Colefax: Does old faithful hit the magic number?

This classy fabric designer is a reliable earner and returns surplus profit to shareholders. Analyst Richard Beddard discusses whether that's enough to justify buying the shares at the current price.

Over the last two years, revenue has risen convincingly at Colefax after a decade in which it bobbled between about £70 million in a bad year and £80 million in a good year. Much of the improvement though, is the result of lower exchange rates, which have increased the value of overseas revenue when translated into pounds. 

Colefax earns most of its money from luxury fabric and wallpaper designs, and the majority of that revenue comes from the USA. A substantial amount is earned in France, Germany, and Italy too.

Source: interactive investor      Past performance is not a guide to future performance

The increase in revenue in 2017 coincided with a decrease in profit. In that financial year the company took out contracts to fix the exchange rate at $1.50, which it believed might be a historic low. Britain voted to leave the EU, though, and the subsequent decline of sterling to $1.20 meant the company lost significant amounts of money, about £2 million in 2017, and £0.8 million in 2018. It is no longer hedging so if exchange rates stay low, Colefax should get the whole benefit in 2019.

Otherwise, it was business as usual in 2018. The company sells fabric mostly, but also wallpaper, to interior designers and retailers. This part of the business earned 83% of revenue in 2018. In constant currency terms revenue growth was very modest, a substantial increase in demand from the USA diluted by a flat performance in Europe and the UK, where high stamp duty and uncertainty about Brexit are deterring oligarchs from buying houses. 

Profitability recovered in 2018 due to lower losses on currency hedges. Colefax’s smaller decorating and furniture businesses performed better too.

Sybil Colefax and John Fowler, the original business, decorates mansions. It earned 14% of revenue in 2018 and contributed 44% of the profit increase, partly because it is doing more work overseas. We shouldn't get too excited though. The profitability of the decorating business varies depending on when it completes projects, and in 2018 it completed a number of substantial projects. Furniture manufacturer Kingscome Sofas also had a profitable year, but since it only earns the company 3% of revenue, financially at least, furniture is a bit of a sideline.

As usual I'm scoring Colefax to determine whether it is profitable, adaptable, resilient, equitable, and cheap, criteria. Each criterion can achieve a maximum score of 2, and a minimum score of zero except the last one. The lowest score for companies trading at very high valuations is -2.

Profitable: Does it make good money?

Score 1

Source: interactive investor      Past performance is not a guide to future performance

Colefax just about achieves an 8% return on capital even in its worst years, but it has had few a few of those: 2009, 2012, 2013 and 2017. Over the last 12 years the company has averaged a good but not great 10%. Profit margins are surprisingly thin though, for a business producing luxury goods. Colefax relies more on efficient operations than high mark ups. 

It owns five fabric brands: two English (Colefax and Fowler, Jane Churchill), two American (Cowtan and Tout, Larsen)  and one French (Manuel Canovas). The brands have separate design studies, which design new collections every year, but manufacturing is outsourced to over 100 mostly European suppliers and the brands have common marketing, sales, sampling, warehousing, purchasing, accounting and IT systems. By limiting the number of patterns, Colefax keeps tight control of stock and minimises wastage. Rumour has it the company’s executive chairman and majority shareholder David Green hawks end-of-line stock himself.

The good news is the profit is real money. Cash flow has all but matched profit over the 12-year period:

Adaptable: How will it make more money?

Score: 1

Colefax is directing most of its investment at the USA, its biggest and fastest growing market. Its policy is to use its own salesforce where sales justify it and agents elsewhere, and in recent years it has opened showrooms in Atlanta and Boston. 

While Colefax says it would consider buying one of its many, mostly family operated competitors, the owners invariably expect too much money. Its last acquisition was Manuel Canovas 20 years ago. 

A cheaper approach, the company says, would be to establish a new brand from scratch, or launch a sub-brand of one of the five established brands, but it has been reluctant to do this as well.

So far, Colefax has preferred to take the low risk route, launching new collections for the established brands every year, and returning surplus cash to shareholders via dividends and buybacks.

Source: interactive investor      Past performance is not a guide to future performance

Its conservatism betrays, perhaps, a lack of confidence that it can earn sufficient returns from acquisitions or new brands.

Resilient: What could go wrong?

Score: 2

Having eschewed hedges, hopefully Colefax has learned its lesson and won't speculate on interest rates again. The important thing is to be consistent. Business can lose out if they hedge, and they can lose out if they don’t. Over the long term it tends to even out, unless the business succumbs to animal spirits and chops and changes its policy.

I think Colefax is a pretty resilient business, the brands are well known, and the company is protecting their exclusivity by preventing retailers from selling fabric on the Internet and focusing on interior designers. Because customers have plenty of money, they're fairly insulated from recession, although people tend to redecorate when they buy property and as we’re seeing in the UK if the mansion market is moribund, demand dries up.

While they are all upmarket, and therefore expensive by normal standards, Colefax's brands have different price points and cater to different tastes. Colefax and Fowler, for example is in  traditional English Country House style, while Jane Churchill is more contemporary - and cheaper. This diversification is helping it prosper even if individual markets, like the UK, don't. 

Brexit too is a worry since Colefax buys most of its fabric from the EU and tariffs, if introduced, would increase costs, as well as cutting into the 21% of revenue earned there.

Equitable: Will we all benefit?

Score: 1

I really don't know. Touched by the circles they move in, perhaps, the directors get eye-watering salaries, but they do not have Long Term Incentive Plans, which have resulted in the worst excesses at other companies. 

Colefax, says very little about its staff too. The one review by an ex-employee on Glassdoor, a recruitment site lauds the firm and its CEO, and having visited the company I can imagine it has a close-knit feel to it.

Cheap: Is the firm's valuation modest?

Score: 1

A share price of 540p values the enterprise at about 16 times adjusted profit, which is probably a fair valuation for a company run as conservatively as Colefax is. Lack of growth means most of the value has come from dividends and buybacks, perhaps limiting annual returns to shareholders to about 6% at the current share price.

A total score of 6 out of 10 means Colefax falls just shy of the magic 7 that would allow me to recommend it. 

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Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.