SCS - SCS Plc

[samwise]

Second largest sofa retailer in UK.

 

If I count all cash as excess I get EV/ FCF = 2

 

If none of the cash is excess, I get p/FCF = 5 (no debt)

 

FCF has been higher than income for a while.

P/E is 8.5.

 

No debt, lots of excess cash. Which is weird for a business 25% owned by private equity. Their biggest competitor carries some debt. I haven’t seen this amount of cash sitting around except in family companies or in Japan.

 

ROE is 28% (with cash), which is because of a negative working capital model: customers pay a 50% deposit, get the sofa in 8 weeks, pay the rest before delivery, and the supplier gets paid a month later.

 

This model produces good ROE, but caused a liquidity squeeze in 2008, and SCS went bankrupt, rescued by private equity. The same management is in place now and they keep talking about the resilience of the business, which they seem to measure by the cash on the balance sheet. While I can see the comfort it provides them, I doubt this is sustainable in a public UK company.

 

There is a VIC writeup from a couple of years ago, but the author seems to have sold his holdings.

 

I don’t expect anything quick. There will no only slight growth with UK gdp and inflation, although management has been talking of a few more stores forever. Until  then you have the 7% dividend yield.

 

Has anyone else looked at this name, or shopped there?

[WneverLOSE]

I took a 15 min look at their annual report so I might got it wrong but it seems that they are really the subprime retailer of sofas.

50% of their customers buy using financing they offer with a 1 year no payment and a zero percent interest after (and they really push it hard, you can see in the store pictures in the annual report the posters in the store).

 

ROE is too high in my opinion, if it could be sustained I would take a plane to the UK and start my own competing sofa store, I suspect that if you take away the credit they offer (and get payment immediately since they use 3rd party lenders) ROE would be much lower.

 

so basically you have a company that is not growing much in a not growing sector, selling for 9 times earnings that I suspect will be hit hard in the next recession / credit crunch, seems fairly valued to me (but again, what do I know about the UK and investing (I am down 10% YTD  :P))

 

 

[samwise]

8.5 P/E is with cash included in market cap. If it’s all excess cash then the P/E is 3.

 

It’s useful to spend 15 minutes on the competition too: DFS. Whose sales are 3 times bigger. DFS is at 15 P/E. with debt.

 

They have the same negative working capital model, but keep no excess cash. ROE would be amazing (except that they also have a lot of goodwill). But it serves to demonstrate that the sofa retailers in UK all have this business model. It also shows that you can run this model without the excess cash.

 

The ROE has lasted a long time. My best guess is it’s because suppliers of furniture and credit are too fragmented and commodified. There are also advertising advantages of scale ( as I recall, scs spends 7% of revenues on advertising). These guys also seem to be tremendous operators with non-stop focus on costs. They are able to make it work in their current format, but it doesn’t travel well to a different demographic. Some sofa stores within House of Fraser (which looks like a department store) were not successful. So don’t catch that plane to the UK just yet :)

 

Agreed that they are the dollar store of sofas. Sofas are big ticket discretionary purchases, so sales would fall in a recession. I don’t have any evidence that we are at peak earnings either.

 

ROE on the financing might be lower, as I am sure is the ROE for suppliers. But unless their bargaining power is changing it will remain that way.

 

 

[Cigarbutt]

Interesting idea (to compare). I would not invest in SCS before having a deeper understanding of the competitive dynamics in the UK. The negative working capital model seems to be shared but the fact that it is shared does not eliminate the risks, on an absolute basis.

 

Some thoughts:

--The positives:

-SCS has been able to maintain and even slightly increase its market share (upholstery sofa segment) in a deeply competitive market and was able to maintain margins doing so.

-They show high gross margins (not so great with the administrative costs).

-They have improved working capital management.

 

--The negatives:

-Despite the above, their net margins have remained quite low and SCS has relied on inventory turnover to achieve relatively high returns on capital.

-They rent a significant part of the retail properties. In a way, there's nothing wrong with that but the actual accounting does not reveal the capital commitment (that will change next year with the new lease accounting rules). The reporting changes will not change the substance of cash flows but will show better the necessary capital to run the business (the return on asset numbers will go down). Leases are not debt and offer some flexibility but funding the retail space (operating or financial) is a form a semi-fixed financing.

-They have improved free cash flows over the last few years mostly through decreased inventories and higher payables which did not seem to impact sales or profitability in a negative way but I don't think it would be reasonable to expect more gains from this part. Profitable growth in market share is likely to be difficult.

-Looking at the 2019 annual report, they show ending inventories at 19.2 which appears (from a North American point of view) to be very low compared to sales (333.3). I also think that they have stretched payables to the limit (56.6) compared to sales. I would say such a divergence between low inventories and high account payables means that even a slightly tougher retail environment would result in suppliers getting tighter on credit and bringing the two numbers closer together means that the excess cash (57.7) may not be excessive if they want to keep some flexibility going forward. A typical 5-10% cash cushion versus sales may be OK in this type of business under normal circumstances but their supplier-funded model IMO requires a much higher balance in order to deal with unforeseen credit developments.

-Also, they describe reinvesting in their stores but capex appears to be low versus depreciation over the years. Are they maintaining a "fresh" look to their stores?

-Today, they announced that the CEO is retiring. Maybe that was part of the plan but leaves the following question unanswered: where to next?

 

--Additional neutral comments

-They focus on the lower end of the segment with a high level (about 50%) of free interest offers (risk borne by third parties) which can work fine in most circumstances.

-They have grown their online sales but this has remained relatively low which tends to confirm an opinion of mine that, for these large-ticket discretionary purchases, most people will appreciate an online search but will actually complete the sale in store.

-They've chosen to distribute dividends versus using the funds to buybacks which appears, so far, to be a neutral value proposition.

[samwise]

Thanks for sharing your thoughts CB.

 

I mostly agree. The big difference is the excess cash. otherwise 8/9 x PE is sort of ok in the UK market currently. (Car dealers are at 7, banks like lloyds are at 6-7, when adjusting for rolling off legal expenses). but a PE of 3 is excessively cheap.

 

A lot of what you describe is part of the business model: high turnover, low margin (lower gross margin than DFS means value for customers) and low investment in store Capex all point to a bargain shopping model. They seem to be in lower end strip malls (? although I don't understand the UK terminology here). Inventory is almost all just the sofas in the store for display. The customer's sofa shouldn't spend much time in inventory.

 

They do have risk from wayfair or other online competition, although it's good that they are targeting online sales, or atleast enable online window shopping before the final purchase. I think I read that >80% people have researched their sofa(s) before they come to the store. But most prefer to finish the sale after sitting down. That could change, as online shopping preferences in other categories have changed. Good for them to keep a foot online. Ultimately Wayfair will offer pretty much the same services and same products, same deliver by truck (or Parcel?). So it's hard to see how wayfarer beats them on anything except rent and showroom costs. In this light their recent changes make sense: to manage delivery from a central office with central call centers, to insource their website design and rebuild it to allow easier online browsing and shopping. If sales move online, they will be in a decent position to depend less on their stores. But they will still be stuck with their leases for unto 10 years: "The Group continues to ensure a low average remaining lease tenure on our store portfolio by ensuring low tenures on existing lease renewals and on new stores. This provides the Group with increased flexibility to exit or relocate stores where required. The majority of recent leases entered into are 10 years in length.". So the risk really depends on the speed of transition online.

 

On the effect of leases. You could capitalize them and thin of them as financing charges, but then you should remove the rent deducted from operating income. It's too complicated for me to try to be that exact. And if this was going to alter the investment decision I just wouldn't do it. Instead, I take comfort in their statement from the annual report that 76% of their costs are variable or discretionary. Rent is not: "Rent, rates, heating, and lighting make up the remaining £36.2m (11%) of total costs (2018: £36.5m; 12%)." So it seems they would not suffer much in a downturn. But this is based on faith, their financials don't really go back far enough for me to see this. And I don't know how to dig up their pre-bankruptcy reports from the UK equivalent of Edgar. Anyone who can help? I couldn't navigate company house.

 

 

 

As for how much cash is excess. Perhaps best to remove the 14.6 million which is customers deposits. That leaves 57.7-14.6 ~= 43 million that is the companies and not the customers. EV = 92-43 ~=49. NI=11. FCF = 17. They should be able to buy 50% of their market cap with the excess cash. Or less if they run the price up.

 

Now for the main issue: "A typical 5-10% cash cushion versus sales may be OK in this type of business under normal circumstances but their supplier-funded model IMO requires a much higher balance in order to deal with unforeseen credit developments."

 

Thats absolutely how they think. They believe that they need the cash for resiliency, and their own experience in 2008 bears this out. If that is true, then DFS will go bankrupt in the next credit crises because they haven't kept the cash around. Instead they have debt. So one of these companies is wrong. Or SCS has not been able to get a credit line which they can trust even in a credit crunch, while DFS has got it. DFS is three times bigger, but I am not sure that the credit market is that split in the UK.

 

they did buybacks recently when the PE owners did a secondary. Maybe the start of a trend.. but I won't complain about a 7% dividend.

I think they were one of the bidders for sofa.com but walked on price. If all the cash becomes goodwill like at DFS, it's probably not the best outcome, but won't be too bad as long as they are disciplined. Buying back stock would be the best outcome, or just dividending out all the excess cash.

 

The competition in the UK sofas seems intense, but top 5 retailers control ~53% market share. Thats much more concentrated than furniture suppliers and customers. That seems to be the source of their bargaining power and the negative working capital model. Not sure if there are barriers to entry, but the concentration in the industry definitely points to that.

 

Thanks for flagging the CEO leaving. Will have to see if there is a new direction. Hopefully the next guy won't be as scarred from 2008 and actually buyback stock with the cash. Otherwise we keep clipping 7% coupons. Even in a Brexit blow up the cash should help them. If they return the cash I'll sell and move on, assuming prices are still ~9x earnings.

 

[Cigarbutt]

^That is a strong answer. Again, I will not compete with you as a buyer in the UK furniture retail market but the competitive dynamics are interesting and the discussion helps with the buying or renting issue for stores, the negative cash flow model as well as the growing online presence.

 

I just spent a few minutes on DFS and I see your point of view better.

 

Sales: DFS almost 4x

Free cash flow potential: DFS about 3.5x

(DFS is slightly different with some vertical integration, a Netherlands presence and interest expense and the past shows some noise, so just an estimate)

 

The market has clearly rewarded DFS as a leveraged consolidator (I doubt significant economies of scale are available after a certain reach) as market cap (equity) is 6.5x.

For DFS (debt+market equity) over (market equity) is 1.33 whereas for SCS it is less than one if we agree that there is excess cash on the balance sheet. It's interesting because, as a contrarian, I would put a higher price on financial flexibility (or a much lower price on the lack thereof).

 

I could see how the market values of both may converge. Please give follow-up in due course if applicable.

[DollarKing]

I have hard copies of the 2003 - 2007 annual accounts. (These reports seem to have been removed from the internet.)

 

And some newspaper financial magazine articles on SCS from this time. (I'll PM any images of annual report pages if anybody is serious.)

 

The quantitative valuation put forward here is correct, except how the sofa business really works seems to be missing. When a new store is opened the local sales are great, promoted by local TV advertising, along with the initial free rental period on unit leased, the first few months produce a terrific profit and great cash flow. A great first year for all new stores is baked in. Then the store goes straight to break even at best.

 

This format is destined to fail. As it becomes harder to find and open new stores. Along with the ever increasing number of 'dead' stores. This business runs on fresh air and a pray. One small blip in sales now and its over.

 

More stores have to be opened to maintain this flywheel effect. This is not unique to the sofa business at SCS. The directors understand this fully. The guys still running this ‘business’ have made out very well though, administration or not, no problems for them.

 

There is zero free cash in this business. The entire cash balance is fully off set by what is owed to the sofa manufacturers for orders already placed. Every single penny of spare cash has been paid out as dividends.

 

(and the directors seemed to have missed their recent period in administration and complete shareholder wipe out from the ‘Our History’ pages of the recent annual reports.)

 

Also a financial journalist from the UK, Richard Beddard wrote several articles on SCS before administraion, singing its praises on a valuation basis, he lost bundle, but he owned the mistake afterwards to his professional credit.

 

(Please excuse my basic and blunt writing style I've never been good at it.)

[Cigarbutt]

^You seem to almost imply some kind of Ponzi scheme which is a step further than questioning earnings quality.

I don't plan to spend much more time on this but, outside of the smallish concession business (which has been discontinued), the number of stores went from 96 in 2015 to 100 in 2019 which would tend to go against your thesis, given the pattern of free cash flows over the same period.

However, if considering a long position here, i would try to get more 'color' ('colour' if you prefer British English) concerning the lease arrangements, especially for the early years.

BTW your writing style is fine (keep those comments coming) and despite your flywheel concerns, i continue to see them as a company with two personalities: aggressive on the sales side with a negative working capital model and conservative (relatively) on the cash cushion side. Not exactly a tight parallel but in the same spirit of somebody being avidly competitive for investment opportunities while being able to maintain a cash balance of 130B or so at the head office. It can be confusing at times.

 

Edit:

https://www.valuewalk.com/2011/06/late-sell/

Interesting going-back-to-the-future potential circumstances.

[DollarKing]

I don't mean to suggest anything illegal by the directors. They just understand perfectly the quality of these earnings.

 

The 96 to 100 store count between 2015 - 2019 may be slightly misleading. Were there any closed? Just a couple of good openings a year can produce wonders. The scale of business at a new store can be a multiple of the revenue just eighteen months later, with superb initial operating leverage.

 

Nowhere in the annual reports will you find the scale of sales at new stores.

 

I'll try to post one of my favourite images below which may illustrate better the scale of what I'm attempting to explain.

 

This show SCS with increasing total sales, at the same gross margin, yet paradoxically a collapse in the profit and the cash balance.

 

(It should be used on a MBA course to see if any students can work out what is happening. All the information needed is on the one page.)

[Cigarbutt]

^It looks like our opinion is similar but here are some nuances.

I think the model can still make sense but you have to make sure that the model can go through cycles (if you believe cycles still exist) and manage to achieve adequate returns on capital over the complete cycle. The numbers you show would tend to indicate that today's cash cushion is larger (cash over equity was 1.34 at the end of their 2019 year). It would be interesting to see the pattern of their inventory and account payables (to suppliers) numbers around 2006-7-8. From the link (from the repenting journalist), it is implied that what caught SCS off guard in 2007-8 was the sudden disappearance of credit insurance available to suppliers (which was a salient feature of the period) and the episode simply revealed that credit risk has to be borne at all points of the cycle. Some furniture retailers can benefit from these credit episodes by surviving and increasing market share. However, these transitions may require some kind of reorg (new capital and debt to equity swap). I was involved in such an episode around 2007-8 with The Brick, a CDN furniture retailer whose business was more than selling sofas although this was a significant segment. They managed to pull through (with outside help) and think that they could have done better if management had completed the potential MBA case study that you refer to (but then there wouldn't have been this opportunity...). But I would say that the model can make sense although it requires that you wear a suit when the tide goes out.

[samwise]

DollarKing ,

 

I really appreciate your input here. I had never heard of SCS until a few weeks ago, and all I know is from reading their reports, their competitors reports, online articles from financial and industry sources. My main reason for posting here is to generate exactly this kind of discussion and feedback. If you convince me that I am wrong and save me money, I will be grateful.

And like CB, I see no issues with your language. Blunt is good.

 

I would like to preserve my ability to change my mind and sell tomorrow, if I see anything that convinces me of the need. Publicly taking positions on a stock is not conducive to that. But I do appreciate your feedback and have looked at some of these issues after you pointed them out. See my responses below. I hope to just focus on facts and my judgement about them. Feel free to point out where I am wrong.

 

Just restating your view:

It seems you suggest the only owner earnings are the dividend (7%) with eventual collapse in a “sales blip”. Even the dividend is maintained by new store openings with lower first year rent. I’ll try below to look at all these issues.

 

Resilience to a “sales blip” aka global financial crisis, credit crunch etc:

 

On their 2008 bankruptcy(the blip in sales which wiped them out), the best discussion is probably here: https://www.valueinvestorsclub.com/idea/ScS_Group_plc/9156282408

A lot of information there can also be sourced from the IPO document. https://www.scsplc.co.uk/media/1231/scs-group-plc-prospectus-23-jan-2015.pdf

 

The VIC write-up seems to absolve the management of blame, since it wasn’t leverage and expansion which led to the downfall, but withdrawal of credit insurance by the major credit insurers. I tend to agree based on the following: On FT you can find articles about how widespread the withdrawal was (SCS was one of thousands of businesses affected). Part of the blame is put on the credit insurers for stretching themselves, which seems in line with the general behaviour of financial companies in the time before 2008.  Shareholders who got wiped-out are angry at management getting 10% of the new equity. But that’s normal in bankruptcy, which is always about negotiations and needs, not fairness. The new owners needed management to stick around, but didn’t need anything from previous shareholders. There is no kindness from strangers.

 

That was then. Now, in their reports you will find them obsessing over resilience. Like generals fighting the last war. (Even though financial regulations probably ensure that the next blip in sales will be different.) on page 45 of their annual report you can find their viability statement. They stress test a scenario with fall in revenue, gross margins and withdrawal of credit insurance. They survive due to variable costs+cash+a line of credit. These are consciously developed defences. I don’t understand why they need so much cash +LOC, when in the GFC they only required a 20 million cash infusion to survive. Is the next crisis likely to be worse than the GFC?

 

However, a retailer with negative working capital is always at some risk, even though no one mentions that about Amazon. So I have sized this appropriately.

 

New stores:

 

About the new stores, here are the numbers:

2015: 3

2016:1

2017: 4

2018: 1

2019: 0

2020: 1 so far

 

If everything you say is correct, then their cash generation should have varied a lot as new stores varied from 0 to 4. But CFO has been very stable. I wonder if what you are describing is their model from their expansion years till 2007? They probably had much more fixed costs then, which would explain the results you have shared in that image. (A fall in same store sales is bad for a retailer if its costs per store are fixed. A few new stores can help get to the same revenue and gross margins, but higher S&GA from the new stores leads to falling net margins. 100 in sales is much more valuable from one store than from 10. See note 28 on their discontinued concession business for an example where the same gross margin wasn’t enough to produce any profits.) Companies do change. An investment in AIG, BAC was quite different in 2007 vs 2013.

 

Rents in first year:

Accounting convention does require straight lining of rent, even if there are concessions in the first year. The difference should show up in the accounts just like any difference between cash and accruals. The only thing I can find is “lease incentives” which are part of non-current payables (note 25). These are 6 million, changing by about 0.5 annually. Rent charges are mentioned as 25 million (in the IFRS 16 discussion). If they got some initial period rent free, on a 10 year lease, i’d calculate that at 3 months based on these numbers. But I am not an accountant, so very happy if someone can correct me.

 

Compared to CFO, earnings these are pretty low numbers. I don’t think they can explain all or most of the cash flow.

 

Industry model:

DFS survived in 2008, when it was private. I don’t know how. And they don’t try to keep cash around. Do you know how they manage to be so different from SCS in the same sofa business?

 

Bottom line:

As long as they keep the cash, no “sales blip “ should bother them, unless the whole model starts failing (Wayfair risk).

 

If they deploy some of the cash, owners should do well. They might need to keep a bigger LOC to ensure resilience.

 

If they just decide that they have enough cash, they will start using the earnings for purposes other than growing their cash pile. They could do buybacks. This isn’t as good as the case above, but still ok.

 

And they are not family controlled or Japanese, once PE sells out their remaining 24% shares, some activist could force them to do something with the cash.

[DollarKing]

The DFS model differed in that they made a lot of their own sofas up to 2010. I don't know the percentage as it was privately held then (by a well known regional famous/infamous businessman to me, who had had it since the eighties.)

 

That valueinvestorclub write up I'd seen before and seems on the money, though SCS between Oct 06 - and July 08 had gone through all £25m of the cash and just started into the overdraft, whilst making a loss of about £17m in the previous 12 months, blaming the withdrawal of supplier's credit insurance for the failing seems a misnomer.

 

I've said a lot of negative things about SCS, especially about the quality of the earnings and the true availability of that cash to shareholders, so I'm going to stop now.

 

I want to finish by saying something positive; the main directors at SCS really are experienced and true experts at selling sofas.

[Cigarbutt]

The DFS model differed in that they made a lot of their own sofas up to 2010. I don't know the percentage as it was privately held then (by a well known regional famous/infamous businessman to me, who had had it since the eighties.)

 

That valueinvestorclub write up I'd seen before and seems on the money, though SCS between Oct 06 - and July 08 had gone through all £25m of the cash and just started into the overdraft, whilst making a loss of about £17m in the previous 12 months, blaming the withdrawal of supplier's credit insurance for the failing seems a misnomer.

 

I've said a lot of negative things about SCS, especially about the quality of the earnings and the true availability of that cash to shareholders, so I'm going to stop now.

 

I want to finish by saying something positive; the main directors at SCS really are experienced and true experts at selling sofas.

Hi DollarKing,

Thanks for the perspective.

I understand that you "want to finish" this discussion but, if you have time, could you provide a copy of the balance sheet and cash flow statement that SCS produced in year 2007?

[DollarKing]

Attached are the last annual report from SCS images.

 

(Beware SCS brought forward their tax year end from 30th September 2007 to the ten months 28th July 2008 in this report.)

 

Then 3rd July 2008 is when it's bought out by Sun Capital.

[DollarKing]

(You can shorten your company's financial tax year in the UK as many times as you like. No questions asked.)

[Cigarbutt]

Attached are the last annual report from SCS images.

 

(Beware SCS brought forward their tax year end from 30th September 2007 to the ten months 28th July 2008 in this report.)

 

Then 3rd July 2008 is when it's bought out by Sun Capital.

Thank you for the info showing the results for the 10-month period from 2006 to 2007.

Given the negative working capital model, looking at the difference versus inventory and accounts payables and adjusting for sales, I think that a similar credit crunch to 2008 would be covered by the cash they have now on the balance sheet. And DFS would be cooked. With or without credit insurance, when liquidity is a concern, the suppliers start to require immediate payment and distressed retailers may be tempted to reduce inventory, then cut sales staff, triggering a negative self-feeding loop. These episodes are best prevented and if supplier credit does get tight, sources of capital (intrinsic or extrinsic) can do the trick. Of course, one could hope that the credit cycle remains muted during the holding period.

[samwise]

I think that a similar credit crunch to 2008 would be covered by the cash they have now on the balance sheet. And DFS would be cooked. With or without credit insurance, when liquidity is a concern, the suppliers start to require immediate payment and distressed retailers may be tempted to reduce inventory, then cut sales staff, triggering a negative self-feeding loop. These episodes are best prevented and if supplier credit does get tight, sources of capital (intrinsic or extrinsic) can do the trick. Of course, one could hope that the credit cycle remains muted during the holding period.

 

Thanks both for a very thoughtful discussion. I checked DFS’s viability statement. DFS has liquidity for this scenario. They have a credit line for 250 million. (The assumption of course is that the unwillingness of suppliers to provide credit will not last past the maturity of the LoC.)  I guess the debate is if one should keep cash around for a  once in 25 years event, or keep a line of credit.

 

Other things I noticed: DFS don’t seem to ever mention credit insurance in their report. They mention variable and discretionary expenses, but only name advertising. Unlike SCS which classifies all expenses and quantifies how much is variable.

[samwise]

the main directors at SCS really are experienced and true experts at selling sofas.

 

Thanks for your opinion on this. They do seem to be very good operators.

 

If you have the same faith in their honesty and integrity, then we can probably believe the statements they have made about viability of the business, and control over variable costs.

[Cigarbutt]

Interesting development:

https://www.scsplc.co.uk/investors/regulatory-news-and-alerts/

 

The private equity group that saved the day before is selling (or trying to sell) its last residual large "block" of shares and, so far and unlike last November, SCS has not reported an intention to participate on the buying and cancelling side.

 

If one likes the long term prospects of the business, that may constitute a valuable entry point.

But it feels funny that a private equity entity is leaving an unlevered firm full of cash.

[samwise]

Who knew that cheap sofas were a necessity in lockdown.

 

Order intake Y/Y

During 9 weeks of lockdown down 92.5%

During 9 weeks after lockdown up 92.5%

 

All pent up demand.

[Anglozurich]

Is anyone still in this? I am reading the posts above (pre-Covid) and they seem to have taken 2020 on the chin and past the stress test with flying colours. Capital allocation been decent. They reacted well......tapped an RCF and repaid it immediately. They made full use of the UK governments Job Retention Scheme for furloughed workers and are reporting unrestricted cash on hand of £48m at year end (£82m less £34m of customer deposits). I am a UK guy from the regions who has lived in London and yes, its real...young families or couples are moving out of London into the regions where money goes much further. London and the regions.....think two separate countries. The government have increased the stamp duty threshold to £500k temporarily to spring 2021 so UK house sales outside London with space and a garden are naturally booming. I think this trend continues even with stamp duty on lower value homes. House purchases often come with sofa purchases. The destination/out of town stores with big car parking spaces work nicely for young couples or family to drive out to, in order to try the sofa before making the final purchase decision. The work from home trend could also see greater share of household budgets being spent on big ticket home items such as sofas given people are spending more time at home. Order intake is +45.8% on a like-for-like basis for the first nine weeks of the new financial year to 26 September 2020.

 

With regards to the market, this is a tough and tight market for new entrants to access. ScS seem to have deep entwined and close relationships with suppliers. They have a proven track record and are conservative retailer in the eyes of suppliers. Logistics and central distribution centre also ensures quality control....customer reviews are positive (trust pilot reviews https://www.trustpilot.com/review/www.scs.co.uk). Companies with a stronger online presence in home furniture such as Dunelm are staying clear of sofas - they are focused on smaller ticket items. ScS and DFS seem to be holding market share of the sofa market. It is safe to say consumers are not executing the complete purchase decision of a sofa online. Consumers will try before buying and cost along with good customer service is a factor for lower income households. This is just from personal experience, but Northerners and people from the regions are drawn to old school reliable brands for bigger ticket items. They have heard ScS adverts on the radio and on ITV adverts growing up. The UK consumer and household seems to be holding up and anything consumer credit relates is not diving as predicted. Lloyds and Natwest (UK bell-weather banks which are also way too cheap imo - i am also invested) are not citing issues with household balance sheets and will in my opinion release back loan loss reserves next year. This has never been a credit crisis and i think those that made this distinction early are and will be rewarded.

 

The shareholder structure is becoming tightly packed with some longer term well-known value guys taking big positions, which could keep capital allocation front of mind. Michael Bury (Scion) and Stadium Capital Management now own 10% of the company. The CEO has agreed to stay on and I note he has racked up a decent amount of skin in the game (£3m of shares) so will be incentivised to ensure the ship

 

With a market cap of £75m and lets discount the £82m of cash by £34m of customer deposits and £20m of additional cash that they will always need to have had hand to for conservative reasons to show suppliers they are solid to keep that strong working cap cycle going. Lets say true cash attributable is £25-30m. EV of £50m with a business that can do £15m of true earnings. This trades significantly below DFS. The spread does not seem rational.

 

Could management execute another a buy back as the vaccine is flying out the door and a brexit deal is done. In 2021 could this trade at a 13-15x multiple on £10-15m of earnings. Yes, absolutely.

 

Sorry for typos. I wrote this quickly as have a busy weekend.

 

Any thoughts?

[samwise]

Thanks for the additional perspective. I still own and bought more when it tanked. I still think it’s safe and cheap.

 

Lots of home retailers have great sales now as people are staying home, including mattresses and apparently sofas! But HD and TPX and ZZZ.TO have rallied and SCS not as much.

 

I haven’t followed the stock recently in quite as much detail as you, but they don’t seem to have done anything out of character yet, AFAIK. Who knows what multiple the market will assign this relative to DFS, or the multiple rerating of the British market as COVID and Brexit end. Meanwhile it appear cheap and has survived the storm as management intended. They may resume returning cash once they are sure of surviving a 100 year storm, but probably as dividends first.

 

Didn’t know that Mike Burry bought a stake. Good for him. https://www.londonstockexchange.com/news-article/SCS/notification-of-major-holdings/14680991?lang=en

 

 

 

 

 

 

 

[Anglozurich]

Agree. One feels this has been kicked into the melting ice cube UK bricks-and-mortar retail basket by market participants.....as oppose to thinking in a more nuanced way about the components of the consumer purchasing cycle for items such as sofas, how online and physical presence participates in that decision process and the ingrained competitive advantages of certain UK retailers in cottage sectors. NEXT Plc seems to be a textbook example of how to execute this shift to online with slimmed down a physical presence. They are masters of  the click and collect and I hope ScS management learn from these examples to bolster the online customer experience given the decision originates there.

 

The catalyst for this......'hit investors between the eyes with a 2x4' via out-sized return of capital to shareholders that starts to make the MCAP look too stupid, while still holding £20m of cash in reserves after deposits. Agree its more likely to be dividends. Much to my frustration, I find buy-backs much less common in the UK versus the US.

 

The Michael Bury investment surprised me too. I received a notification from ScS investor relations saying Scion had went over the 5% threshold. I said to wife (she is used to me boring her)....I am sure that name rings a bell. Lets hope it moves like his Game Stop position...up!