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John Engle
John Engle
Articles (286) 

Is There Growth in the Cards for Card Factory?

The British greeting card company presents an intriguing story

May 21, 2018 | About:

Although it is admittedly not as exciting as chasing the latest trend in the tech sector, sometimes it can pay to shop around in more traditional industries. Card Factory PLC (LSE:CARD) is a chain of greeting card and gift stores in the United Kingdom. The stock is listed on the London Stock Exchange and currently trades around 2.20 pounds ($2.95) per share with a market capitalization of 816 million pounds ($1.095 billion).

Unsurprisingly, Card Factory’s main product is greeting cards, accounting for 56% of total sales in the year ended Jan. 31. The remaining 44% is comprised of gift wrapping and party supplies, as well as other miscellaneous holiday merchandise.

Card Factory’s competitive edge comes from its vertically integrated model, in which design, manufacturing and distribution all take place under the umbrella of its own business. Card Factory’s vertical integration has created a meaningful competitive advantage, allowing the company to pay regular and generous dividends to its investors while simultaneously making it easier for it to weather some economy-wide headwinds that have put pressure on many companies.

In today’s research note, we take a closer look at this intriguing under-the-radar company from across the Atlantic.

A wee dip in profits

Card Factory posted total revenue for 2017 of 422.1 million pounds, up 6% compared with 2016. Net profits, however, dropped slightly, with underlying profit before tax coming in at 80.5 million pounds, down from 85.1 million pounds in 2017.

The dip in profit was due to a number of factors. First, margins have been compressed by the the depreciation of the pound, driven primarily by concerns over Brexit. The weakening of the pound-dollar pair has driven up costs for card inputs and general merchandise, which are largely imported from outside of the United Kingdom.

Second, the introduction of the National Living Wage (the U.K.’s minimum wage scheme) has driven up staffing costs, which the company has decided to absorb rather than raise prices.

Vertical integration pays off

At first glance, the decision to absorb costs and not increase prices may look unsettling from a shareholder’s standpoint, as it results in the company clipping its margins. But a closer view shows there is, in fact, strategic merit insofar as the move permits Card Factory to retain talent and ensure stability within its workforce – a must for a vertically integrated enterprise operating in a comparatively low-margin business environment.

Furthermore, these cost factors affect Card Factory’s competition as well. That is good news for Card Factory and its shareholders on a net basis because of its key strategic advantage: vertical integration. Card Factory’s competitors have lower margins and are, therefore, comparatively less able to deal with these downturns. As evidence of this, Card Factory’s total like-for-like sales grew 2.9% over the course of 2017 and the chain opened 50 new stores throughout the United Kingdom, bringing the total number of stores to 915. Management plans to open 50 stores a year and views 1,200 total stores as a feasible target in the medium-term.

Dividends for days

In addition to high margins, strong vertical integration and robust sales growth, what makes Card Factory an attractive stock is the fact management consistently pays out good ordinary dividends, as well as occasionally spectacular special dividends.

In 2017, management paid out a regular dividend of 9.3 pence per share (12.47 cents) and a special dividend of 15 pence per share, for a total of 24.3 pence per share, up from 24.1 pence per share the previous year. For the coming year, management has forecasted a special dividend in the range of five to 10 pence per share, which is understandably underwhelming compared to recent history. However, we believe this should be viewed in the context of an industry-wide downturn that Card Factory is dealing with comparatively better than its competitors. By keeping its financial powder dry, it may be better positioned to exploit the weakening condition of its primary competitors.

There are always risks

Card Factory has to contend with a number of challenges going forward.

First, as already mentioned, the depreciation of the British pound sterling poses a continuing fundamental concern for the company. As a company reliant on foreign inputs, the risk of having purchasing power eroded could end up threatening an already fairly low-margin enterprise. While Card Factory is better positioned than its competitors to weather these storms, and could even profit from exploiting others’ weakness, systemic weakness could quite quickly outweigh any potential boons.

Second, the ambitious expansion effort could backfire if management fuels growth with excess leverage. With a debt-to-equity ratio of 1.04, the company is currently not significantly overleveraged; however, this could change if profits do not keep up with growth. Many small companies in the retail sector can get caught in a growth trap, whereby expectations of ever-increasing numbers of stores results in inefficient investment, and even financial overstretching. Thus far, management has shown solid discipline, but the urge to grow faster than is healthy has afflicted many management teams in every conceivable industry over the years. Brick-and-mortar growth decisions must thus be of paramount interest to shareholders and Card Factory watchers.

Verdict

Card Factory’s stock is trading down 36.6% from its yearly high of 3.55 pounds. But the factors driving this downtrend are largely cyclical and economy-wide in nature, rather than indicative of any weakness in the company itself.

Card Factory has a history of solid growth, a competitive advantage thanks to its vertically integrated business model and a still-impressive dividend. Given these facts, the stock looks oversold and may present a nice opportunity for value-oriented investors with an eye toward geographical diversification.

Disclosure: I/We own no stocks discussed in this article.

(This article was co-authored by Stepan Lavrouk, an investment analyst with Almington Capital – Merchant Bankers.)

About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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