Big leap forward

Walker Greenbank 12 October 2016 Outlook

Walker Greenbank

Big leap forward

Interim results/acquisition

Care & household goods

12 October 2016

Price

203.5p

Market cap

£123m

Net cash (£m) at 31 July 2016

2.5

Shares in issue

60.6m

Free float

92%

Code

WGB

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(5.4)

19.4

1.5

Rel (local)

(8.7)

12.3

(7.2)

52-week high/low

218.5p

159.5p

Business description

Walker Greenbank is a luxury interior furnishings group, combining specialist design skills with high-quality upstream manufacturing facilities. Leading brands include Harlequin, Sanderson, Morris & Co, Scion, Anthology and Zoffany.

Next events

Trading update

February 2017

Analysts

Nigel Harrison

+44 (0)20 3077 5700

Toby Thorrington

+44 (0)20 3077 5721

Walker Greenbank is a research client of Edison Investment Research Limited

The proposed acquisition of Clarke & Clarke (the first deal for more than 10 years) represents a big leap forward for the group, increasing our group 2018 PBT estimate by 45%. Moreover, the group’s fabric printing business is back in full production following the major flash flood last December. Despite the challenging trading climate, Walker Greenbank expresses its confident outlook with a 25% increase in the interim dividend.

Year
end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

01/15

83.37

8.13

11.20

2.31

18.2

1.1

01/16

87.84

8.95

12.13

2.89

16.8

1.4

01/17e**

92.00

10.40

12.66

3.20

16.1

1.6

01/18e**

123.00

14.30

15.93

3.35

12.8

1.6

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments; EPS is diluted. **Pro forma acquisition of Clarke & Clarke from 1 November 2016.

Key strategic acquisition

Walker Greenbank has announced the proposed acquisition of Clarke & Clarke for an initial consideration of £25m cash; further payments totalling up to £17.5m, payable in equity, are based on its trading performance over the next four years. The businesses are complementary and broaden the product spread, while we see considerable medium-term benefits stemming from cross-selling and using the group’s manufacturing skills to help broaden the product range. Management indicates that the acquisition will be materially earnings enhancing in its first full year within the group.

Trading back on course

Interim results show underlying pre-tax profit up by 2.7% to £3.78m, consolidating £1.6m loss of profit insurance payments. Further payments, especially related to the loss of profit in the group brands and the likely impact of the flood over the next two years have still to be agreed. More significantly, the factory is now operating at full capacity and we feel able to restore our earlier profit estimates. Trading conditions remain challenging, especially in the context of uncertainties following the Brexit vote, but the group’s consistent long-term investment policy enables us to look ahead with cautious optimism.

Finances remain strong

Net funds increased by £0.2m over the half year to £2.5m. With a £17m (gross) equity fund-raising to help finance the £25m cash element of the acquisition, the group will move into debt during the second half. Our current January 2017 net debt estimate of £5.5m is well within group facilities.

Valuation: The catalysts for the share price

Walker Greenbank’s share price has been consolidating over the past three years. Clarification of the impact of the flood and the earnings-enhancing acquisition could be catalysts for the share price to start moving ahead. The prospective P/E rating relative to its peer group for CY16e (16.3x vs 18.0x) and CY17e (13.2x vs 17.1x) makes the shares attractive.

Investment summary

Luxury interior furnishings

Walker Greenbank is a tightly focused and vertically integrated interior furnishings business, targeting its products at the quality end of the market. Each of its established brands (Sanderson, Morris & Co, Harlequin and Zoffany) is aimed at a distinct market segment, with consistent investment in design and product development enabling it to meet customer aspirations. Principal products comprise woven and printed fabrics, and wallcoverings. Printed fabrics and wallcoverings are produced in house by specialist manufacturing businesses, which also supply a number of leading third-party customers; woven fabrics are imported from specialist suppliers. The Scion and Sanderson Home brands, introduced successfully in 2012, supply a younger, aspiring audience. Anthology, aimed at export markets, was introduced in 2014. Clarke & Clarke and Studio G, currently being added by acquisition, are complementary brands at the more affordable end of the quality market. Other household goods, carrying group brand names, are produced and marketed by a series of licensees, which contribute substantial royalty income.

Valuation

Walker Greenbank shares are currently rated at a discount to four of the other five members of its peer group. In contrast to cautious comment from all of the other companies in the group, Walker Greenbank has presented positive trading news and an earnings-enhancing acquisition. We believe that the prospective discount rating relative to the others (16.3x vs 18.0x CY16e; 13.2x vs 17.1x CY17e) does not recognise the consistent earnings growth and cash generation mentioned above, let alone the current acquisition, which points positively to the future earnings. We recognise that the trading climate remains challenging both in the UK and overseas, but we believe that the current deal could well be the catalyst for bringing the current three-year period of share price consolidation to an end and there is potential for a positive rerating.

Financials

Restoration of earlier estimates following the receipt of substantial insurance payments, plus a major earnings-enhancing acquisition, have lifted our estimates materially. Interim results, consolidating £1.6m loss of profit insurance income, show underlying pre-tax profits ahead by 2.7% y-o-y, comfortably above our expectations.

The net cash position (£2.5m) is largely unchanged, with receipts from insurers and cash flow offsetting heavy capex and the seasonal working capital increase. The second half will see £25m cash acquisition expenditure, partially balanced by a £17m (gross) equity placing.

Exhibit 1: Estimate changes

EPS (p)

PBT (£m)

EBITDA (£m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2016

12.13

12.13

N/A

8.95

8.95

N/A

11.76

11.76

N/A

2017e

10.10

12.66

+25

7.50

10.40

+39

10.40

13.50

+30

2018e

12.92

15.93

+23

9.80

14.30

+46

12.80

17.40

+35

Source: Walker Greenbank; Edison Research estimates. Note: Earnings diluted and before amortisation of acquired intangibles, exceptional items and share-based payments.

Sensitivities

While the group supplies into the more inelastic upper end of the market, it cannot be immune to major changes in consumer spending. Shifts in consumer preference can often be more important, as they can cause fluctuations in the perceived attraction either of the group’s brands or its manufacturing skills.

Company background: Luxury interior furnishings

Walker Greenbank has established itself as a major UK player in the global luxury interior furnishings market, supplying high-quality fabrics and wallcoverings, a majority of which are produced by the group’s upstream manufacturing operations. Consistent investment in both the group’s brands and in its manufacturing operations has enabled management to deliver strong business performance in recent years, including a positive response to the challenging market conditions of the global economic downturn in 2008 and 2009. The medium-term strategy involves organic growth stemming from raising the group’s presence in the contract market, building on its growing international position, stretching the brands into adjacent markets and accelerating licensing income. Acquisitions are firmly on the agenda, as a means of extending the customer reach, without compromising the fundamental requirement for quality.

Broadening of core interior furnishing brands

There are four core brands. Both Harlequin and Zoffany have been group brands for a number of years, while Arthur Sanderson and Morris & Co were acquired in 2003, at the time of a fundamental group reorganisation. Scion and Sanderson Home were introduced as extensions to the Harlequin and Sanderson brands in early 2012, targeting a younger, but aspirational audience, with lower price points. More recently, the group introduced Anthology as a further extension of the Harlequin brand, aimed primarily at international markets, especially China, the Middle East and Russia.

Products reach the ultimate customer through a number of routes. In the UK, the Brands target high street retailers, notably specialist interior furnishings outlets ranging from the group’s largest customer, John Lewis, to a wide range of independent retailers. The group also targets interior designers and contract specifiers. In overseas markets, the group has showrooms in its largest markets and employs specialist agents and distributors elsewhere.

Unique manufacturing skills

Walker Greenbank is vertically integrated, operating its own wallcoverings (Anstey) and fabric printing (Standfast & Barracks) Manufacturing operations; manufacturing turnover is equivalent to 35% of gross group revenues. Each manufacturing business operates at arm’s length from the group brands, and is recognised nationally for its high-quality products and flexibility to adapt readily to distinct customer requirements. Both businesses have responded to consistent investment, countering the impact of increasing cost pressures and the fashion shift towards minimalism in the 2000s, which led to the demise of many other UK manufacturers and a trend towards overseas sourcing. A measure of the skill base of both businesses can be seen in the fact that more than 50% of combined revenues are generated by sales to third-party customers, including competitors to the group’s brands. Both manufacturing operations withdrew from commodity-type business several years ago, with each company using its own extensive design skills and archives to help customers (both internal and external) develop their collections.

Management: Consistent record

The executive team is headed by chief executive John Sach, who joined the group in 1994 as group financial controller. John was appointed CEO in May 2004, having served for a number of years as group finance director. He has masterminded the major restructuring that restored the group to viability and is now leading a compact team that is delivering the clearly defined growth strategy.

Mike Gant joined the group in 2014 as chief financial officer; he brought considerable experience of working in larger global FMCG businesses and has been quickly and effectively absorbed as a key member of the team. David Smallridge, who was promoted to the group’s main board in 2004 and has managed the development of the group’s brands, will be retiring in early 2017. His replacement, Fiona Holmes, joins the group later this month; she brings 30 years of brand and retail experience with M&S, Charles Tyrwhitt and N Brown. Earlier this year, Paul Mullan was appointed to the new role of managing director of the Manufacturing division. In addition, the executive team has been broadened and extended over the past 18 months, with the appointment/promotion of group directors responsible for design, for marketing and for licensing

The group was loss-making when John Sach assumed control 12 years ago. The subsequent record is impressive, notably the resilience in the face of the severe impact of the banking crisis on UK consumer demand and the subsequent pace of recovery; the downturn commenced during the second half of the year to January 2009 and continued into the subsequent year. However, management chose to sustain its investment in innovative new product ranges, reporting significant increases in UK market share while, more recently, the impact of investment in overseas business development has become more apparent.

Exhibit 2: 10-year trading record

Year to January

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Revenue (£m)

54.39

62.45

63.70

60.38

68.78

74.01

75.73

78.43

83.37

87.84

Operating profit (£m)

2.66

4.39

3.98

2.67

5.17

5.97

6.58

7.51

8.34

9.13

Pre-tax profit (£m)

1.60

3.53

3.20

2.41

5.02

5.72

6.38

7.33

8.13

8.95

EPS – diluted (p)

2.73

6.20

4.29

3.09

6.40

7.26

9.41

10.66

11.20

11.20

Source: Walker Greenbank RNS. Note: Before defined benefit pension charge, share-based payments and exceptional items.

As can be seen from our estimates shown earlier in this report, Walker Greenbank looks set to continue to deliver underlying progress in the current year and into 2017, following the sound half-year performance described below.

2016 interims: Meeting the challenge

As foreshadowed by management, the half year’s trading was heavily influenced by the aftermath of the serious flash flood, in December 2015, which led to the closure of the group’s fabric printing factory for a period of 16 weeks. While production restarted in April 2016, the factory has only recently been restored to full capacity working. In addition to the obvious impact on the profitability of the printing business, group Brand sales were adversely affected by reduced product availability, while the wallcoverings business will also have suffered some loss of business where sales were related to matching fabric sales.

Overall group revenues slipped back by 8.7% to £41.83m, but underlying group profitability benefited from the consolidation of £1.59m of insurance receipts in respect of business interruption reimbursements to cover loss of profits. Adjusted pre-tax profits rose by 2.7% from £3.68m to £3.78m. After a somewhat higher tax charge of 26% (13% in H116), which related largely to prior year adjustments, underlying EPS emerged 13.6% lower, down from 5.35p to 4.62p. As a measure of confidence in the future, the interim dividend was raised by 25% to 0.55p.

Brand revenues fell by 2.0%, including a 6.9% decrease in UK sales. Overseas Brand sales slipped back by 1.7% in constant currency terms, but the impact of the weakness of sterling, especially in relation to the US dollar and the euro, led to a 4.0% revenue increase in reportable currency. There were contrasting performances across overseas markets. Sales to the US were down by 6.5% in constant currency terms, but ahead by 2.5% after currency adjustments. Similarly, a 5.7% increase in sales to Western Europe emerged as a 14.3% increase on conversion into sterling.

There was a useful 16.3% increase in licence income. Important new licensees in the US and China began to contribute, while Japanese licence income (especially for Sanderson and Morris designs) stabilised. With costs firmly under control, Brands division operating profits rose by 8.1% to £3.61m.

Exhibit 3: Interim results

Year to January

H117 (£000s)

H116 (£000s)

Change (%)

FY16 (£000s)

Turnover

Brands

UK

International

Licence income

18,756

13,973

1,114

20,155

13,436

958

-6.9

+4.0

+16.3

39,971

25,888

2,043

33,843

34,549

-2.0

67,902

Manufacturing

UK

International

13,184

1,776

16,669

1,978

-20.9

-10.2

30,920

3,409

14,960

18,647

-19.8

34,329

48,803

53,196

-8.3

102,231

Intercompany sales

(6,977)

(7,362)

-5.2

(14,392)

41,826

45,834

-8.7

87,839

Adjusted operating profit

Brands

Manufacturing

3,605

174

3,335

1,807

+8.1

-90.4

8,080

2,482

3,779

5,142

-26.5

10,562

Unallocated costs

59

(1,362)

(1,436)

3,838

3,780

+1.5

9.126

Interest

(60)

(102)

(179)

Adjusted pre-tax profit

3,776

3,678

+2.7

8,947

Source: Walker Greenbank company announcements. Note: Figures before exceptional items, share-based payments and defined benefit pension contributions; unallocated cost reduced in FY16 (£1.4m) and H117 (£1.6m) to consolidate other income, related to loss of profit insurance receipts.

Returns from group manufacturing operations reflected the flood problem. Continued progress in wallcoverings was overshadowed by operating losses in fabric printing. Gross divisional revenues slipped by 19.8% to £14.96m, while operating profits were decimated, falling by just over 90% from £1.84m to £0.17m.

There was the usual seasonal increase in working capital requirements ahead of the main selling season, but the group also received substantial payments from its insurers. Net funds increased modestly over the half year, from £2.31m to £2.53m.

Impact of the flood across the group

Exhibit 4: Revenue breakdown

Year to January

H117 (£000s)

H116 (£000s)

Change (%)

FY16 (£000s)

Brands

Harlequin

Sanderson/Morris

Zoffany

Others

Licence income

15,556

10,648

6,138

387

1,114

16,049

11,029

5,993

520

958

-3.1

-3.5

+2.4

-25.6

+16.3

31,676

21,503

11,749

931

2,043

Total

33,843

34,549

-2.0

67,902

Manufacturing

Standfast

Anstey

5,657

9,303

9,615

9,032

-41.2

+3.0

15,681

18,648

Total*

14,960

18,647

-19.8

34,329

Source: Walker Greenbank RNS. *Note: Before internal sales (H116 - £7.4m; H115 - £7.8m; FY15 - £16.4m).

Brands

Harlequin, incorporating Scion and Anthology: Harlequin is the most successful and largest of the group’s brands. Its products are aimed at the mid-level of the premium market, with price points ranging from £22-89 per metre/roll. Its collections comprise a distinctive range of contemporary styles, which have enabled the brand to establish itself as the UK leader in its chosen market segment. Harlequin is the leading independent supplier to the John Lewis Partnership (6% of group revenues), but is also gaining further recognition among interior designers and decorators. The brand was extended by the 2012 introduction of Scion, a contemporary brand with slightly lower price points (£12-49), and targeting younger age groups. This was followed last year with another specialist higher market contemporary brand, Anthology (£48-121). Its initial collections comprised textured contemporary wallpapers targeted largely at overseas markets, especially in Eastern Europe and the Far East; this year the brand was extended to include woven fabrics.

The Harlequin group was clearly affected by the poor availability of printed fabrics, with half-year revenues falling by 3.1% to £15.6m. UK revenues slipped by 8.7%, partially balanced by a 6.2% rise in export sales. Within these figures, both Scion and Anthology performed well, with a number of important new collections – the latter, which is largely a wallcoverings brand supplemented only by woven fabrics, will have been unaffected by the flood.

The recent upgrading of the Chelsea Harbour showroom and the improved sales facilities in New York and Dubai should have helped the performance. With the availability of printed fabric now improved again, we look ahead to a much improved second-half performance.

Arthur Sanderson, incorporating Morris & Co: Sanderson is the oldest of the group’s brands, dating back to 1860. It is targeted at the mid- to upper end of the premium market, with price points of up to £116 per metre/roll. It is an internationally recognised brand, with a royal warrant and a distinctive and unique archive. Morris also has a similarly long heritage, based on the skills of the acclaimed designer William Morris. It is also supplied into the mid- to upper end of the premium market and its price points are above those for Sanderson (up to £168). The introduction of Sanderson Home in 2012, targeting a slightly younger market segment (£21-50), represented a key move forward for the brand.

With Sanderson and Morris & Co designs particularly lending themselves to printed, rather than woven fabrics (which provide vertical integration benefits to the upstream manufacturing operations), they will have suffered most from the flood. In this context, a 3.5% reduction in revenues over the half year represents a remarkably good result; the impact of Woodland Walk, a highly successful new collection under the Sanderson label, has been impressive. We look forward optimistically to second half trading.

Zoffany: Zoffany is aimed at the upper end of the premium market. The style tends to be historically based, with many patterns adapted from the furnishings found in a selection of stately homes. It is the youngest of the group’s brands, established just over 30 years ago, but has quickly become recognised for the quality of its rich weaves and elegant designs. Price points start at £35 per metre/roll, but are typically more than double those of other group brands and can be as much as £246 per metre/roll.

With Zoffany fabrics tending to be woven, it was largely unaffected by the flood. Recent action to discontinue a number of marginal collections and changes to the leadership of the design team continue to lift the brand’s appeal. Revenues rose by 2.4% over the half year to £6.1m, with improved performance in overseas markets. We believe that the subtle change in the brand’s direction has much further to go and is likely to continue lifting returns over the next two years.

Manufacturing

Standfast & Barracks: Standfast is the last remaining successful UK-based, high-quality fabric printer. It has unique design skills and extensive fabric preparation and finishing processes, which ensure the highest quality of product, combined with the ability to print effectively on a comprehensive range of base fabrics, including cotton, linen, silk, wool and velvet. In addition to supplying the group requirement for printed fabrics, some 55-60% of output is produced for third-party customers, mostly comprising high-quality furnishing fabric houses, such as Osborne & Little and Designers Guild. The progressive introduction of digital printing has added to the flexibility and, hence, the profitability of the plant since 2010. It has also created opportunities to supply product more widely, such as into the apparel industry – the company has supplied Liberty for some years, while discussions are ongoing with a number of other potential customers.

The timing of the flood last December could not have been worse; investment in broadening the plant capabilities had contributed to an 18% rise in revenues in the first half of the previous year, with the promise of more to come. The factory was closed completely for 16 weeks, with production gradually restored over the subsequent six months. The impact on group brands has been described above; for the company itself, revenues fell by 41.2% to £5.7m, with internal sales falling by 35.5% and third-party sales by 49.7%. Walker Greenbank does not disclose profits of individual operations, but there will have been a substantial operating loss for the period.

As indicated at the time of the flood, the business was fully insured for both physical losses and for loss of profit. Payments totalling £12.05m have been received to date, including £11.25m received during the half year. The group half-year results recognised £7.90m of insurance reimbursements, of which £4.56m related to exceptional costs and £3.33m to loss of profits (£1.59m) and exceptional gains for plant and equipment replacement (£1.74m). Further amounts have still to be agreed, notably those related to current year and future (up to two years) loss of profits in the group Brands division.

It is difficult to assess the speed with which third-party business will be regained. Customers will have naturally sourced their requirement from other suppliers – the nature and duration of these alternative arrangements will be quite varied, while there is no guarantee that all lost business will be restored. However, with some of the replacement plant of higher specification than that destroyed in the flood, the company’s ability to respond to opportunities in the market place is considerable. While the group’s third quarter will still be affected, there should be a strong recovery over the final quarter and into 2017.

Anstey Wallpaper: Anstey is one of few remaining UK wallcovering manufacturers, and the larger of two specialists at the quality end of the market. The company is able to use a wide range of paper and vinyl bases and employs a full range of printing techniques to meet the varying needs of a specialist customer base. The plant is equipped to concentrate on shorter runs and is building an impressive third-party customer base (estimated 50% of sales). Investment in recent years has extended capacity, broadened capabilities and introducing digital printing.

Half-year figures show revenue up by 3.0% to £9.3m, with increased internal revenue (including several important new collections for Sanderson and Anthology) rising to compensate for slightly disappointing UK third-party sales, which slipped by 15.3%. We look for another sound performance in the second half.


Acquisition of Clarke & Clarke

Consideration

Walker Greenbank has announced the proposed acquisition of Clarke & Clarke (C&C), a successful designer and global distributor of quality furnishing fabrics and wallcoverings. The consideration comprises an initial payment of £25m cash; in addition, there will be contingent consideration related to the company’s EBITDA performance over the next four years, payable in incremental amounts based on profits in each year. The contingent consideration will be paid in the form of Walker Greenbank shares, subject to a maximum aggregate value of the lower of £17.5m or 10.0m shares. This would make a total of £42.5m if all conditions are met.

The initial consideration will be financed by a placing of Walker Greenbank shares to raise £17m gross, with the balance funded from existing group resources. This will involve drawing on the group’s accordion facility of £10m, leaving the revolving credit facility (RCF) of £12.5m undisturbed.

Business and trading performance

C&C is involved in the design, procurement and distribution of interior furnishing fabrics and wallcoverings, having been founded and developed by its present owners and managers, Lee and Emma Clarke. It was established in 1999 and is based in Haslingden in Lancashire, where there is a modern warehouse; the design studio is nearby in Cheshire. C&C collections are aimed at the affordable end of the quality contemporary market, with price points of £20-60 per metre/roll. A second brand, Studio G, is targeted at a slightly younger market, with price points up to £20 per meter/roll. The wallcoverings business is small, with the vast majority of throughput in the form of furnishing fabrics.

Fabrics are sourced from manufacturers and distributors in the UK, Europe, India, Turkey and China; products are launched into the market through a series of pattern books. The business sells into some 80 countries, supplying direct to home furnishing stores and interior designers in the UK and through a series of agents into overseas markets. It has an exclusive arrangement with its US agent, Duralee, a leading wholesale fabrics distributor with 12 corporate showrooms, plus numerous agency and on-the-road showrooms across the country. The company also supplies quality own-brand product to Dunelm, a leading specialist household goods retailer and a range of ready-made home furnishings for other UK retail chains. The management team sees considerable potential from continued penetration to markets in the UK, continental Europe and the US.

The trading performance has been consistent. Over the three years to 2015, revenue has risen progressively from £18.1m, through £19.6m, to £22.4m last year; over the same period, adjusted EBITDA has risen from £2.8m to £3.1m and then £3.8m. EBITDA margins have risen steadily from 15.5% to 17.0%. Just over 50% of revenues are generated in the UK, with the balance split between the US, Europe and the rest of the world.

Impact on Walker Greenbank

Earnings enhancing: this is Walker Greenbank’s first acquisition for more than 10 years. Comparison of C&C’s 2015 figures with group results for the year to January 2016 indicates that the acquisition would contribute 20% of the combined revenue and 24% of combined EBITDA. The initial consideration of £25m represents 18% of the group market capitalisation adjusted to include the shares to be issued to raise £17m. Management has indicated that the deal will be materially earnings enhancing in the year to January 2018.

Immediate commercial benefits: the two new brands dovetail neatly with existing group brands. It has lower average price points, but keeps the group firmly within the quality segment of the home furnishings market. While the company is to remain a standalone business, retaining its current management and workforce, it brings a number of new suppliers and customers into the fold, strengthening the group’s sourcing expertise and buying power. In addition, it extends the group’s international reach, particularly in the US.

Longer-term benefits: the above cross-selling/purchasing benefits will emerge over time. While the business will continue as a standalone operation, each will benefit from an exchange of ideas. Perhaps more significantly, C&C is not a customer of the group manufacturing operations. Wallcoverings represent only 5% of the company’s throughput – we believe that over the medium term, this percentage will increase significantly as the C&C team develops its understanding of the depth of skills at Anstey and how they can be used to extend the company’s product offer. Similarly, while many of its collections appear more suited to woven fabrics, the investment in digital printing at Standfast offers more scope to the C&C design teams.

Setting a benchmark: we understand from earlier discussions with Walker Greenbank’s management that there have been several potential acquisitions that have foundered when vendor price expectations were deemed far too high. C&C is a recognised high-quality business in the home furnishings sector, with a highly regarded management team. By setting this benchmark, it is quite possible that other potential vendors will view the current deal with its initial cash consideration and earn-out terms over an extended number of years as an attractive proposition.

Strategy

Walker Greenbank has an impressive record over the period since the appointment of John Sach as chief executive in 2004. As shown in Exhibit 2 (page 4), the group has lifted revenues by 62% without the benefit of acquisitions, and grown its underlying pre-tax profit from £1.6m to last year’s £9.0m, over the past 10 years without coming to the market for funds. The group has a clearly defined strategy for organic growth, which has been pursued consistently over this period, financed entirely by funds generated from operations.

The main plank of this strategy involves five key facets:

Market penetration: the four longstanding brands have expanded through consistent investment in new innovative collections, broadening the product offer, often adapting archive designs to meet current demand trends. In addition, the group has extended the targeted customer base by introducing new brands, with slightly lower price points aimed at the younger market. More recently, it has produced its first children’s collections within its brands and established a new brand targeting overseas markets. The group has experienced design teams, led by an experienced group design director, constantly looking to broaden the appeal of products, with a willingness to look outside the box if commercially viable.

Web presence: there has been a major investment in upgrading the brand websites. Customers can now view the whole spectrum of group products online, experimenting with a variety of designs to create their own style. There are four websites covering the core brands, plus a Style Library covering the whole group product range for the first time on one site. While the benefits will emerge over the medium term, the sites appear particularly suited to specialist interior designers in key export markets, notably in the US.

Overseas opportunities: the Walker Greenbank brands were slower to enter export markets than many competitors; however, targeting in recent years has lifted the export content of brand sales to almost 40%, spread across 75 countries. The New York showroom was extended and refurbished in 2014, following the opening of a Dubai showroom in 2013. A showroom in Paris has been in place for a number of years. In addition, there are recently opened partnership showrooms in Shenzhen (China) and Moscow. Other territories tend to be serviced by a network of agents and distributors. We see the main opportunities to lift revenues in certain key markets, especially the US, Western Europe, Russia and the Far East.

Licensing: royalty income has been almost doubled from £1.1m to £2.1m since 2010. Equally significantly, several licensees have been changed to more positive partners. While the Sanderson and Morris brands still contribute the majority of income, both Harlequin and Scion have seen rising momentum. Protection of the brand remains fundamental to the appointment of new licensees, but the recent appointment of a new licensing director is a measure of the potential.

Manufacturing investment: the recognised skills of both of the group’s manufacturing businesses enable them to supply more than half their sales to third-party customers, which are often competitors of the group brands. Investment in specialist printing techniques has enabled the businesses to broaden this skill base and offer greater flexibility to both designers and customers, without undermining quality. Group brands and third-party customers are thus able to design more creative products, broadening their customer appeal.

Acquisitions remain on the group agenda. As can be seen from the current C&C deal, smaller brands supplying complementary products can benefit from exposure to the group’s design, marketing and manufacturing skills; moreover, their own expertise can also strengthen certain group functions. As mentioned above, by setting a pricing benchmark further opportunities may emerge at acceptable asking prices.

Sensitivities

Macro issues: demand for all types of consumer goods will be affected by shifts in the economic cycle in the various territories in which the group’s products are sold. Group products are targeted at the upper and premium end of markets, where cyclical movements in demand tend to be more inelastic. While the two new brands, introduced in 2012, and the current acquisition involve lower price points than previously, the group is not involved in the more volatile higher-volume/low-margin products. Foreign exchange movements will obviously affect margins, with imported raw material prices rising in recent months following the weakness of sterling; on the other hand, export revenues are also correspondingly higher.

Consumer preferences: during the move towards minimalism, consumer preferences shifted away from wallcoverings towards painted walls and less-distinctive furnishing fabrics. The demise of considerable competition during this phase has created an opportunity now that fashion trends have become more broadly based. Group manufacturing operations have benefited from a move back towards colour, where printed fabrics offer more scope to the designer.

Design skills: a fashion business is only as good as its latest collections. While many group products tend to have a shelf life of up to five years, there is a constant need to reinvent, adapting the archive bases to meet the changing needs of the market place. Features of the rebuilding of group brands have been the strengthening of the various design teams and consistent investment in new product. More recently, the group has appointed a design director, promoted from within the company. The breadth of product now offered to the market is sufficient to absorb the occasional disappointment.

UK manufacturing: there is a perception that UK manufacturing cannot compete with similar businesses in lower-cost territories. However, the flexibility in techniques and ability to adjust production schedules at relatively short notice offers considerable attractions, both to the group brands and the division’s external customers. The fact that several competitors employ the group’s manufacturing operations is a testament to the product quality, the strength of the arm’s length relationship with group brands and the sustainability of the businesses; operating margins have steadily increased over the past five years. The flash flood at Standfast has put a temporary brake on progress, but with the company now restored to full production, the opportunity has been restored.

Pension deficit: the group operates two defined benefit schemes, which are closed to new entrants. Management acted some years ago to control the level of risk. The January 2016 balance sheet showed a deficit of £4.3m, down from £10.4m 12 months earlier; the reduction largely stemmed from a higher discount rate being applied because of increased bond rates. The volatility of markets since the Brexit vote has encouraged management to suggest that the deficit at 31 July 2016 may have been higher than six months earlier.

Valuation

Walker Greenbank shares have continued a period of consolidation at just above 200p that has now lasted more than two years. They were fundamentally re-rated over the two previous years and stand at almost four times the level prevailing at the beginning of 2012. Over the last five years earnings estimates have been regularly beaten, with the group delivering consistent growth in the face of a challenging trading climate. Management has invested in several new brands, upgraded its websites and transformed the printing capabilities of its unique manufacturing operations. Meanwhile, it has continued to generate cash. It is currently embarking on its first acquisition for more than 10 years.

Exhibit 5: Peer group valuation

Price (p)

Market cap

(£m)

Sales
(£m)

CY16e P/E
(x)

CY17e P/E
(x)

Colefax Group

480

49

77

17.0

17.6

Burberry Group

1479

6,542

2,515

20.9

19.7

Dunelm Group

790

1,593

881

15.6

15.5

Portmeirion Group

782

84

69

13.8

11.7

PZ Cussons

372

1,558

821

21.8

21.0

Walker Greenbank

205

124

88

16.3

13.2

Average for peer group

18.0

17.1

Source: Thomson Datastream, Edison Investment Research. Note: Prices at 10 October 2016; ratings based on pro rata calendar year adjusted and diluted earnings.

Perhaps surprisingly, the share price continued to hold firm in the aftermath of the major flood. However, management indicated from the outset that the group was effectively insured, a judgment that has been reinforced by the £12m of interim payments and the indication of further sums to be received over the coming months. With management having consolidated £1.6m of loss of profits payments over the half year and reaffirmed market estimates for the full year, we have reinstated our earlier estimates. In addition, we have included a contribution from the group’s current acquisition, which will be consolidated in the final quarter of this year.

The shares are currently rated at a discount to four of the other five members of our peer group. In contrast to cautious comment from all of the other companies in the group, Walker Greenbank has presented positive trading news and an earnings-enhancing acquisition. We believe the relative rating does not recognise the consistent earnings growth and cash generation mentioned above, let alone the current acquisition, which points positively to the future.

We recognise that the trading climate remains challenging both in the UK and overseas, but we believe the current deal could well be the catalyst to lift the share price to higher ground.

Financials

Estimates raised

At the time of the preliminary results announcement last April, we were aware of the severe impact of the flash flood, which had an obvious adverse effect on the Manufacturing division, but was also affecting Brand’s sales. In that context, we decided not to consolidate any loss of profit insurance payments in our current year estimates and awaited indications from management. This resulted in a sharply reduced underlying pre-tax estimate of £7.5m. However, for valuation purposes we had assumed that sufficient payments would be forthcoming (as indicated by management) to enable us to sustain our expectation of previous underlying PBT estimates of £9.4m (excluding proposed acquisition).

In the interim results, the group consolidated £1.59m insurance receipt for loss of profit income at Standfast (agreed and paid by group insurers), enabling management to declare adjusted pre-tax profits of £3.78m, representing a 2.7% increase on the £3.68m declared for the corresponding period of the previous year. This figure includes no payment for the considerable loss of profits in the Brands division for the period, which has yet to be negotiated. During the second half there will have been further disruption at Standfast before the restoration of full working, which has only recently been confirmed; the knock-on effects elsewhere in the group will also have continued.

An assessment of the interim figures suggests that the actual impact of the flood on trading was more severe than we had been expecting. On the other hand, management reported a 0.7% increase in Brand sales for the first nine weeks of the second half, despite the continued disruption. With the plant fully operational, we are optimistic that the group is now ready to respond to the challenges of the key autumn selling season. We remain mindful of the continued challenging trading climate but, with the board expressing its confidence that the market’s pre-flood expectations will be met, we have decided to restore our full year pre-acquisition PBT estimate of £9.4m. This will require further payments from the group’s insurers, but management is expressing optimism about the outcome of ongoing negotiations.

The group will also be consolidating the C&C acquisition for the final quarter. November is usually one of the strongest months of the year, but December tends to be a poor month, with some recovery expected in January. Management has indicated the deal to be immediately earnings enhancing and we are assuming a contribution of around £1.0m to pre-tax profits, lifting our full year estimate to £10.4m. The tax charge for the first half was higher than expected, because of a prior year adjustment. Nevertheless, we look for diluted adjusted EPS rising by 4% from last year’s 12.13p per share to 12.66p, despite dilution from the new equity currently being issued. The interim dividend was raised by 25% to 0.55p; we now look for a final payment up from 2.45p to 2.65p. This will narrow the disparity between the two payments, while our revised total of 3.20p will be covered 3.9 times by diluted EPS.

We do not propose yet to adjust our £9.8m underlying pre-tax estimate for the original group for the year ending January 2018, balancing the positive actions of management towards delivering organic growth with the growing uncertainty in the market place. C&C is indicated to be materially earnings enhancing in its first full year within the group. At this stage we are looking for a pre-tax contribution of £4.5m, lifting the total to £14.3m. Although there will be full dilution from the equity issued to finance the acquisition, while we are assuming some deferred equity to be issued against the profits being earned under the earn-out arrangements, our estimates suggest diluted adjusted EPS rising by 26% to 15.93p.

Insurance payments dominate cash flow

Forecasting cash movements was made difficult by the likely impact of the flood on cash flow and the timing of payments from the group’s insurers. EBITDA amounted to £6.3m, while insurance receipts of £11.3m exceeded the cash outflow related to the flood by £3.4m, making a total of £9.7m. The seasonal rise in working capital (inventory build-up ahead of the autumn selling season) absorbed £4.1m, capex was necessarily high to replace damaged plant at £3.4m while taxation, interest payments and other charges added up to £2.0m, leaving the group largely cash neutral over the period. Net funds rose by just £0.2m to £2.5m.

As mentioned previously, the £25m initial consideration for C&C will be financed by the net proceeds of the £17m (gross) equity issue, with the balance drawn from the group’s accordion facility. There ought to be some recovery of the working capital outflow, with our current estimates showing net borrowings of £5.5m at January 2017.

Clean balance sheet

Walker Greenbank has consistently generated cash since we started writing reports on the group in 2006. Back in 2004, the group had net borrowings of £11.6m, equivalent to 134% gearing. It has generated net cash in virtually every subsequent year, with the group showing net funds of £2.3m at January 2016; there had been an outflow in the previous year, as a result of a major investment programme. During this period the group issued no new equity, other than modest amounts related to share option schemes.

In the absence of further acquisitions, our estimates indicate that the group will clear the current level of net debt within two years, leaving it with net funds.

Banking facilities were renegotiated in December 2015. The group has a multi-currency RCF of £12.5m, with an additional £10.0m accordion facility. While the group has drawn on the accordion facility, there is ample headroom to cover foreseeable requirements.

Tax losses utilised

Problems in the distant past have meant that Walker Greenbank has paid no mainstream corporation tax for many years, although deferred taxation reserves have been built up during this period. The carried forward tax losses have now been largely utilised, with the group expected to start paying mainstream tax from the current year onwards.

Exhibit 6: Financial summary

£'000s

2013

2014

2015

2016

2017e

2018e

Year end 31 January

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

75,725

78,434

83,373

87,839

92,000

123,000

Cost of Sales

(30,193)

(30,347)

(32,674)

(35,875)

(37,574)

(54,120)

Gross Profit

45,532

48,087

50,699

51,964

54,426

68,880

EBITDA

 

 

8,625

9,730

10,689

11,764

13,500

17,400

Operating Profit (before amort. and except.)

6,577

7,513

8,340

9,126

10,700

14,500

Intangibles Amortisation

0

0

0

0

0

0

LTIP/Exceptionals

(746)

(970)

(1,005)

(924)

(900)

(900)

Other

0

0

0

0

0

0

Operating Profit

5,831

6,543

7,335

8,202

9,800

13,600

Net Interest/defined benefit pension charge

(897)

(1,048)

(1,006)

(864)

(900)

(900)

Other

0

0

0

0

0

0

Profit Before Tax (norm)

 

 

6,384

7,333

8,132

8,947

10,400

14,300

Profit Before Tax (FRS 3)

 

 

4,934

5,495

6,329

7,338

8,900

12,700

Tax

(972)

(451)

(1,224)

(1,466)

(2,250)

(2,700)

Profit After Tax (norm)

5,412

6,606

6,908

7,481

8,150

11,600

Profit After Tax (FRS 3)

3,962

5,044

5,105

5,872

6,650

10,000

Average Number of Shares Outstanding (m)

57.5

58.5

59.3

60.0

62.7

69.1

EPS - normalised (p)

 

 

9.41

11.30

11.64

12.47

13.00

16.79

EPS - normalised and fully diluted (p)

 

9.41

10.66

11.20

12.13

12.66

15.93

EPS - FRS 3 (p)

 

 

6.89

8.63

8.60

9.79

10.61

14.47

Dividend per share (p)

1.48

1.85

2.31

2.89

3.20

3.35

Gross Margin (%)

60.1

61.3

60.8

59.2

59.2

56.0

EBITDA Margin (%)

11.4

12.4

12.8

13.4

14.7

14.1

Operating Margin (before GW and except.) (%)

8.7

9.6

10.0

10.4

11.6

11.8

BALANCE SHEET

Fixed Assets

 

 

18,506

21,142

21,463

18,899

37,153

37,591

Intangible Assets

6,683

7,289

7,158

7,104

21,854

21,804

Tangible Assets

9,808

11,690

12,714

11,687

15,087

15,687

Deferred income tax assets

2,015

2,163

1,591

108

212

100

Current Assets

 

 

32,618

35,295

37,105

40,286

49,559

57,567

Stocks

16,825

18,428

22,004

18,104

29,000

33,272

Debtors

12,810

13,884

14,130

19,280

21,500

24,345

Cash

2,920

2,830

971

2,902

-941

-50

Other

63

153

0

0

0

0

Current Liabilities

 

 

(17,340)

(19,435)

(20,710)

(19,392)

(27,900)

(26,818)

Creditors

(16,940)

(19,035)

(20,310)

(18,992)

(23,500)

(24,418)

Short term borrowings

(400)

(400)

(400)

(400)

(4,400)

(2,400)

Long Term Liabilities

 

 

(9,602)

(10,150)

(10,921)

(4,509)

(4,200)

(4,200)

Long term borrowings

(1,364)

(942)

(569)

(196)

(200)

(200)

Other long term liabilities

(8,238)

(9,208)

(10,352)

(4,313)

(4,000)

(4,000)

Net Assets

 

 

24,182

26,852

26,937

35,284

54,612

64,139

CASH FLOW

Operating Cash Flow

 

 

6,023

6,165

3,468

7,103

9,209

11,202

Net Interest

(209)

(152)

(181)

(149)

(300)

(200)

Tax

(16)

(18)

(32)

(630)

(2,354)

(2,588)

Capex

(3,119)

(4,735)

(3,230)

(2,510)

(3,500)

(3,500)

Acquisitions/disposals

0

0

0

0

(25,000)

0

Financing

(145)

(28)

(367)

(66)

15,950

(50)

Dividends

(711)

(900)

(1,144)

(1,444)

(1,852)

(1,973)

Net Cash Flow

1,823

332

(1,486)

2,304

(7,847)

2,891

Opening net debt/(cash)

 

 

667

(1,156)

(1,488)

(2)

(2,306)

5,541

HP finance leases initiated

0

0

0

0

0

0

Other

0

0

0

0

0

0

Closing net debt/(cash)

 

 

(1,156)

(1,488)

(2)

(2,306)

5,541

2,650

Source: Walker Greenbank accounts, Edison Investment Research. Note: FY16 and FY17e consolidate loss of profit insurance receipts to adjusted PBT. FY17 and FY18 estimates also include acquisition of Clarke & Clarke from 1 November 2016.

Contact details

Revenue by geography

Bradbourne Drive,
Tilbrook,
Milton Keynes,
Buckinghamshire MK7 8BE
08708 300365
www.walkergreenbank.com

Contact details

Bradbourne Drive,
Tilbrook,
Milton Keynes,
Buckinghamshire MK7 8BE
08708 300365
www.walkergreenbank.com

Revenue by geography

Management team

Chief executive: John Sach

Chairman: Terry Stannard

John Sach is a qualified accountant, who joined the group in 1994 as group financial controller. He was appointed to the board as group finance director in 1999, becoming chief executive in May 2004, masterminding the restructuring and subsequent building of the group.

Terry Stannard joined the group as a non-executive director in 2007, becoming chairman in December 2008. His career in both an executive and non-executive capacity has comprised a number of senior roles including the development of consumer brands on an international basis.

Chief financial officer: Mike Gant

Mike Gant is a chartered management accountant, with an MBA from Nottingham Business School, who joined the board in 2014. He has brought a breadth of international, financial and brand experience from previous roles with Bass, Marstons, Geest, Constellation Brands and Britvic.

Management team

Chief executive: John Sach

John Sach is a qualified accountant, who joined the group in 1994 as group financial controller. He was appointed to the board as group finance director in 1999, becoming chief executive in May 2004, masterminding the restructuring and subsequent building of the group.

Chairman: Terry Stannard

Terry Stannard joined the group as a non-executive director in 2007, becoming chairman in December 2008. His career in both an executive and non-executive capacity has comprised a number of senior roles including the development of consumer brands on an international basis.

Chief financial officer: Mike Gant

Mike Gant is a chartered management accountant, with an MBA from Nottingham Business School, who joined the board in 2014. He has brought a breadth of international, financial and brand experience from previous roles with Bass, Marstons, Geest, Constellation Brands and Britvic.

Principal shareholders

(%)

Investec Wealth & Investment

13.77

Octopus Investments

13.35

Schroder Investment Management

11.63

Blackrock Investment Management

6.91

Royal London Asset Management

4.02

Rathbone

3.54

John Sach (chief executive)

3.08

Companies named in this report

Colefax Group (CFX), Burberry Group (BRBY), Portmeirion Group (PMP); Dunelm Group (DNLM); PZ Cussons (PZC)

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Walker Greenbank and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

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Level 15, 171 Featherston St

Wellington 6011

New Zealand

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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