Card Factory — Confident on FY25 outlook

Card Factory’s H125 results demonstrate it is executing well on its growth strategy, with year-on-year revenue growth of c 6% in H125, which compounded the more than 11% growth that it enjoyed in the comparative period, H124. Most of the individual businesses contributed to the overall growth, although Getting Personal continued to decline in the period. Its growth rate compares favourably to the rest of the non-food retail sector, where the operating environment has been challenging with a general deterioration in high-street footfall and, per management, the broader celebrations occasions market.

cardfactory stores’ revenue growth was driven by the increasing contribution from newer product categories, with 6% lfl growth across gifts (c 11% lfl) and celebration essentials (c 3%). Cards generated positive like-for-like sales of c 1% despite the reallocation of space away from the category towards the new categories in the prior year. In H125, management introduced new ranges in baby gifting as other existing categories were further developed with an accompanying strong revenue response (eg soft toys +27% lfl, confectionery +30% lfl and licensed ranges +17% lfl).

Overall like-for-like growth in the stores was 3.7% and the contribution from new space took total yearonyear growth to 6.1% in H125. Card Factory is making quick progress on its aspiration to increase the number of stores in the UK and Ireland by 90 by FY27 from the FY23 base of 1,032 stores, while also improving the sales productivity of those stores. We note the net new number of stores added in H125 of 15 was the same as H224, with a back-end weighting to the additions for the whole of that year. Management’s preference is to open new stores before the important Christmas trading period to maximise the contribution from a new store in the financial year.

The online site, cardfactory.co.uk, has reported two consecutive six-month periods of growth, having been on a downward trajectory since H222 following the boost during the COVID-19 pandemic. Investment in the platform to improve the customer experience and ongoing range development are driving customer traffic to the site and the number of transactions. Card Factory has redesigned the event reminder tool and introduced AI-powered product recommendations in H125. The company also announced a new, limited (across 19 UK stores initially and a further 21 stores in H225) exclusive partnership with Just Eat to trial an ondemand service covering cards, balloons, gifts and gift bags. Development of the online ranges continues, including a number of exclusives to be launched ahead of Christmas.

Partnership revenue increased by c 3% y-o-y to £6.6m in H125, from £6.4m. The main contributor to the growth was Card Factory’s South African business, SA Greetings, with its first full H1 revenue contribution since being acquired in April 2023, adding £1.7m incremental revenue versus H124’s £2.2m. The implied decline for the other partnerships is due to the phasing of wholesale shipments (to the Reject Shop in Australia) in the prior year, which management expects will normalise over the rest of FY25. As the number of partnerships are expected to move to a full-service model, away from the wholesale model, these phasing effects should become less of an issue in the financial results in future periods. There is plenty of exciting newsflow for this division including: 1) expanding the partnership with Aldi from the end of September 2024 so that it covers the whole of its estate in the UK and Ireland, effectively doubling the revenue opportunity; 2) securing a wholesale retail partnership in the US that will begin trading ahead of Christmas; and 3) acquiring Garlanna, a publisher and wholesaler of greeting cards, wrap and gift bags in the Republic of Ireland in September 2024. The company is also in advanced discussions with The Reject Shop in Australia to renew the existing wholesale agreement and move to a full-service model, including seasonal ranges.

Following strong growth in H124 and H224, H125’s gross profit was negatively affected mainly by higher costs for staff in stores and warehouses due to the c 10% increase in the National Living Wage from April 2024 and the growth in the store portfolio versus H124 (note the step-up in the number of new stores added in H224 and H125 in Exhibit 2). The underlying product margin (which includes the costs of goods, freight and packaging) was broadly stable on a reported and constant currency basis at 70–71%, despite inflation in international freight costs. However, the c 21% y-o-y increase in staff costs, equivalent to 3.4pp of gross margin was the main cause of the 4.2% drop in gross margin to 32.6%, from 36.8% in H124. Management believes this effect on gross margin is temporary as we discuss below. Cost control further down the income statement mitigated the drop in the gross margin to a smaller year-on-year reduction in the EBITDA margin of 3.7% to 19.4% for H125. We remind readers that Card Factory’s definition of EBITDA and other adjusted profit measures differs slightly to ours as we exclude share-based payments from the calculation.

Relative to revenue, the lower profitability and higher working capital investment led to a reduction in operating cash generation in H125 versus H124, which was partially mitigated by lower targeted investment in tangible and intangible assets (ie stores and technology infrastructure) to give a smaller reduction in free cash generation. Working capital, specifically inventory, typically builds ahead of the peak trading period in the second half of the financial year and management noted the H125 increase is in line with its expectations, with some proactive management for higher freight costs.

The typical H1 free cash investment and the payment of the reinstated dividend meant that net debt excluding leases increased to c £75m in H125 from c £34m at the end of FY24. However, this was only marginally ahead of the c £72m at the end of H124, despite the ‘new’ £15.5m cost of the dividend.

Management has indicated that its expectations for the year are unchanged (see below), which implies a significant step-up in profitability in the second half to meet our unchanged profit expectations for the year, following the decline in profit reported in H125. Management had indicated at the time of the FY24 results that profitability in FY25 would be weighted to the second half of the year, reflecting the phasing of planned investments and inflation recovery actions.

To achieve our FY25 adjusted PBT estimate (using the company’s definition) of £65m (margin 11.9%), Card Factory will need to generate £50.5m of profit in H225 (16.2% margin), following the £14.5m reported in H125. As well as being a big step-up in profitability intra-year, it would represent strong growth in absolute terms and from a margin perspective, versus the £40m (13.8% margin) earned in H224.

Management points to four key levers it expects will drive the growth in profitability: 1) the typical seasonality of the business will drive approximately half of the margin growth; 2) a programme of productivity and efficiency savings will make a material contribution; 3) range development will be margin enhancing; and 4) ongoing prudent management of costs. Here we will focus on the reasonableness of the first two levers as they are the most material. The latter two are really a continuation of current trends and the way the business is run, for example total operating costs increased by only £0.6m in H125 versus the £13m increase in group revenue.

First, we look at Card Factory’s seasonality. The second half of the year is typically the most important part of the year from a revenue perspective as it includes Christmas. In Exhibit 4, we show the percentage of the full-year group revenue and operating profit that was earned in H1 and H2 for each of the years from FY19 (post the introduction of IFRS 16, accounting for leases) through our estimates for FY25, as well as the operating margin. We exclude FY21 and FY22 as their results were distorted by the outbreak of the COVID-19 pandemic. We focus on group-reported numbers due to the changes in the portfolio of companies, as well as changes in disclosure with respect to the individual businesses and the definition of adjusted numbers. Our focus on operating profit overcomes any impact from changes in leverage on PBT.

On average, the H1:H2 revenue split for the years featured through FY24 has been 43%:57%, so there is a clear skewing to H2 due to Christmas. We note our estimates for H125 and H225 are consistent with the historic average so we do not appear to be making an overly aggressive assumption in our FY25 revenue estimate, which requires 7.5% growth versus H125’s 5.9%.

There has typically been an even greater skewing to profit generation than for revenue. On average, the H1:H2 split of operating profit has been 37%:63% for the featured years to FY24. The typical uplift in operating margin from H1 to H2 of any year has been 4–6pp. Our estimated split for FY25 shows a greater dependence than this historic average, with 73% of the full-year outturn expected in H225 and a required pick up in the operating margin of around 9pp. Therefore, the non-seasonality elements of the expected improvement in profitability requires an extra 3–5pp of operating margin in H225 versus what has been delivered historically.

We now move to the second of management’s key levers that will deliver the incremental margin. They point to the H125 implementation of a store labour model optimisation tool and a programme to eliminate non-value-adding activities. The key point here is there has been a mismatch between the known staff cost inflation in H125 and the expected benefits from the above that should accrue in H225 and beyond, the investment for which also suppressed profitability in H125.

Outside the stores, management is also focusing on central overheads and support operations. Additionally, management has highlighted that international freight spot rates have eased in H225 so far from those seen in H125.

In addition to these initiatives to help the core retail business, Card Factory should also benefit from some of the highlighted changes for Partnerships: the doubling of the opportunity from Aldi stores (albeit for only part of the year); the first-time contribution from the new wholesale retail partnership in the United States; and a (minor) contribution from the acquisition of Garlanna in the Republic of Ireland.

We have made no changes to our overall group estimates although we have adjusted the shape of the forecasts to include greater revenue growth for cardfactory stores, offset by a lower contribution from cardfactory online and Getting Personal than previously forecast to reflect the H125 performance and commentary that current trading is in line with those trends.

With the H125 results, management declared an interim dividend of 1.2p per share and indicated it would represent 25% of the full-year dividend, so total dividends of 4.8p per share for FY25, growth of 7% from FY24’s 4.5p per share. We now forecast 22% growth in the dividend to 5.9p per share in FY26. The stated dividend policy under the capital allocation policy presented in April 2024 is unchanged (ie, a progressive dividend with a coverage ratio of 2–3x based on adjusted EPS), and management indicated dividend cover for FY25 would be at the higher end of the range, around 3x. This is above our prior estimate as we had assumed a coverage ratio of 2.5x (the mid-point of the range) for FY25 and FY26. Therefore, we have lowered our FY25 dividend estimate to be consistent with the guidance and assume a gradual reduction in cover to 2.75x in FY26.

Our updated DCF-based valuation has increased to 200p per share, from 180p per share previously, to reflect a lower estimated WACC of 8.5% from 9.5%. The lower WACC reflects declines since our last report in the risk-free rate to 4% (from 4.3%) and the equity risk premium to 4.9% (from 5.5%; source: Damodaran). The sensitivity of the valuation changes in the WACC and terminal growth rate are as follows:

We believe Card Factory’s valuation multiples continue look very attractive relative to the peers below, given we expect higher revenue growth than the peer average/median and higher levels of profitability. It also offers a superior dividend yield.