Topps Tiles — Early delivery

The majority of TPT’s group businesses contributed to the strong 6.3% y-o-y increase in revenue to £262.7m (FY22: £247.2m), which far exceeded management’s estimate of a 9% market decline in the year. Gross profit delivered good underlying growth for all businesses, increasing by 2.8% yo-y to £139.2m, while adjusted PBT declined by c 20% to £12.5m due to cost pressures, which was modestly ahead of consensus expectations of £11.3–12.3m.

The most significant absolute contributor to TPT’s overall revenue growth was Online Pure Play, whose revenue increased from £9.3m in FY22 to £22.4m in FY23. This growth is not like-for-like as FY23 represents the first full year of ownership or trading for the two brands, Pro Tiler Tools and Tile Warehouse, which were acquired or launched in March and May of FY22, respectively. Underlying revenue growth was exceptionally strong at 52% y-o-y, with the majority of this growth by the larger Pro Tiler Tools. Pro Tiler Tools’ growth has been fuelled by a combination of the offer of more trade-focused product brands, an enhanced service proposition and the launch of two new trading brands focused on underfloor heating and other flooring materials, to complement the existing four brands. Management accepts that growth for Tile Warehouse has been slower than originally anticipated due to technical issues (integration with core systems, search strategy needing refining and range issues). However, it is confident of stronger growth in FY24 following changes to the management team and a refreshed focus.

The omni-channel brand, Topps Tiles, recorded its highest-ever annual sales of £230.9m, with y-o-y growth of 1.7%. This was the third consecutive year of year-on-year revenue growth since the outbreak of the COVID pandemic and took revenue to almost 8% above pre-pandemic levels of £214.3m in FY19 despite operating from c 16% fewer stores (303 stores at the end of FY23 versus 362 at the end of FY19). The influence of higher inflation on reported revenue growth is highlighted by the square metres of coverings sold declining by just under 5% in FY23. The improved sales densities, ie sales per average store that were 30% above pre-pandemic levels, are testimony to the self-help measures and new product launches that have enabled Topps Tiles to grow its market share. There was one further store closure in the year, along with three store relocations; management indicates that the store closure programme is now complete. As indicated in the year-end trading update, revenue growth for Topps Tiles slowed through FY23, as inflationary cost pressures eased, thereby reducing how much inflation needed to be passed on to customers, and macroeconomic conditions deteriorated.

As previously reported, the Commercial business, Parkside, had a challenging year due to weakness in its end-markets that necessitated a restructuring of the business. Effectively, the cost base has been right-sized given management did not expect a quick recovery in trading conditions. The division’s cost base was reduced by 35%, mainly via headcount, during the company’s Q3, and management points to a positive business contribution in every month of the final quarter. Management remains confident that the division is capable of delivering at least £20m in profitable sales in the medium term. FY23’s revenue of £9.4m, which was down from the recent FY22 peak of £10.9m, having grown in every year prior to that.

As expected by management earlier in the year, moderating input cost inflation translated to a steady increase in the gross margin as the year progressed: H223’s gross margin of 53.3% was 50bp higher than H123’s 52.8%. Overall group gross profit increased by 2.8% to £139.2m, a group record, from FY22’s £135.4m. The decline in gross margin from 54.8% in the prior year to FY23’s 53% was wholly due to business mix changes (the newer group businesses, Commercial and Online Pure Play, operate with a lower gross margin than Topps Tiles-branded stores) and foreign exchange, which reduced the gross margin by a combined 200bp. The underlying trend in gross margin was more encouraging, with a 20bp increase highlighted by management, with all three of the verticals enjoying some benefit.

Below the gross profit line, adjusted operating costs increased by c 5.7% to £122.6m, with a number of positive and negative drivers. Looking at the positives first, a smaller store base for Topps Tiles (304 average stores in FY23 versus 310 stores in FY22) and the business rationalisation of Parkside provided combined year-on-year cost savings of £2.3m. On the negative side, there was naturally underlying cost inflation of c 5% and the first full 12-month contribution from Pro Tiler Tools added a further c 2.7% to the underlying cost base. Management proudly points out that it has offset virtually all of the inflationary cost pressures faced since FY19 through a combination of self-help and improving average sales densities in the stores, which has enhanced profitability. We remind readers that although the newer businesses have a lower gross margin than Topps Tiles, ultimately management believes they can all generate a net margin of 8–10%. Online Pure Play was not dilutive to net margin in FY23; the other businesses will take some time to scale their margins.

The lower gross margin, higher operating costs and slight increase in the net finance charge led to a year-on-year decline in PBT of c 38% to £6.8m (FY22: £10.9m). Adjusting for one-off costs, predominantly the higher costs related to the acquisition of Pro Tiler Tools (£4.1m for a full 12 months instead of £1.6m for six months in FY22), which are treated as an employment expense instead of an acquisition, the underlying decline in PBT was just under 20% to £12.5m (FY22: £15.6m).

The effective corporation tax rate of 42.5% versus 16% in the prior year is ‘inflated’ as the expenses related to the acquisition of Pro Tiler Tools (above) are not deductible from a tax perspective. Once the acquisition of the remaining 40% of shares is completed in FY24, the effective tax rate should revert to a more normal underlying tax rate, which was 24.9% in FY22.

Shareholders have been rewarded with another full-year dividend of 3.6p per share, which was split 1/3:2/3 between the interim and final dividends. The sustained dividend versus the prior year is consistent with management’s policy of paying out 67% of adjusted EPS, but not reducing dividend payments year-on-year if an EPS decrease was believed to be due to any short-term performance considerations or macroeconomic conditions, providing an attractive reason to hold the shares.

TPT’s operating cash flow generation before net interest improved significantly in FY23 in absolute terms, from £26.8m in FY22 to £41.3m, and relative to revenue. The lower reported profitability was more than offset by a swing back to a working capital inflow that TPT typically enjoys. The inflow of £3.4m in FY23 contrasts with the relatively large outflows of more than £10m per year in each of the two prior financial years as a result of higher inventory days through the pandemic given sourcing problems, the additional stock for the new business, Pro Tiler Tools, and higher input cost inflation. Management attributes the improvement in working capital to good stock control in the main, along with smaller relative gains on both payables and receivables. The significant reduction in inventory days to 107, from 126 in FY22, includes an underlying reduction for Topps Tiles as well as the effects of the growth in Pro Tiler Tools, which typically operates with lower levels of inventory.

The strong absolute and relative gains in operating cash flow were only marginally diluted by a yearonyear increase in investment in tangible and intangibles assets to c £4.1m (FY22: £3.2m) to give a strong improvement in free cash flow generation in the year, an inflow of £14.7m versus £0.8m in FY22.

The significant improvement in free cash generation meant that TPT’s closing cash position improved further, from £16.2m at the end of FY22 through £19.9m at H123 to £23.4m by the end of FY23. TPT has no debt beyond its lease liabilities of £94.5m at the end of the year, which declined in value by just over £8m during the year.

As is typical, management has not provided profit guidance, but has given some indication of how it believes operating costs will progress along with any expected changes in cash flow dynamics.

Most importantly, management continues to believe that its market-leading brands, world-class customer service, specialist expertise, strong balance sheet, growing cash position and ambitious growth strategy leave it well-positioned to continue to take market share. Industry data (source: Topps Tiles FY23 results presentation) suggests a CAGR for the UK ceramic tile market of c 3% through 2026.

Management’s current trading statement confirms the industry-wide deterioration in the RMI market, such that total sales declined by 3% in the first eight weeks of the financial year, which includes a like-for-like decline in Topps Tiles of 6.1%, offsetting the continuing strong growth by Pro Tiler Tools.

With respect to operating costs in FY24, management has quantified c £5m in inflationary cost pressures, which include the recently announced increase in the National Living Wage, a 9.8% increase to £11.44 per hour from 1 April 2024 for those aged 21 and over, which follows an increase of a similar magnitude in April 2023, and property costs. However, these inflationary cost pressures will be offset by some cost efficiencies and a lower provision for the cost of the remainder of Pro Tiler Tools, which was £4.1m in FY23. There should be a typical slight skewing of full-year profits to the second half of the year due to the typical holiday pay accrual that occurs in H1 and then reverses out in H2, and energy costs are expected to be £1.5m higher in H1 than H2, also reflecting the winter months when stores and offices require more heating.

Cash flow generation is expected to be helped by an even better working capital inflow of £7m as the company’s current 52-week accounting period means the current financial year will end before the final month-end payroll and supplier payment runs. This will reverse in a few years’ time when the company next has a 53-week accounting period. In the other direction, capex will increase to £6–8m, from just over £4m in FY23, and the company will pay for the remaining 40% of Pro Tiler Tools.

The more challenging trading macroeconomic environment has led us to take a more cautious stance in our forecasts for FY24 and FY25; predominantly lower like-for-like growth in Topps Tiles, with no growth now assumed versus 3% previously, and low single-digit growth for Parkside versus expectations of a stronger recovery of 5% previously. The changes are summarised as follows:

We remind readers that our definition of adjusted profit before tax differs slightly from the company’s – we exclude share-based payments and amortisation of goodwill on acquisitions.

The medium-term revenue opportunity for the business remains very attractive, with management’s ambitions for revenue of the individual businesses of £30m+ for Pro Tiler Tools (FY23: c £20m), £20m+ for Parkside (FY23: £9.4m) and £15m+ for Tile Warehouse (FY23: c £2m).

The downgrades to our profit estimates and an increase in our WACC to 10%, which includes a higher UK 10-year bond yield of c 4.3% and equity market risk premium of 5.9% (source: Damodaran), from 9% previously, leads to a reduction in our DCF-based valuation to 88p per share (104p per share previously). The sensitivity of the valuation to changes in WACC and terminal growth (we use 2%) is as follows:

Below we show TPT’s prospective EV/sales multiples relative to its historical high, average (figure quoted) and low multiples in each year. To make the comparison over the long term more valid, we exclude IFRS 16 liabilities from net debt. While we recognise the various drivers of valuations at different stages of TPT’s development and economic cycle, we can see from both charts that it has typically traded at a higher multiple than its prospective multiples when it has historically reported similar rates of revenue growth and profitability according to our forecasts.

TPT is currently valued at a significant discount to the median EV/sales and P/E multiples of the two sets of peers that we monitor: manufacturers and distributors of products that are exposed to the same end-markets, and retailers that are exposed to changes in consumer spending on housewares. All figures are annualised to TPT’s September year end.