Stockwatch: A hot share for income-seekers

Has Halfords repaired its puncture? Since the wet summer, Halfords has plunged from 561p to 322p, amid weakness in cycling-related sales.

About 30% of revenues from this mid-cap retailer of car and bike products derive from cycling, which is expected to grow at 6-8% a year. About 70% of sales are motoring-related, which, as a market, is expected to grow at 2-3% annually.

The consensus forecast (see table) for flat earnings in the short to medium term looks pretty much priced in, considering a forward price/earnings (PE) multiple below 10 and a prospective yield over 5% covered twice by forecast earnings.

Stock de-rated to attract income investors

Disillusioned growth investors have been selling out, pushing the stock to levels that are attracting income investors instead.

With the chart line of least resistance recently heading down, maybe there has been a momentum effect also. But unless the UK enters recession, or first-half weakness festers, the stock is beginning to offer attractive risk/reward if the marketing mix competes well. A new chief executive - Jill McDonald - with a strong marketing background has been in place since May, and initiated a review.

As the UK's leading retailer of motoring and cycling products and a leading independent operator in car servicing via "autocentres", Halfords is a good opportunity for her. Downside risks include the UK retail environment becoming more competitive amid deflation, making it difficult to grow margins, and being out-smarted by rivals, especially online.

The five-year record has yet to show consistent progress and the balance sheet could be better. Barring a recession, however, such risks are starting to look priced in.

Cycling's shortfall looks temporary

The 13-week period to 3 July started Halford's first half year quite well: like-for-like sales up 3.5% or 4.2% adjusting for the timing of Easter. Premium bike sales rose 8% and cycle repair 24%. This appears to show Halford's bike offering for enthusiasts being genuinely competitive. Car maintenance revenues were also good, with parts up 7% and workshop 10%, also enhancement services such as connectivity equipment and dash cams rose 31% and child safety seats were "strong performers". Online sales rose 8.2%. The implied weaker areas weren't clarified though, beyond "subdued car cleaning sales".

An early September update revealed cycling sales down 11% in July and August with poor weather discouraging casual cyclists and rivals discounting. This appears to be an ongoing risk whenever demand softens, e.g. from the likes of www.wiggle.co.uk which have grown rapidly. Otherwise the mundane reality of needing cycle repair delivered 27.6% like-for-like growth. Also, the 2014 comparative was tough due to all the hype for cycling when the Tour de France started in Yorkshire. Good progress in car maintenance and enhancement, however, mitigated weakness in bike sales.

November's interims quantified all this as a 5.9% fall in pre-tax profit to £46.5 million on revenue up 1.8% to £533.5 million, with profit anticipated flat for the year to 3 April 2017. The retail gross margin slipped 0.29% to 50.3% while in the autocentres it edged up 0.76% to 64.6%. It's not a dire situation just uninspiring, hence enough selling has hit the stock price.

Growth is expected to resume in the 2017/18 year, but that is a long shot depending also on the wider UK economy. The group can anyway afford a 2.9% rise in the interim dividend, due to its cash flow profile and cash reserves, although it seems likely the board will defend its dividend policy firmly - targeting annual dividend growth with earnings cover of about twice over time.

New boss's actions are a crux for the future

The previous chief executive left for Tesco i.e. not as if the board made a replacement after seeing problems. The incomer, from McDonald's, has sought to refine the strategy to improve all-round marketing and infrastructural efficiency.

Her review concluded that motoring-related, Halfords has a 15% share of a £3 billion market for parts and accessories, growing at about 3% annually. Autocentres' servicing is smaller at 1.5% of a fragmented £9 billion market. This is all expected to grow at 2-3% a year over the medium term, which looks supportive for the dividend even if unexciting for capital growth. The number of cars and their mileage is rising, likewise technology is making DIY repairs harder.

The cycling side has a 24% share of the market for bikes which is growing at about 6-8% annually and worth about £800 million; while there is a 15% share in parts/accessories/clothing, amarket worth about £750 million. Cycle repair is worth a further £100 million where Halfords is doing well and taking share.

Plenty of research has been done on cycling customer profiles, and management reckons on attracting more people into cycling besides increased spend from existing cyclists, while expectations for overall market growth are about 3-5% annually for the medium term. The strategic review reads well and it will be interesting to follow its outcomes - effectively the future for this stock as regards capital growth.

Dividend growth supported

It could be better, but looks capable of supporting dividend growth and investment. In early October, intangibles comprised 93% of £386.5 million net assets and the ratio of current assets to current liabilities was nearly 1.1 times, trade payables of £183.6 million contrasting with £61.5 million trade receivables.

Such an imbalance is not new, yet it begs questions as to payment schedules to suppliers etc. Total debt was £85.6 million and £1.5 million interim net finance costs were amply covered by £49.7 million operating profit. Management notes net debt reducing by £7.9 million to £62.4 million although this reflects end-of-period cash jumping from £3.7 million to £23.2 million, like-for-like.

As regards capital spending needs, the five-year table shows capex per share trending at 20% to 40% of cash flow per share; and the interim cash flow statement shows £17.5 million capex and £21.4 million dividends paid, versus £37.1 million net cash generation - i.e. these variables reasonably balanced.

Attractive for income-seekers

Capital growth-oriented investors are likely to await the third-quarter trading statement due 21 January, although Halfords now offers a competitive yield which ought to begin providing support. For patient investors a recovery to at least the 350p to 400p region is feasible if the new boss can sharpen up marketing.

For more information see the company's website.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.