Walker Greenbank — H1 dividend and full year guidance unchanged

Walker Greenbank saw a modest headline sales decline in H119 but a more significant profit impact, which arose in the Brands division. A positive cash flow performance in the period reinforced the company’s strong balance sheet funding position. The H1 dividend was unchanged despite the earnings reduction and – with unchanged PBT and earnings estimates, which provide cover over 2x – we expect the dividend to be held for the year as a whole also.

Note: the company adopted the IFRS 15 reporting standard – revenue recognition in H119; overall, there was a slight improvement in restated H118 EBIT. The inclusion of charged carriage costs within revenue now – rather than netted off distribution costs previously – increases annual revenues by c £2m, we estimate, with a modestly dilutive impact on reported margins.

Internationally recognised heritage and contemporary, premium and mid-market, wall covering and furnishing brands (Sanderson, Morris & Co, Harlequin, Zoffany, Scion, Anthology, Clarke & Clarke, Studio G).

Progress in the US and in licensing activity were the highlights of first-half trading, although this was offset by softer product sales in other markets, leaving divisional revenue down by 3.3% overall in local currency (slightly more in sterling terms), with a sharper profit decline.

The UK accounted for just over half of product sales (at 54%) in H119 and, as previously noted, trading conditions here were challenging during the period, resulting in a 5.9% revenue reduction. Generally weak demand has been experienced across a broad range of high-street retail names and with flat to slightly lower residential transaction trends also, subdued activity in the housing market is an unhelpful backdrop for renovation/improvement sector spending. UK GDP is still expanding, albeit slowly, and with tourism numbers remaining healthy, we would expect the commercial/contract sector to have been relatively resilient for Walker Greenbank. International product sales have been identified as offering superior growth rates to the UK and steps are being taken to capitalise on these opportunities. The US is an obvious example of success; Walker Greenbank already has a direct salesforce here and the opening of a second showroom towards the end of 2017 contributed to local revenue growth of +5.8%. Elsewhere, the migration from distributor-led to a direct presence in Russia and Germany in the first half will have caused some short-term sales disruption (eg western and eastern European regional sales -5.8% and -10.4%, respectively). Other smaller international markets were mixed and possibly more influenced by commercial order patterns. For product sales overall, at individual brand level, Clarke & Clarke/Studio G performed well in the first six months (revenue +7.8%), which we believe reflects its positioning at the more affordable end of Wlaker Greenbank’s target markets. In contrast, the heritage brand groups, collectively marketed under the Style Library umbrella, saw worldwide revenue declines of between 7 and 10%.

Licensing currently accounts for less than 5% of Brand divisional sales but contributes well to profitability, owing to a favourable drop-through net of costs compared to product sales. Reported revenue rose by over £0.5m (c 35%) in H119. Walker Greenbank has been steadily building a base of multi-year agreements largely in the soft furnishings category (eg bedding, blinds) but was also successful in signing new seasonal deals in the apparel and accessory categories for Sanderson designs (Radley, Uniqlo) and those of Wm Morris (H&M). As previously announced, the H&M contract is the largest individual licence agreement signed by the company to date and is expected to be delivered during the second half of the year. Overall, just over half of licensing revenue was generated in overseas markets and local currency growth was slightly ahead of the rate of headline progress.

Despite a more favourable contribution from licensing activities, divisional profitability fell by over 20% overall in H119. We suggest that some of the discrete (eg showroom and sales) costs associated with establishing a new direct presence in Russia and Germany will have contributed to this outturn, although we expect this effect to weaken as sales build in these countries. Otherwise, lower volumes of (most likely higher-margin) heritage brands will have been the primary driver of lower profitability, in our view. Responding to market challenges, Walker Greenbank is to place an increasing focus on its existing strategy (to expand international sales, licensing and product category extensions), possibly developing more brand-specific initiatives in each case.

Two locations, Anstey (wallcoverings) and Standfast & Barracks (fabrics), which produce high-end furnishings with third party output now larger than that servicing the group Brands division.

Divisional gross sales grew modestly overall in H119, the net result of expanding third-party revenues (+10.7% y-o-y) largely offset by lower internal Brand requirements (-10.6%), and operating profitability rose by c £140k to c £0.64m.

We consider that the internal Brands performance is largely consistent with the H119 heritage Brands revenue trend mentioned earlier and amplified, we believe, by some inventory reduction in that division. (The Clarke & Clarke brand has historically not been a significant user of group manufacturing capacity in its supply chain and so its positive sale momentum brought little benefit to this division.) Third-party sales were clearly firmer, more so in international/export markets, which grew by 41.5% (£0.75m) compared to the larger UK customer segment (+3%). As already noted, the UK market is experiencing lower overall demand, so we attribute the 3% third-party sales increase to market share gains, although no particular customers were highlighted. Faster growth in export markets is a stated strategic aim and the manufacturing division’s performance in the first half of the year indicates that this is being achieved.

Walker Greenbank’s two manufacturing facilities delivered contrasting performances in H119, with Anstey delivering wallcovering revenue growth to third parties in excess of 20%, while Standfast & Barracks (S&B) revenues were broadly flat y-o-y – check in the period, chiefly due to softer UK sales. (Both operations experienced significantly reduced internal sales to the Brands division.) Adding more detail to the divisional export performance noted above, both product categories grew overseas sales strongly in the first six months to become almost 16% of total divisional (or 25% of net, third-party) sales. At S&B, additional digital printing capability has supported export growth, while new in-house paint tinting and distribution will have aided Anstey’s top-line growth, although not necessarily in export markets.

Group net debt stood at £3.4m at the end of September, £1.9m lower compared to the position at the beginning of the year, including c £0.1m favourable translation of overseas cash balances.

At £4.2m, operating cash flow was £2.5m better than the prior year, despite a £1.6m reduction in EBITDA y-o-y. The main component of this underlying y-o-y improvement was a much lower working capital outflow at £1.1m (versus £4.1m in H118); all three line items contributed to this outturn with inventory reductions and a smaller receivables outflow characterising the trading performance, while a smaller payables outflow also reflected some lower central cost elements. Otherwise, the c £1m pension scheme contribution was similar to the prior year, while there was a c £0.7m insurance receipt (relating to the Anstey fire) compared to a small net timing outflow in the prior year (concluding an earlier flood-related loss of profits claim at S&B).

Working further down the cash flow statement, interest costs were similar to the prior year while cash tax payments were lower (combined outflow of £0.7m). Capex on tangible assets was also down y-o-y (at £1.1m including a digital pigment printer, a new process for S&B) slightly below the depreciation charge in the period) and capex on intangible assets was similar to H118 (at £0.5m, being largely collection design costs). Note that Walker Greenbank received £1.8m insurance proceeds for replacing equipment at S&B in the prior year that did not recur in H119. The company makes all of its annual cash dividend payments (ie the prior year final and current year interim) in the second half of its trading year, so there were no such outflows in H1, as in the prior year.

We expect to see a small EBITDA improvement in the second half compared to the first and a similar operating cash flow performance. On substantially unchanged estimates and allowing for slightly higher tax and capex outflows in the second half, we estimate £0.7m free cash flow generation in H2. The payment of declared dividends, totalling £3.1m, results in our projected year-end net debt position of £5.2m, similar to that reported at the end of FY18.

Compared to our £13m FY19 EBITDA estimate, balance sheet funding is set conservatively, in our view. (The impact of IFRS 16 leases with regard to operating lease commitments is currently being assessed.) For the record, Walker Greenbank has a small-term loan, a £12.5m multi-currency RCF and, additionally, a £10m accordion facility, which all run to December 2020.

The company clearly has headroom to make acquisitions should suitable opportunities arise (the last being Clarke & Clarke in October 2016). This may or may not influence future decisions regarding dividend payments. Our current estimates indicate a subdued earnings recovery beyond FY19 and, while dividend cover is more than two times covered in our model, free cash flow cover is 1.5x or less over our estimate horizon. We retain our existing expectation for an unchanged dividend payout in the current year and the two that follow, and will continue to monitor this assumption in the context of any changes to prospective earnings and cash flow profiles. On this basis, we expect Walker Greenbank to generate net cash at or above £1m in both FY20 and FY21, with net debt trending down accordingly.

As noted earlier, IFRS 15 (and specifically the inclusion of charged carriage costs as revenue) increases our previous Brands revenue estimates by c £2m pa, which is mostly reflected at group level also, save for a minor reduction to our Manufacturing revenue expectations by FY21. There are no substantive changes to our profit estimates and – given that previous guidance for FY19 company PBT norm is intact – we sit at the lower end of that £9.5–10m indicated range.