The Design Group’s (IGR) strong story across all regions is a result of the active management of the group, rather than a function of improving markets or the impact of external factors such as currency or inflation/deflation. It is also far broader than enhancing the operating efficiencies, although this has been an area of considerable focus. The underlying strength of the group – far harder to measure – is the focus on working alongside customers to provide solutions for their product categories and by ensuring that design is of a uniformly high standard. This is showing through in the financial performance, as shown below.
Exhibit 1: H117 revenue and operating summary
£000s |
US |
Y-o-y
growth (%) |
UK & Asia |
Y-o-y
growth (%) |
Europe |
Y-o-y
growth (%) |
Australia |
Y-o-y
growth (%) |
Eliminations |
Group |
Revenue – external |
58,560 |
63.6 |
55,117 |
(3.6) |
16,545 |
28.3 |
15,303 |
9.6 |
|
145,525 |
Revenue – intra-segment |
|
|
1,448 |
|
224 |
|
|
|
(1,672) |
|
Total revenue |
58,560 |
63.6 |
56,565 |
(3.4) |
16,769 |
30.0 |
15,303 |
9.6 |
(1,672) |
145,525 |
Segment result before exceptional items |
3,758 |
|
4,000 |
|
1,258 |
|
1,020 |
|
|
10,036 |
|
|
|
|
|
|
|
|
|
|
|
Organic sales growth |
+21% |
|
(4%) |
|
+11% |
|
(6%) |
|
|
|
Organic operating profit growth |
+36% |
|
+12% |
|
+25% |
|
+54% |
|
|
|
The US market is self-evidently attractive, both in terms of its scale and the relevance of the product categories. The capital investment in the conversion capacity (transferring large rolls into smaller, retail sizes) made in the final quarter of FY16 has made an early start on payback. Organic growth up 21% translated into operating profit growth of 36% in the region, which represented 40% of group revenues. The Design Group’s gift packaging offer was heavily wrap-oriented and there has been a successful effort to stimulate sales across the broader category, including stationery and activity products, with the drugstore sector particularly attractive as a sales channel. The addition of Lang to the group has brought in a large number of additional customers, as well as adding to the range of licences under the group’s remit. It also brings a limited B2C exposure and further export sales. There are still plenty of efficiencies to be reaped from putting the two operations together, across logistics, distribution and conversion, as well as from a rationalisation of the supplier base, which has been a common theme globally. The boost to operating profits from the inclusion of Lang should not, though, be extrapolated. The business has an inherent seasonality due to the nature of the products and its most profitable months fell into IGR’s H1. The combined US businesses are now estimated to have a 23% share of the US gift calendar market.
The UK and China (which are disclosed together as the Chinese manufacturing and procurement are all destined for overseas markets) was the only region to report a slide in sales, albeit of just 3%. This is understood not to be any fundamental issue, more that certain client orders slipped across the half-year boundary and full year results should demonstrate further progress. In-house manufacturing in China has stepped up its production in gift bags and cards to record levels. The group has been working to consolidate its supplier base for additional gifting products in China, which increases efficiencies. Although this does lead to some increased third-party risk, the group’s strong local presence means that any potential issues can be spotted and counteracted at an early stage. Licensing has been a smaller positive in the period, as there have been fewer big franchise releases, but the evergreen properties continue to perform well. The UK operations continue to innovate through design, adding value to the existing product ranges through additions such as pearlised finishes.
Europe contributed a good increase in both revenue and margin, the latter benefiting from production efficiencies and large order volumes from value retailers. The order book for H2 is reported to be strong, both in terms of volume and visibility.
The Australian business (JV) has changed in mix, replacing some high-volume, low-margin Christmas-oriented business with longer-term everyday contracts. There has also been an element of slippage into H2 and, in local currency terms, the sales line was 6% lower than H116. Despite this, operating profits leaped 54% – a reflection of both the shift in mix and efficiency gains. In sterling terms, the Australian operation doubled its contribution.
Positive impact on forecasts
The overall impact of the trading circumstances described above, along with the contribution from favourable forex moves, has rendered our earlier revenue forecasts well short of the likely outturn. A mechanistic approach would suggest that our implied H217 revenue figure remains conservative and there may be scope to revisit these numbers further into the year.
We have revised down our estimate of finance costs within the model as a consequence of the strong cash flow and the positive impact of the refinancing completed in June 2016. This has boosted our projected PBT number, although this does not fall through fully to the EPS number as: i) there are a greater number of shares in issue post the £5.0m placing to fund Lang and associated working capital; and ii) we have edged up our anticipated rate of tax as the historic losses in the US have been eliminated at a faster rate than expected. This also affects our FY18e numbers. The exceptional item in H117 includes a non-cash adjustment on the assets from the Lang acquisition – effectively implying negative goodwill. This is likely to be offset by investment in H217.
Exhibit 2: Summary changes to group forecasts
|
Revenue (£m) |
EPS (p) |
PBT (£m) |
EBITDA (£m) |
|
Old |
New |
% chg. |
Old |
New |
% chg. |
Old |
New |
% chg. |
Old |
New |
% chg. |
FY16 |
237.0 |
N/A |
|
13.5 |
N/A |
|
10.1 |
N/A |
|
16.5 |
N/A |
|
FY17e |
268.5 |
300.0 |
+12 |
14.5 |
16.1 |
+11 |
12.2 |
14.8 |
+21 |
18.8 |
20.9 |
+11 |
FY18e |
282.0 |
320.0 |
+13 |
16.0 |
17.6 |
+10 |
14.5 |
16.6 |
+14 |
21.3 |
22.8 |
+7 |
Source: Company accounts, Edison Investment Research
We have maintained our forecast level of capital spend at £6.0m for both years, with projects in H117 including a warehouse management system in the Australian JV and investment in retail collateral (eg upmarket paper carrier bags) production in China and the UK. There is also some investment associated with the new business in Australia and some additional spend in the UK on conversion to come in H217.
The raising of earnings forecasts also has a positive impact on the implications for the balance sheet. Net debt at the half year was £76.4m, £7.0m of which can be attributed to currency translation. Our model now shows year-end net debt of £10m (was £17m), with a zero balance for end FY18e. There will still be meaningful interest payments, though, because this is naturally a business that has substantial working capital requirements and peak net debt (normally end October, early November) will continue to rise as the business grows. Management’s target is to reduce average leverage below 2.5x.
The degree of confidence in the outlook is clearly indicated by the increase in the interim dividend and the 4.0p indicated for the full year. This is the figure that we had pencilled in for the following year.
