Electronics retailer Dick Smith has been our claim to fame over the past few months. Matt’s excellent exposé of the private equity shenanigans leading up to the float made Dick Smith is the Greatest Private Equity Heist of All Time the most popular Bristlemouth post of all time – by a factor of 10.
But the share price is down more than 80% since the time of the float and our job is (sorry Matt) making our clients money. Any stock that falls that far is worth a look, especially one that doesn’t have much debt.
The opportunity here is clear. At today’s price of $0.38, Dick Smith’s market capitalisation is $89m. Throw in $40m of net debt and you could buy the whole business for $129m (its “enterprise value”). The company generated revenue of more than $1.3bn last year. That ratio of enterprise value to sales – less than 10% – is extremely low for a retailer. JB Hi-Fi trades at 54% of revenue, Myer 34% and even Specialty Fashion trades at 20% of revenue.
It might sound like an absurdly simplistic metric, and it is. Obviously JB Hi-Fi makes more profit from every dollar of revenue, so is worthy of a higher ratio. But in retail it is a useful starting point. Flipping Dick Smith’s sub-10% ratio on its head, if the company can earn just 1% profit margins, the owners will earn in excess of 10% on today’s enterprise value. Eke out a 2% profit margin, and you are looking at 20% + returns.
So the question is, can this business make 2% margins?
It should. Two percent is still a very poor retailer. But I’m not sure Dick Smith has been making anything. Not when Woolworths owned it. Not when private equity owned it. And not since it has been listed.
The financial accounts will say different. According to the 2015 annual report, Dick Smith made $65m of Earnings Before Interest and Tax (EBIT) in the year ended 30 June 2015, and $62m in 2014. That $127m of cumulative profit quickly gets whittled away, though, if we factor in prior and subsequent events.
There has been roughly $50m of benefit from private equity write downs and provisions ($15m in annual depreciation and $10m in annual provision release). They may have been legitimate, but it’s a big chunk of the total profit.
Now we also know that inventory bought during that two years it has been listed is worth at least $60m less than it is on the books for.
All retailers have obsolescent inventory. Most of them clear it regularly and also put it through their cost of goods sold as a regular provision. I couldn’t find a “below the line” write off of inventory in JB Hi-Fi’s history, and I can assure you it’s not because they sell 100% of their purchases above cost.
The best case is that Dick Smith has made some poor purchasing decisions that won’t be repeated. It could also be that obsolescent stock is a regular cost of doing business that hasn’t been appropriately recognised in recent years. And if that’s the case, you could knock another $60m of the last two years’ EBIT, leaving you with next to nothing.
My guess is that that is a bit too extreme and that the true answer is somewhere in between, but it is genuinely difficult to ascertain whether this business is making any money or not. And private equity left it with such a working capital deficit that the cash flow has been even worse.
Nagging away at me is the feeling that we are getting too conservative on some of these “fallen angels”. We’ve taken a decent look at Metcash and Slater & Gordon in recent months and haven’t done anything. Perhaps the Forager of five years ago would have been more enthusiastic given the undoubted universal pessimism about them. For now, though, Dick Smith can be added to the list of stocks where we can’t quite get comfortable.
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11 thoughts on “Is Dick Smith Now Worth a Punt?”
DSH is probably cheap to a retail predator but the business fundamentals versus competitors are still horrible. The stock-turn/margin equation is too low so they earn 20% less gross margin return on investment than JBH. When you then add in the higher CODB (function of 1/5 the sales/store) you get the magnitude of the structural problem. The issue facing them now, assuming proper accounting (!) is that if you cut margins from last years 24.8%, to earn the same $ on investment in inventory means a lot more stock turn eg 24.8% to 17% means stock turn needs to go from 4x last year to 6.5x this year. BTW, the auditors should not let DSH get away with a below the line inventory write-off – that’s part and parcel of being a retailer, like shrinkage, which would be pretty big in DSH.
An obvious corporate history that electronics and electrical retailing in Australia is a mugs game unless you are brilliant at it. Vox, Billy Guyatts, Strathfield anyone?
You made the front page of the AFR on this bandwagon! Nice going Steve 🙂
You can add Stan Cash, Rick Hart and Clive Peeters to Andrew’s list.
I thought Clive Peeters went down because of a $20 million employee fraud.
The inventory that is now being written down may not have existed at all. One should be very wary of when companies record a Discount on Acquisition such as what Anchorage did during the initial acquisition from WOW.
The supposed write downs of inventory at acquisition were actually substantial write ups from what WOW recorded at disposal date. I have emailed you an analysis with breakdowns.
@ Dennis: Yep by one Sonya Causer, she’s out of jail and back at it again:
Dennis you should know the facts before speaking, Clive Peeters had a pick and choose approach to marking down of stock. They also “floated” stores that should have been closed, as for Causer did you ever wonder why people higher up the chain sold almost 3 million in shares just before the “payroll” embezzlement was uncovered or how why her superiors were never investigated???? And if you actually paid attention to the article from the employment office it refers to the her time as ITL BEFORE she was sentenced, therefore not at it again.
reading the last paragraph may be an indicator Forager is ‘feeling’ the stocks as a measure of emotional ‘comfort’…
‘Perhaps the Forager of five years ago would have been more enthusiastic [or less vacillating] given the undoubted’ psychology mindset use to test potential value investment stock!
is Forager slipping into a phase of emotional attachment, in order to periodically strengthen it’s resolve and conviction of Forager valued invested principles…
perhaps Forager could go to hell back in sand-shoes, to ‘feel’ the pain
what disciplines need to be retested in order to further develop and strengthen the psychology of Forager investing…
start with a word count of ‘feeling’ in 2015 blogs
could it be time in 2016, for Forager to take a deliberate and purposeful pause from foraging investing activity and attend to some housekeeping?
to forfeit forager investing time maybe time well spent
forager is now into the 7 year itch
tidy house tidy mind, time for a small forager reno, steve
You can also add Brash’s and Gowings from the listed space and umpteen from the private space such as WOW Sight and Sound and Pie Face in just the recent past.
One of the problems with retailer analysis is that even companies without debt liabilities still have considerable unrecorded liabilities due to shop leases and rent is a big expense in a retail operation, especially if it involves shopping malls.
I think your track record of finding things means you can leave this one in the too hard bin.
In retrospect, this gamble was an extremely bad idea. Good luck getting your money back, any of you who followed this bad advice.
I would think Tommy that you perhaps need to read the article a little more closely before assuming any advice was given let alone to take a gamble and buy Dick Smith (which it certainly didn’t).
The article was an exercise in one way to take a look at a ‘fallen angel’ such as Dick Smith and see if an opportunity existed. The article and following comments (excluding yours I might add) help to get some perspective before making a decision. And what was the conclusion Steve came to?
Forager were not interested, still too many question marks before they could get ‘comfortable’ to invest.
Events since then have confirmed the conclusion made.
I would suggest that if you interpreted this article as advice to buy, you perhaps need to ……… (best if I leave you to finish that sentence).