with the fitting by going to the customer’s house and helping them with the installation.
DIY(Do It Yourself)- This segment Involves the selling of supplies to customers carrying out DIY, through buying in-store or ordering through the Wickes DIY app. They offer free delivery on orders over £85 and free returns and free click and collect services within one hour. They offer approximately 9500 products in-store and more than 8000 online with everything from light trade to heavy trade. 60% of all products are Wickes’s brand products which normally have higher margins than third-party products from named brands. They carry out regular product reviews so that the stock that they keep is minimal but still meets the demands of customers.
Digital Integration:
Wickes has invested a lot of money into having a digital lead business model and it has paid off for them because they have been able to generate a lot more money, unlock more growth potential and increase their margins over time. In this section, I am going to talk about how Wickes’s digital integration has improved its business significantly and we are also going to take a look at how Wickes has set up their store to synergise with its online business.
Store Size- Wickes currently has around 235 stores in the Uk and the typical Wickes store is 28,000 Square feet in size. Wickes’s 28,000 Square feet store is significantly smaller than some of its close competitors such as Travis Perkins which has a store size of 117,000 Square feet and Kingfisher which has a store size of 110,000 Square feet. Even though Wickes store is significantly smaller than Travis Perkins and Kingfisher it is not smaller than Howden Joinery which has a store size of 10,000 Square feet as shown in the table below.
Store Layout-In terms of store layout, Wickes’s store format is designed to support its digital offering, with its centralised order fulfilment system integrated with the store estate, meaning that website orders can be fulfilled via retail stores via online order matching to the nearest store. As shown below 95% of online sales touch the store whether that is from click and collect or store visits.
Source: Wickes Quarterly Report
Management
When looking at management I like to assess them in several different ways such as experience, capital allocation skills and Incentives. In this section, I will cover if management incentive is aligned with shareholders.
Experience-David Wood has been the CEO of Wickes Group for 3 years. David Wood has gained experience across several international consumer-facing brands, with a strong track record for turning around and growing retail businesses. He was previously Group President of Kmart Holding Corp, a grocery retail and pharmaceutical business, where he successfully transformed the customer value proposition and retail operating model, returning the business to sustainable profit growth. Before this, he held several senior commercials, marketing and general management positions at Tesco where he achieved similar results in the UK and internationally. He has a great track record in similar circumstances across international and consumer-facing brands and is a highly effective operator of retail operations. David Wood was a director of Tesco Freetime Limited and Nutricentre Limited for the past five years. He served as Managing Director for Health and Wellbeing at Tesco PLC until March 2015. Below is a table illustrating the current experience of the Wickes Board.
Capital Allocation-When it comes to judging management I think capital allocation is very important because we want management to create shareholder value and not destroy it. So far Wickes’s capital allocation has been spot on because they are giving value back to shareholders via dividends which currently stand at a 10% yield. Although that is considerably high the current dividend is sustainable because only 48% of Wickes’s free cash flow is paid out in dividends. The only issue I have with Wickes’s capital allocation is the lack of share buybacks at this price.
Incentive-This is important because if the current board is actively purchasing stock of their own business this is a positive indicator that shows that management believes the stock is undervalued and they believe in the long-term prospect of the company. As you can see below insiders are buying Wickes shares with CEO David Wood making up the bulk of the purchase.
Bull And Bear Case:
In this section, I am going to highlight the bull and bear case for this investment.
Bull Case-My first bull case for this investment is the DIY market is set to remain stable and grow at a 2.5% rate while DIFM is set to increase and grow at a 3.6% rate. This will benefit Wickes as they are one of the leading DIY stores in the UK and they should capture a lot of this growth going forward.
Source: Wickes Quarterly Report
Bull Case-My second bull case is the opportunity for growth. Study shows there is more potential opportunity for growth as more of the younger generation are getting involved with DIY as they are buying their first home. 46% of 18-34 say they have purchased more home improvement products online compared to those in the 35-54 category. The table below illustrates the growing demand for DIY amongst the younger demographic.
Source: Wickes Investors Presentation
Bear Case-My first concern is the current macro environment with inflation. As inflation keeps going up this could affect Wickes because fewer people will be spending to renovate their homes instead people will opt to save more. In the short term, this could be an issue but if you have a long-term time horizon it shouldn’t be an issue as Wickes is well-equipped to survive an environment like the current macro trends.
Bear Case-My second concern is Supply Chain. Most of the products sold by Wickes are imported from outside the UK. If the supply chain persists there is a potential risk of supply chain disruption and a loss of product offering.
Valuation:
In this section, I am going to talk about valuation. Using some basic metrics I am going to compare Wickes against some of its industry rivals and see if the company is cheap relative to its peers then I will value Wickes using a discounted cash flow model to come up with a price I am willing to pay based on expected growth rate and our desired return of 15%.
As shown below when comparing Wickes against its peers it beats its competition in 3/6 metrics that I used with rivals Kingfisher also scoring 3/6. You might be wondering why don’t we just buy Kingfisher since they look like the better company if you go by the metrics and that is because even though Wickes and Kingfisher are comparable they don't offer the same benefits to trade customers who are the most valuable. Wickes has grown revenues at double the rate of Kingfisher these last few years potentially due to consumers shifting their preference to DIFM. Wickes Inventory turnover is also much greater at 5 compared to 3. This is down to Wickes focusing on a much tighter product range.
In this final part, I will be valuing Wickes using a discounted cash flow model to come up with a price that I want to pay using 15%. When valuing a company I tend to be conservative so below is the valuation of Wickes based on a 6-year projection.
As you can see based on a conservative assumption where Wickes is looking to grow around 3% I went conservative and assumed no growth 6 years out. In my assumption, I also went with an exit multiple of 5x earning which is below the multiple it traded at when it got spun off( 7x earning). Based on my assumption I have come to a buy price of £1.53p which means right now Wickes has significant upside potential if you compare it against the stock price of £1.28p.
Thanks for reading my newsletter on Wickes Group PLC. Disclaimer this newsletter is not financial advice this is for educational purposes only so please DON’T take this as a buy or sell signal. Don’t forget to follow me on Instagram and Twitter by clicking the text.