Stockwatch: A 7% yielding bid target?

Value opportunity, or trap? Discount clothing retailer Bonmarche is paying a 7.1p dividend for its latest year to 1 April, implying a yield of 7.2% both for this year and next.

Profits and like-for-like revenues are down as Bonmarche invests in opening new stores and various costs have risen. Any current case for investing here assumes that profits will recover from £6.3 million to £8 million.

The table shows capital expenditure typically taking about half of cash flow. Meanwhile, the 1 April balance sheet shows cash nearly halved to £6.9 million, the cash flow statement citing £3.4 million paid out as dividends in context of £10.9 million investment (mainly opening new stores).

Initially, the share price eased a couple of pence to 94p, the market justifiably edgy whether such a payout is sustainable unless sales and profits improve; despite 2017 earnings per share (EPS) of 10.1p being more than the 9.2p projected (representing Investec, the company broker, and Cantor Fitzgerald).

Yet, by Thursday lunchtime on results day the price had bounced to test 100p, as if confidence remains upon digesting the detail.

Marketing improvements still due

While total revenue edged up 1.1% to £190 million, like-for-like sales fell 4.3% and online sales rose just 2.2% to represent 7.1% of the total. That suggests that in marketing terms the ex-senior buying director of George at ASDA, who has now led Bonmarche as CEO for 10 months, has yet to prove her initiatives.

The dilemma is this business being operationally geared with a relatively high cost base – see from the table how the operating margin is down from about 7% to near 3% - so as an outside investor you want to be confident of a positive sales trend.

There is at least extensive disclosure explaining how, in product terms, long lead times and supply dominated by China have restricted an ability to react to shifts in seasonal demand. This is a big contrast e.g. with Boohoo.com which can respond literally within days, having honed a slick online operation as customer interface.

Bonmarche's management says its casual ranges didn't appeal, there wasn't enough innovation, new interest in a loyalty bonus club has waned and retail disciplines need sharpening up. At least there's a clear sense of issues. Out of management's control, BHS's administration a year ago meant discount stock clearances that hit first-half sales. Thus my drawing attention tentatively a year ago at 120p on the basis of the CEO, was premature, despite cautioning any "buy" case assumed no fresh uncertainties for consumer spending.

Unfortunately, this is what we now see by way of rising inflation liable to hurt discretionary spending; although if Bonmarche is adept it should be able to thrive as more shoppers pursue lower-priced clothes

Costs have risen widely

Cost of sales as a percentage of revenue edged up from 76.1% to 77%, but the hike in administration expenses relative to gross profit was sharper, from 59.1% to 67.6%. At least distribution costs were better controlled, down 5%. Within the gross margin, sterling's devaluation increased the cost of stock bought in and clearing slow-selling items meant discounts in the November/December peak selling period.

Operating expenses have risen by 8.4% amid a litany of issues e.g. £3.3 million on store openings, £1.3 million due to the Living Wage, £900,000 on modernising software and £1.2 million linked to national TV advertising.

Expensive TV campaigns when this £50 million company faces a range of challenges, contrasts with slick online retailers' use of social media. Partly this reflects Bonmarche's older demographic being more likely to watch TV, but when management confesses it has fallen well short on product marketing anyway, this looks like money frittered away.

Management hasn't got leeway to gamble when these results show it's essential to maintain the dividend, otherwise – if disappointments continue – the payout will be seen as needing a cut, exposing the stock to slip nearer tangible net asset value of 58p per share.

Is a 20% rebound in EPS realistic?

The reason I would continue to pay attention here is a favourable demographic – Bonmarche's target customers being women over 50 – set to increase.

Management is certainly upgrading the business and, with adept marketing, it can yet prosper. Management cites current trading in line with the board's expectations, implicitly as reflected in its broker Investec looking for EPS of 13.7p and a slight rise in the dividend to 7.3p. Mind that forecast was mid-February, albeit seemingly the latest in the market unless Investec republishes.

Clothing retailers must pray the current heat-wave subsides because it can wilt sales: the next update (in respect of Q1 trading to end-June) will be 27 July. Plenty here can change according to consumer sentiment: Bonmarche is wholly-exposed to the UK, i.e. rising inflation and a political mess - so the company's situation can easily change.

In overall context of 327 stores, openings continue at a similar pace as recently, about 15 stores overall targeted this financial year, albeit with about six due to close if at the end of their leases or break points in leases. This aspect of costs will persist and if combined with a fall in UK discretionary spending then it can potentially hurt profits enough to put the dividend payout in question.

A sound balance sheet

More positively for dividends, the balance sheet has immaterial debt, no pension deficit and fair asset-backing – i.e. relatively low-risk to endure a UK consumer downturn should that happen.

At 1 April, cash was £6.9 million, down from £13 million, as investment weighed and the dividend took £3.4 million. So the balance sheet is supportive, yet the dividend is not underwritten in harder times.

Even if the share price drifts towards net tangible asset value, the situation seems unlikely to attract a bidder given BM Holdings (related to private equity managers Sun European Partners) owns a controlling 52.4% stake. They would have to decide to sell say to Steinhoff International, the expansionist South African retail group that bought Poundland last September.

It's not impossible if they are looking to free up capital in pursuit of other deals, albeit with Bonmarche valued in the market at only a third of the levels it traded for two years after flotation at end-2013.

I figure something will eventually give way here: Bonmarche being a small operation on the stockmarket fringe, liable to be forever rated modestly; maybe Sun European Partners will indeed look to sell on. In a difficult climate, though – heat and inflation-wise – I'd at least await the 27 July news to see how current progress is shaping. This is becoming more like a special situation than quality yield stock.