(05-06-2019, 10:20 AM)karlmarx Wrote: [ -> ]There have been quite a few points raised. Let's try to discuss each of them.
Just how much cash/working capital does THG require?
1) That depends on how much THG wishes to grow. We don't know the plans that management has for the future, but the requirement of working capital can still be illustrated by looking at past figures.
($000) Revenue Changes in working capital
FY08: 489,768 -7,334
FY09: 441,908 -10,039
FY10: 488,298 -22,262
FY11: 521,834 -34,442
FY12: 611,780 -43,827
FY13: 607,758 -54,500
FY14: 688,943 -6,599
FY15: 740,804 -36,642
FY16: 714,029 -45,480
FY17: 703,952 1,314
FY18: 691,645 9,802
FY19: 727,315 -21,205
Growth in Revenue over 12 years: $237m
Total Change in Working Capital over 12 years: -$271m
As THG grew its revenue by $237m over the past 12 years, its increase working capital -- mainly inventory -- is $271m. So it looks like THG has to use an extra dollar to earn an extra dollar (and part of the reason is that it is holding inventory for longer periods than before). How much revenue growth does THG desire? Does its present cash balance represent a realistic amount of growth that THG may wish to achieve, in the near future?
2) But working capital is not all that THG requires for growth, although it constitutes the largest proportion. More retail shops means more PPE requirement. How much? I will spare readers the details and summarise the numbers.
Total Depreciation & Amortisation over 12 years: $66m
Total Investment Cash Flow over 12 years: -$156
Difference over 12 years: -$89m
Not all of its investment cash flow is being spent on PPE, but to save myself the trouble of digging for the numbers, the illustration here should not be too wide off the mark. Thankfully, the requirement on capital expenditure is not as high as for working capital.
3) So what does all these mean for THG? How much cash does it really need? How much cash does it really generate? In a previous discussion, I have mentioned how companies may allocate their capital into 3 broad areas: growth, financial security, and distribution. How much does THG spend on each of these?
Total Operating Cashflow before WCC: $739m (100%)
Total Change in WC: -$271m (37%)
Total Investment Cash Flow: -$156m (21%)
Total Dividends: -$146m (20%)
Remaining ‘Excess Cash’: $165m (22%)
It should be clear that the bulk of the cashflow is spent on working capital and PPE; growth. And the remainder is split between distribution and financial security.
So if (prospective) shareholders are expecting to have a higher payout ratio, it has to either come at the cost of growth or cash accumulation. Certainly, the absolute amount of dividend can increase in proportion with the profits. But for THG to increase the payout ratio -- while it is certainly possible -- may signal a shift in management strategy, the effects of, which as previously mentioned, may or may not be favourable to shareholders.
Can THG distribute a bumper $50m or $100m special dividend? Sure, from its $165m 'excess cash,' which it accumulated over 12 years. Will THG do so? This is something for (prospective) shareholders to ponder over. Perhaps the real amount of 'excess cash' from management's perspective is the amount that they are holding in fixed deposits.
VB Karlmarx's post back in mid 2019 was my favorite post on THG and I will replicate it here. Full post (for those interested to re-read):
https://www.valuebuddies.com/thread-258-...#pid152918
Some years have passed since FY19 and so i decided to check out how THG used its cash in the last 4 years (FY20-FY23). As a retailer, receivables turnover is only ~1 week and so changes in working capital are approximated to be inventory driven.
FY23 FY22 FY21 FY20 Sum
OCF (after lease) 132,232 194,122 148,926 84,957 560,237
(100%)
Real estate/PPE/business 87,933 44,973 80,814 117,256 330,976
(59%)
Inventory changes 35,137 -4,715 -28,307 -8,021 -5,906
(-1%)
SBB/dividends 108,797 75,631 28,159 21,740 234,327
(42%)
Retained as cash/others -99,635 78,233 68,260 -46,018 840
(0.1%)
Notes:
(1) The allocation of cash has seen a big change in recent years, in alignment with the luxury watch environment changing. Annual revenue has increased from 727mil (FY19) to 1136mil (FY23), an increase of 409mil (or 56%) with negligible/slightly negative inventory growth, all thanks to the bundling effect/waiting list gimmicks that previous VBs earlier described.
(2) With almost no inventory growth and little retained in the business, the cash has gone towards real estate/PPE/business (59%) and shareholders via SBB/dividends (42%). More has been used in real estate than returning to shareholders, which isn't a surprise as this had been previously communicated by Chairman Tay in AR22. With an increasing interest rate environment, will there still be enough "attractive real estate" opportunities?
(3) It is worth noting that returns to shareholders via SBB/dividends have seen a substantial increase in proportional usage compared to 2010s. It has however came at an expense of no inventory growth while business grew. With the luxury watch environment normalizing, or we could argue that the 2nd hand market hasn't found its bottom (based on subdial index), would we still see such similar levels of returning capital to shareholders?
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To Choon:
For something to be a "value trap", it first needs to have someone see the "paying pennies for a dollar" illusion (hence value), but been ignorant/not accepting the fact that the odds of extracting the dollar is dismay (hence "trap"). As VBs ghchua/dzwm87 mentioned, just based on NAV for a retailer, there isn't the first part illusion. We could argue that NAV undervalues THG because of its AD status/ relationships with the Swiss watch makers but that is an argument for another day.
Simply based on looking at "buying real estate and never selling it" alone is probably not enough. We need to look at the entire structure as well. At least with good business economics of the last few years, we have seen Chairman Tay giving to shareholders, returns above the historical norms, while also spending more on real estate. And because of this 2 things, Mr Market has responded via a market price above NAV, reflecting the fact that you can't really own THG by "paying pennies to the dollar".
