Walker Greenbank — Strategic progress in challenging markets

Market disruption caused by COVID-19 lockdowns dented the H121 sales performance though a small profit was generated in the period which ended with a monthly revenue run rate in line with the prior year. Actions to manage the cost base and cash flows, including government furlough monies, contributed to an improved net cash position of £4.5m at the end of July. No interim dividend was declared and some redundancies have been announced. Management is retaining a cautious outlook for the remainder of the year.

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).

Trading performance: Product sales (ie wallpapers and fabrics) fell by 35% y-o-y in the first five months of FY21 according to AGM comments, so the 28% reduction reported for the half as a whole indicates that momentum was somewhat better at the period end. We believe that July had recovered to similar levels to the prior year after a sharp contraction around the UK lockdown, especially in April.

UK revenue, which represented around half of product sales, was c 30% lower y-o-y while international sales overall were 25.4% lower. Individual brands’ trading highlights were substantially as had been previously noted by management with Morris & Co continuing to outperform its in-house peers and this fed into northern Europe (revenue -13%) being the best of the three international regions served. Sales in the other two reporting regions were more broadly in line with the UK performance, including North America (c -33%) and Rest of the World (c -28%). Overall, products accounted for c 96% of Brands division sales in the first half. In headline terms, licence income (generated from the use of group designs by third parties) was almost 59% below the prior year though this masked resilience in underlying core (non-apparel) income, being down c 7% against H1 last year. Hence, the absence of apparel-related income and any material new other licensees1 were the major y-o-y swing factors.

Total divisional revenue declined by 30.6% y-o-y (or by £13.9m) while EBIT reduced by £3.3m to £2.3m. Applying a group gross margin of c 60% to the sales foregone due to market disruption from COVID-19 would translate to a c £8m gross profit reduction. Significant reductions in distribution and administration costs were seen at the group level and we presume that management actions taken to control some of these fixed and semi-fixed costs were important contributors in mitigating the divisional EBIT reduction. Government furlough receipts also aided this process but we are unable to identify the quantum at divisional level.

Visible management activity: Judging by commentary from other home improvement names (including B&Q, Screwfix, Wickes and Toolstation), the UK lockdown has actually been a catalyst for a significant upswing in sector demand across a broad front. Operationally, the early decision to keep warehousing facilities open in the UK and US almost certainly avoided a larger sales hit in the first half and captured some of this benefit. The prior year consolidation of Clarke & Clarke inventory into the group facility also lowered the ongoing cost base. The majority of staff furloughed earlier in the year are now back full time, although Walker Greenbank has also announced redundancies of 10% of pre-lockdown levels. These have occurred across the business, in both divisions as well as centrally.

We have previously commented on gathering momentum behind collection collaborations. The company undertook its first digital pattern book launch in July (Harlequin, Little Book of Treasures); as well as lower launch costs, tracking feedback through initial sales and sample requests will bring downstream benefits in production and inventory management and, most likely, in more focused physical pattern books where they follow. Other new brand collections launched around the period end – slightly later than originally planned – included those by Morris & Co (Ben Pentreath, Queens Square) and Zoffany (Palladio, including Sam Wilde designs).

Outlook: In an operational sense, the current business challenge is to maintain an appropriate balance between somewhat uncertain and potentially variable, but currently flat y-o-y, market demand and inventory and supply chain management. At a corporate level, the near-term business development focus is on enhanced customer interaction. Digital pattern books are one example of this. An intended name change to The Sanderson Design Group (at the end of November) will also be reflected in a re-skinned website at that time followed by a fully renewed version with enhanced functionality at the end of December. These steps bring together management’s aspirations for an elevated strategy – across traditional and contemporary individual brands – with increased digitalisation and ease of doing business under a simplified company structure at a time when the importance of having online marketing and distribution channels has been a key differentiator. Over time, new digital launches and lifecycle management will account for an increasing proportion of the design portfolio and feed into rationalisation of the number of product stock-keeping units (SKUs) carried, underpinned by a collection level return on investment methodology. We would expect there to be some working capital and manufacturing benefits arising from this process but they have not been formally communicated externally. With regard to new Licensing income, discussions are said to have been understandably pushed back, we presume due to potential licensees dealing with COVID-19 impacts in their respective markets.

Two locations, Anstey (wallcoverings) and Standfast & Barracks (fabrics), which print high-end furnishings; c 60% of FY20 gross divisional revenue was to third-party customers, c 40% supported the group’s Brands division.

Trading performance: Overall, gross manufacturing revenue declined by c 38% comprising a 32.5% reduction in external/third-party sales, slightly lagging the Group’s own Brands division performance, and 46.1% lower internal Brands sales. As distribution activities were generally less restricted and able to sell from warehouse inventory during the COVID-19 lockdown period, a weaker relative manufacturing outcome is intuitively right and certainly applied to this division. We note the difference in (gross) sales progression between Standfast & Barracks and Anstey which were c 23% and c 51% lower y-o-y respectively. Starting inventory positions may have contributed to this variance but we believe that the larger digital printing capability (c 60% of capacity versus c 10% at Anstey) was a more important factor. Greater flexibility in run length and changeover times means that a post-lockdown re-start at Standfast would have been more straightforward than Anstey. Underlying demand of course will also been a factor but we do not have any insight regarding the relative volumes of fabric and wallpaper pulled through by the group’s Brands division. With regard to third-party sales, as seen in the Brands division, international performed better than the UK.

At the EBIT level, the Manufacturing division moved from a £1m H120 profit (6.1% margin) to a £0.4m loss in H121. For illustration, if we assumed that this division usually generates a gross margin in line with the group, £6.6m lower revenue y-o-y would equate to a c £4m reduction in gross margin, even before lower recoveries of fixed manufacturing overhead from reduced volumes. Consequently, we consider that a £1.4m profit reversal y-o-y is a creditable outcome in a disrupted period that included initial shutdown actions, a two-month lockdown phase followed by a managed production restart. Cost reduction actions and receipts from the UK government furlough scheme (£3.2m government support) would have served to partly mitigate the loss of manufacturing volume.

Outlook: An analysis of manufacturing operations has been undertaken and completed at group level though the details were not shared externally. In our view, the experience of trading through COVID-19 challenges has served to highlight the benefits of Walker Greenbank’s vertically integrated business model, providing supply chain reliability for Brands and enhanced demand visibility for Manufacturing. That said, improvements are to be targeted including developing closer relationships with suppliers, increased supply chain responsiveness, and active management of Environmental, Social and Governance (ESG)-related issues. In targeting a reduction in Brands SKUs over time there should also be upstream benefits in manufacturing and increased efficiencies. In turn, lower unit costs should lead to improved collection-level returns on investment and also increase the competitiveness of manufacturing operations in the commercial contract segment where management is targeting growth.

Maintaining a breadth of printing techniques at both Anstey and Standfast, coupled with in-house design capability, represents a competitive advantage in attracting and retaining third-party customers as well as supporting group brands. We do expect further investment in digital capacity at Anstey, possibly in the next financial year, but operations are unlikely to move entirely to digital in our view to retain a differentiated, UK-based service offering.

Walker Greenbank ended H121 in a £4.5m core net cash position (excluding IFRS 16 leases), having generated a £3.1m inflow in the period despite reduced profitability. Under existing committed banking arrangements (ie a £12.5m Revolving Credit Facility and £2.5m overdraft facility), the company retained almost £20m liquidity headroom at the period end. The balance sheet also recorded £8.4m IFRS 16 finance leases at the end of July.

Operating cash flow actually rose y-o-y to £5.1m (+£1.5m) in the first half. The main moving parts behind this were the £4.7m EBIT reduction shown in Exhibit 1 being more than offset by a favourable £5.3m working capital swing (from a £3m prior year outflow to a £2.3m inflow). Inventory reduction was the largest contributor to this variance with an inflow of just over £5m in H121and this is consistent with the ongoing sales and distribution/manufacturing stop scenario we outlined in the Manufacturing trading performance. Lower activity levels naturally resulted in a partial unwinding of normal receivables and payables positions. We should also note that cash recovery payments into the defined benefit pension scheme (£0.6m) benefited from a temporary three-month suspended period which preserved a further c £0.6m within the company compared to H120.

By definition, all of the other cash flow items combined resulted in a net £2m outflow in the first half, the largest component of which was £1.4m IFRS 16 lease repayments. Otherwise, capex was closely managed at £0.4m. Traditionally, Walker Greenbank pays both the prior year final and current year interim dividend in the second half of the year. So there was no outflow and no year-on-year effect in H121 and as no dividend was declared for either period, there will be no cash outflow in the second half.

As a final cash flow comment, the group’s H121 cash flow performance included some benefits from government support related to national COVID-19 restrictions. The £3.2m receipt under furlough schemes was obviously reflected in the EBIT performance. We understand that a temporary tax payment deferral of c £0.5m – expected to flow out in FY22 – benefitted H121 also.

Cash flow outlook: As noted above, no dividend payments will be made in FY21 and we would expect capex to remain tightly controlled. There will be H2 one-off costs associated with a redundancy programme (c 10% of the workforce, reflecting an uncertain macroeconomic outlook) and the corporate re-branding process, but these items should be below £1m in total. There is likely to be a natural re-build of inventory and the extent of this will be dictated by the level of sustained demand to be serviced. Over time, the stated intention is to reduce inventory SKUs and we assume that this will also release working capital. The accounting defined benefit pension deficit stood at £9.2m at the end of July and recovery plan cash contributions are set £192k per month until the outcome of the next triennial review which is to take place in April 2021.

The new management team is progressively putting its mark on the business through operational and organisational changes. The plan to rename the company the Sanderson Design Group at the end of November is part of a strategy to elevate individual group brands, emphasise the core design skillset and increase the value generated from an extensive design archive. It is also paving the way for business simplification and increased digitalisation (in collection launches, marketing and customer interaction).

As far as current trading is concerned, July group revenues were in line with the prior year – representing a good close to a half in which some months were significantly down y-o-y – and August and September appear to have continued in a similar vein. October and November are seasonally strong months so the company is currently in the midst of an important trading period. Management noted that the Manufacturing division started the second half with ‘both factories having strong third-party order books and sales,’ so momentum going into the autumn selling season appears to have been encouraging. Understandably, Walker Greenbank’s management team has adopted a cautious stance with regard to the outlook for the remainder of the year. We consider this to be appropriate given ongoing uncertainties regarding the impact of COVID-19 on consumer confidence and demand.