Stockwatch: An AIM stock to benefit from Brexit

Is it time to reconsider AIM-listed luxury interior furnishings group Walker Greenbank at 220p currently?

I drew attention repeatedly from 22p in January 2010 when it traded on a forward price/earnings (PE) multiple of about 8 times, also revitalised brand strengths showing through.

Testing 150p in summer 2013 its valuation looked fully priced if consumer spending and the housing market were to slow, so I turned cautious after the stock's strong run.

Low interest rates have persisted much longer than expected, though - what home-buying and refurbishment need - aiding the stock into a 150p-240p range. Due to a pretty high PE - the annual average historic multiple has traded over 20 times - the stock has consolidated in a sideways channel as if needing fresh stimulus.

A December 2015 flooding at a Lancaster fabric printing factory, with ensuing disruption, caused a setback in the financial year to end-January 2017. But it didn't hit the stock like the Brexit vote did, which sent it down temporarily to 160p.

Clarke & Clarke acquisition provides a kicker

As if the board sensed the need for a game-changer, last October saw the acquisition of Clarke & Clarke, a complementary designer of fabrics, wallpapers and cushions - positioned more at the affordable end of the market and thus balancing the brand portfolio.

It also introduced financial substance: with £25 million as initial consideration and a £17.5 million potential earn-out, it may represent a quarter of the group's £160 million capitalisation. This explains the hike in expectations for 2017 and reduces the PE to the low teens despite equity funding, which puts the stock back on the radar for value-hunters.

Mind, the true test is how well the brands perform overall - including Harlequin, Sanderson and Zoffany - should the consumer climate change in the next few years. Earnings growth is projected to ease to about 8% in the 2019 year but this seems just a pencilling in.

Profits should at least be cleaner than the proclaimed 16.9% rise in last year's underlying pre-tax profit to £10.4 million, excluding a raft of costs relating to acquisition, flood, reorganisation and the long-term incentive plan. You can see from the table how Company REFS' criteria take a curt view of "normalised" profit: a fall to £4.7 million.

Are luxury goods so exposed to a general slowdown?

A visceral fear with this kind of stock is a fall in discretionary spending as inflation creeps ahead of wages. Interior makeovers also benefit from a busy housing market as people revamp after a move.

Despite mixed opinion within the Bank of England's monetary policy committee, the thinking among elite fixed-interest investors is scant chance of a rise in UK interest rates until the second half of 2018 - and even then, for any upward trend to be very slow as the Bank seeks to support the economy during the Brexit years.

My caution in 2013 may also have under-estimated how wealth in Britain is increasingly polarised: some economists argue luxury goods enjoy high income elasticity of demand, i.e. as people become wealthier they buy more luxuries.

Middle incomes may be squeezed but there seems little chance of capping high remuneration packages in private industry.

Export trend picks up with a lower pound

The UK represented 61% of group revenues in the year to end-January 2017, with international at 39% involving 85 countries.

London is a prime means of showcasing to foreign visitors and Walker Greenbank has just announced a new showroom at the Design Centre Chelsea Harbour - bringing together the portfolio of brands. There are showrooms in New York, Paris, Amsterdam, Dubai, Moscow and Shenzen, China.

A 21 June AGM statement cites both manufacturing sites, in Lancaster and Loughborough, seeing an increase in export orders: sterling's devaluation is helping and the group is also benefiting from currency translation when sales are made abroad.

Brand sales are up 4.5% since February in reported currency and 1.1% in constant currency, with Europe and the US offsetting flat UK sales.

By way of comparison in the last financial year, UK sales fell 4% reflecting flood issues compromising production, with overseas brand sales up 10% in reported currency and 0.5% in constant currency - making a 5.2% rise in annual sales to £92.4 million.

Thus, some modest improvement in UK sales is underway after a 16-week halt to fabric printing in Lancaster until full production was restored in October 2016 with brands fully restocked by the 31 January year end.

It's still quite dicey to discern whether UK demand can improve domestic sales or the medium-term prospect is growth from exports being trimmed at the group level by UK weakness.

Balance sheet should weather a slowdown

Versus £1.5 million cash at end-January, there was £8.8 million short-term debt and no long-term debt, although the £17.5 million earn-out could potentially see a rise in 10.4% net gearing. The earn-out element should however reduce if the business is affected by a consumer slowdown.

Otherwise a circa 2% yield and 28p per share of net tangible assets doesn't mitigate downside, as shown by the June 2016 drop.

More positively, sterling's de-rating not only helps exporting, as a counter-balance it makes this portfolio of high-quality brands attractive to a foreign buyer. So, despite no quantifiable "margin of safety" there is genuine intangible support on the balance sheet.

Regarding the pension fund and checking back to my analysis seven years ago: its deficit had doubled then to £8 million and has returned as a modest issue - if due to a lower discount rate applied to lower bond yields.

Additional funding required in this last financial year has edged up to £1.4 million but the deficit has leapt to £7.4 million. It's not a major drag but without it the dividend could double to provide a 4% yield hence better support.

As the company confirms the final payment of £19.3 million insurance compensation for the flooded Lancaster factory, what revised cost of the ongoing premium seems more pertinent in terms of liabilities generally. This aspect doesn't appear under note 15 clarifying liabilities, but I sense it exists.

Net positive risk/reward profile

So yes, Walker Greenbank has taken genuine initiatives - organically and by acquisition - in support of brand marketing; the unknown being how overall demand for its items trend in the consumer climate and housing market.

It is however a good example of the kind of company able to benefit from a Brexit scenario, harnessing exports in new markets and helped by a weaker pound - which also empowers foreign takeover interest. The stock therefore merits renewed attention and long-term buying interest.