Carpetright Look 2

In July I took a look at Carpetright. It was - and is - an interesting company if only due to its enormous RoE. Since July its share price has declined from 640p to 345p, and it has just issued a fairly grim set of interims. So I took another look.

First the consistent features:
- Margin of about 60%.
- High fixed costs.
- Negative working capital.
- Return on Equity of 50-130% (until the latest set of interims).

At the moment their sales are being squeezed by:
- The low level of house-buying.
- The impending recession and general lack of consumer confidence.

The lower sales have two insidious effects:
- Sharply lower profits. Their high fixed costs cause a strong multiplier effect.
- A rapidly worsening cash position. Their negative working capital is unwinding, leading to substantially increased debt.

Their bank facilities are up for renewal in September 2009. They're positive, but of course they would be. They have limited headroom in the meantime.

Carpetright's very high Return on Equity needs to be paired with a "moat" if it is to be maintained in the long run. For a carpet company, that comes primarily from its size. It can achieve economies of scale and take market share from smaller independent operators. It is exploiting this advantage, and widening its moat, with its new warehouse and cutting facilities. This gives it reduced costs and the ability to achieve keener pricing than its competitors.

About 25% of Carpetright's sales appear to be directly linked to house sales. That's based on the way their like-for-like sales fluctuate based on mortgage approvals. The drop in mortgage approvals from a long-term average of about 60k per month to 22k per month has translated to a 15% decline in Carpetright's like-for-like.

Although house prices will almost certainly continue to decline, I imagine we'll see a recovery in purchase volume in advance of a price rally. So that's one point in Carpetright's favour - although shaky consumer confidence and rising unemployment might well cancel out any gains.

Once we are out of the recessionary woods, Carpetright looks like a good company to invest in. It has excellent growth potential. In the meantime, I am concerned over their cash position. Paying any dividend at all is frankly barmy in my opinion, even a much-reduced one. 2009 is not going to be a good year - and while I expect they will eke out a profit, there are going to be heavy outflows of cash.

Post-recession I think reasonable earnings would be 70p per share. A reasonable P/E ratio is difficult to come by. On the one hand are a low tangible asset value, but on the other are its high growth prospects and strong cash generation. A P/E ratio of 10 doesn't sound totally unreasonable, and in a buoyant market 20 might be achievable (it can pay out 80% of its earnings in dividends, still reinvest enough to grow the business, and a yield of 4% doesn't sound mad).

The share price was 345p when I started this latest look, but has recently rallied to 385p. I think this is quite tempting at 350p, and certainly at around 250p I don't think I could resist. In the meantime I'll continue to keep an eye on its cash position for any sign of improvement.

Greene King, Tesco updates

Two updates out this morning. Initial reactions:

Greene King - Pretty much as expected. Things have definitely declined since last year, but they're still profitable, still well within debt covenants, and still very good value at their current price.

Tesco - Very positive, doing well despite poor conditions. Continuing strong growth internationally, although as you'd expect, less substantial growth in the UK.

Let's see what the market's reaction is:
- Greene King down 8.28%. Slightly surprised by that, I know the results aren't great, but they still met earnings expectations.
- Tesco up 6.22%. I think these results were better than analysts expected.