Stockwatch: another share to watch after tip doubles in 4 months

With modern business - especially technology - driven by intellectual values, the virtue of tangible net asset value has largely dropped from attention. The assumption behind a stock slipping to much of a discount to tangible assets is that it says something about the calibre of the business.

In property, for example, if a building concept comes into vogue – student accommodation was one such – you might see related stocks trade at a premium, anticipating growth. Or if more recently like in offices and shopping centres, at a discount due to revolutions of working from home and e-commerce.

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It means that run-of-the-mill listed businesses can become trapped in a negative spiral of cheap ratings: the stock is the undervalued for capital-raising and stock options become less-attractive as a motivator. Typically, such businesses end up on the periphery of the market but are still having to pay material fees and engage time on listing matters.

N Brown shows how this leads to takeovers

This mail order fashion clothing and related financial services, has for many years been around 60% owned by the Alliance family – having effectively been founded by Lord David Alliance who owns close to 50%. His son Joshua Alliance - who is also on the board as a non-executive director - is initiating a buyout at 40p per share which is a done deal given Frasers Group (LSE:FRAS), with a 20% stake, is supportive.

Last June I drew attention to Brown (N) Group (LSE:BWNG) as a “buy” at 20p after its annual results to 2 March showed a profits turnaround despite a 10% revenue slip to £601 million. Clothing constituted 63% of this and the financial services side was down nearly 11%. But a market capitalisation of £93.5 million represented a 70% discount to the last balance sheet value for net tangible assets of 69p per share. Moreover, the price/sales ratio (market cap versus annual revenue) was just 0.16 – implying that if efficiencies could be wrested then value would kick in.

The cheap rating was a function partly of increased competition online from Chinese suppliers, and in recent years of higher interest rates, £14 million net interest rates on £240 million net debt, employed as part of a £500 million “gross customer receivables” book. Relative to £600 million annual revenue, it made Brown subject to criticism it is a skewed business: something of a sub-prime lender, helping people buy clothes they cannot necessarily afford. Such a current asset is admittedly exposed to bad debts in the event of recession. However, the stock’s extent of discount to assets arguably (more than) priced this in.

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Yet there had been successful launches of new product lines across the strategic brands of JD Williams, Simply Be and Jacamo, which cover men and women of different ages. There were new smart casuals and a lifestyle sports brand with selected lines in Sainsbury’s, as part of marketing.

Mid-July, Joshua Alliance bought one million shares at 20p, likewise his mother who is wife to founder David Alliance. A decade ago, the price traded as high as 565p but has seen a long bear market run as low as 15p last April. The financial summary shows a significant gap between reported and normalised earnings mainly due to depreciation charges and software amortisation.

Yet implicitly the Alliance family believe there is a median performance to be exacted from Brown’s assets: certainly better than 2p of earnings per share, which is the market target in respect of financial years for the end-February 2025 and also 2026, even if substantially lower than the more than 20p achieved nearly a decade ago:

Robust cash flow profile also raises odds of buyout

Brown similarly reflects this as something to look for – as a catalyst – after a discount-to-assets implies they can be worked harder. Cash generation helps service any additional debt an acquirer or buyout team might be assuming.

In the last financial year, the group’s operating cash generation improved from £6 million to £92 million, supporting £23 million of investment and £31 million debt repayment, also period-end cash nearly doubled to £65 million. Interim results to 31 August were profitable at both adjusted and reported levels, and period-end cash soared 34% to £66 million, helping net debt ease 18% to £212 million.

40p offer represents possible exit PE around 20x

No one is likely to dispute such takeover terms given the way Chinese competition from Shein and Temu has disrupted UK retail – especially clothing – making it hard to forecast such UK businesses.

Brown has not paid dividends since Covid, so it is not as if investors will fret for lack of income.

It sets a perturbing precedent, however, for replacement of businesses exiting this way. Brown’s board blames very low trading liquidity and “limited UK fund manager appetite for small-cap consumer stocks” – which is odd given some of the greatest long-term UK growth stocks have been ASOS (LSE:ASC) and Next (LSE:NXT) – even if they required trading along the way.

Brown’s move is also said to help “provide additional capital, expertise and resource to accelerate the longer-term potential of the business...in its current cycle, we will be able to achieve this more successfully away from the public markets.” It’s as if the AIM market in particular is no longer fit for such purpose, only propped up by the carrot of tax relief.

Sanderson Design also at a discount to assets

It is another AIM-listed consumer-facing group. Shares in Sanderson Design Group Ordinary Shares (LSE:SDG) had a great bull run during the home improvement boom but have retraced it all – back to pre-Covid levels:

Source: TradingView. Past performance is not a guide to future performance.

Last Wednesday, the price fell from 76p to 65p, settling around 67p after interim results to 31 July showed a plunge of more than 70% in profit on revenue down 11% to near £50 million. Growth was achieved in the US - up 4% - but the UK remains challenging.

“Trading conditions in the second half have been more challenging than expected in almost all territories particularly in the UK and Northern Europe.” It came across as a mild profit warning, how expectations are “reliant on a projected improvement in trading during the remainder of the financial year, which includes our important pre-Christmas selling period”.

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The 31 July balance sheet shows £86.7 million net assets, of which 31% comprise intangibles – although I would respect there are various classy brands within the product portfolio. Even subtracting for this, tangible net asset value per share is just over 83p.

Sanderson also has a robust cash flow profile and, despite trimming its interim dividend from 0.75p to 0.5p, it is still paying out and has a good record of doing so – affirming cash flow – possibly interesting a US buyer given the brands’ potential there. Management declares: “We remain focused on the strategic growth opportunity of North America.”

In my view, the outlook here is not just linked to activity in the housing market. A dilemma is the huge cost nowadays of having capable people put up the expensive wallpapers this group is known for. As a DIY job, you would risk tearing your hair besides your bank balance. There seems a double whammy of cost issues, beyond existing hurdles to buy luxury goods. So with downgrades already mooted, I would exercise care here – but Sanderson has become worth watching. Hold.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.