Loss-making companies with sky-high valuations that require investors to “believe in the growth story” should always be approached with scepticism. Add to that a lack of clarity about where THG, formerly The Hut Group, actually makes its money, as well as broader corporate governance concerns, and the fall from grace in the ecommerce specialist’s market valuation looks justified.
If you’re a public company under attack, the best way to fend off your critics is with cold, hard numbers. Therein lies the problem with the defence mounted by Matt Moulding, THG’s chief executive and chairman, and John Gallemore, its finance chief. An enterprise value of almost five times forecast sales at its initial public offering has shrunk to a multiple of 2.4, or 26 times earnings before tax and other charges, leaving plenty of room for disappointment.
A presentation on Tuesday aimed at doing a “better job” of explaining just how THG’s business works backfired spectacularly. With just over a third of the ecommerce group’s market valuation lost in only one day, the bullish stance adopted previously in this column needs to be reassessed, to say the least.
THG was founded in 2004 as an online reseller of CDs, before shifting its focus towards health and beauty, running 300 separate websites and THG Ingenuity, a technology logistics business that helps other companies to sell online. Questions around the true value of that tech platform are at the heart of the group’s now-pariah-like status. A deal struck with SoftBank in May, which gave the Japanese investor the option to purchase a 19.9 per cent stake in Ingenuity, gave the division a £4.5 billion valuation. That trumped even the optimistic value placed on the platform at the IPO, which analysts estimate was about £3 billion, or just over half THG’s overall market value.
As things stand, you’d expect the terms of that agreement to be renegotiated, if the technology investor doesn’t walk away from the deal entirely. THG says that things remain on track for SoftBank to exercise its option next year. But analysts at Davy, the broker, estimate that the present share price implies the market is valuing Ingenuity as close to worthless.
Too harsh? Well, you can’t blame investors for not putting much faith in Ingenuity. The commerce side of that business, which offers the full ecommerce service, from payment solutions and website construction to fulfilment for third parties, is the fastest revenue generator: it took $18.3 million in revenue in the first half of the year, only 2 per cent of the group total.
There are plans to carve out each of THG’s three businesses next year. Ingenuity might start generating more revenue from the services it provides to the beauty and nutrition divisions, but, without knowing how much it will charge, that complicates attempts to value the earnings potential of each. Admittedly, Ingenuity Commerce is launching a rapidly growing number of websites, 163 by the third quarter. It charges a flat licence fee for use of the service, with a layer of revenue share on top. But the problem is the terms on which the business charges clients and exactly how much it earns from those websites is unclear.
How might THG find redemption? To start, perhaps by giving more detail on the level of earnings before tax and other costs that it generates from each of its three core segments when it reports third-quarter earnings this month. More helpful would be SoftBank coming good on its option. For now, though, there are far too many unknowns to warrant taking an interest in the shares.
ADVICE Avoid
WHY A lack of disclosure about where it generates earnings and margins, alongside the potential for more short-selling
Barratt Developments
Barratt Developments has an operating margin and return on equity superior to most of its UK-listed housebuilding peers, yet its earnings potential and assets are being valued at a discount to its rivals. That doesn’t seem right.
A cooling in the explosive demand in the immediate wake of the stamp duty break and the reopening of sales sites was inevitable and not unique to Barratt. Net private reservations between July and the start of this month fell to 281 a week, from 288 last year, but were markedly above the pre-pandemic level.
Reassuringly, that increase was alongside only 21 per cent of buyers using the Help to Buy scheme, compared with 45 per cent before the pandemic. To what extent upfront savings provided by the stamp duty holiday have offset tighter restrictions around the government support scheme remains to be seen, but even with the tax break over, the group is 71 per cent forward-sold for the present financial year.
Unsurprisingly, building cost inflation is rising, running at 4 per cent to 5 per cent, up from the 3.4 per cent reported in July, and house sales price inflation is easing at just under 4 per cent. Potential pressure on operating margins should be mitigated by the fact that building costs account for only half the overall outlay.
Analysts at Peel Hunt said that, at worst, they expected a broadly neutral impact on adjusted margins, which they forecast would be 18.9 per cent this year, a touch shy of the 19.1 per cent generated last year. The broker raised its rating from “add” to “buy”, but left trading forecasts unchanged on the back of balanced sales price rises and cost inflation pressure.
A net cash balance of £1.3 billion at the end of June boosts the prospect of a generous dividend. Peel Hunt reckons that a special return is likely, forecasting a bumper total dividend of 51.5p this year, potentially leaving the shares offering a 7.6 per cent dividend yield. With the shares trading at only eight times forecast earnings this year, that income looks cheap.
ADVICE Buy
WHY The shares offer a sturdy dividend at an appealing valuation when judged against peers
