Dr Martens needs to prove it can put a foot right. A costly clean-up job at the bootmaker’s Los Angeles distribution centre and the admission that it needs to invest more to achieve its growth ambitions, means profits not only missed market expectations last year, but will be weaker over the next two.
Its LA warehouse — with its three satellite facilities to deal with excess stock — is a properly knotty problem and when added to the decision to plough more cash into marketing, improve the logistics set-up and open more stores, it’s no surprise pre-tax profits fell by just over a quarter to £159 million, behind a consensus forecast of £178 million.
The expense associated with righting distribution issues in America should wash through by the end of this new financial year, according to Kenny Wilson, chief executive, at which point inventory levels will be right-sized. But recovery in what is Dr Martens’ largest market won’t be that simple.
• ‘Accident-prone’ Dr Martens gets a kicking
It is also grappling with weaker demand and a shift in the sales mix towards lower-margin shoes and sandals versus boots, which were pushed more heavily to US consumers by Docs’ marketers. Revenue last year was down 1 per cent after the impact of dollar appreciation was stripped out. Reversing the decline in the coming months depends on whether the sagging sales are the result of a bungled advertising strategy, rather than a diminishing appetite for Docs’ chunky, boldly stitched boots.
Sales growth this year is set to come in at somewhere in the mid-to-high single digits, potentially accelerating to the high-single digits next year. But getting there is going to require more outlay on marketing, strengthening the supply chain and rolling out more stores.
The result? Adjusted margins that will be between one and two percentage points lower than last year’s 24.5 per cent, which once higher depreciation charges are factored in, will have an outsized impact on pre-tax profit, before some modest improvement next year. It is a far cry from the mid-teens annual revenue growth and 30 per cent margin sold to investors at the time of the group’s IPO. Analysts at Peel Hunt cut their profit forecasts for this year and the next by 20 per cent and 25 per cent, respectively, to £150 million and £164 million.
Sacrificing profit in the short term might be an easier pill for investors to swallow if they could trust the bootmaker not to make another big misstep that derails profit growth. Disappointing guidance comes on the heels of three profit warnings since November. It is little wonder that investors have lost confidence. The shares trade at less than half the 370p float price, which equates to a forward earnings multiple of 12, close to the lowest since IPO.
True, unlike the rest of the class of 2021, a crop of (mostly dud) floats offloaded in a brief period of respite for markets, there is a history and crisp brand identity for investors to grasp on to. A strategy of growing the proportion of direct-to-consumer sales, which carries far higher gross margins than wholesale, to 60 per cent, is also sound. DTC rose to 52 per cent of sales last year, up from 49 per cent. There is plenty to go for outside Britain and America, too. The number of pairs sold per head in Germany is still about half the level per capita than in the UK and even less in markets like France and Japan. Strong revenue growth in each of those markets indicates the demand is there.
The only happy consequence of the LA distribution debacle? Making fewer pairs this year will free up more cash, enough to embolden the retailer to buy back £50 million in shares, the first return of its type in its short history as a public company.
Yet until Wilson and co can demonstrate that sales and profit targets are more than just talk, it is difficult to see its paltry share price as unjustified.
ADVICE Avoid
WHY The risk of margins or sales slipping again may prevent a recovery in the shares
Edinburgh Investment Trust
If UK plc looks cheap, then Edinburgh Investment Trust carries a double discount. Shares in the FTSE 250 fund trade at a discount of just over 7 per cent against its net asset value.
The performance of the trust since Liontrust Asset Management, then Majedie, was appointed in March 2020 indicates that it deserves more credit. The value of its assets has risen 7.8 per cent over the latest 12-month period, outpacing the 2.9 per cent generated by the FTSE All-Share, the yardstick it attempts to beat. Over three years, the total NAV return — with dividends reinvested — amounts to 65.9 per cent, against 47.4 per cent from the index. Against peers the trust stacks up well, ranking ninth out of an extended peer group of 92 UK equity income funds since the portfolio transition, according to Investec analysis.
The 26.2p a share dividend declared for last year was just covered by earnings generated that year, after being rebased to a more sustainable level by the board in 2021. A refinancing of debt has also fixed its annual financing cost at just 2.44 per cent at an average term of 25 years, another boost to revenue of about £5 million a year.
Freeing the fund of a more burdensome dividend commitment also allows the manager to broaden top calls beyond the run-of-the-mill income stalwarts. True, the trust naturally has a chunky enough weighting towards some of those names, including Shell and Unilever. But the list of top holdings has broadened to include names that are rated more for their growth characteristics, such as the equipment rental business Ashtead and the industrial distribution specialist RS Group.
Companies at the mercy of discretionary spending may not seem an obvious choice while household incomes are under pressure. But by increasing positions in companies like Greggs, Tesco and Dunelm, James de Uphaugh, lead manager of the trust, is hoping to capitalise on signs that the UK economy is proving more resilient than expected by economists, as per the first-quarter readout of 0.1 per cent GDP growth. More of the same could be reflected in a recovery in the Edinburgh trust’s share price.
ADVICE Buy
WHY Attractively valued for a long-term recovery
