Stockwatch: can bike firm pedal past lockdown cycling boom?

Halfords benefited from a cycling surge in the hot summer months, but its future rests on whether this is a blip or a permanent shift.

Is Halfords (LSE:HFD) becoming a solid retail play for the Covid-19 era? The small cap shares in this ‘essential retailer’ jumped 32% to 239p on news its positive trading momentum is being sustained after a staycation summer. 

Like-for-like revenues from cycling are up 46% over five weeks to 25 September, motoring products by 7.5% and autocentres (servicing, MOT’s) by 18%. Pre-tax profit for the first half year are guided over £55 million relative to a £360 million market cap, which merits attention.

Expectations were set low, back in March

Mind also, the context was management sounding jaundiced in late March - also suspending the dividend - only for a surprisingly positive update to appear in September. 

The chart has shown recovery to May 2019 levels, after which the stock trend and underlying story had deteriorated ahead of Covid-19. Halfords' back then was a typically pressured retail stock with mixed updates, its numbers boosted by acquisitions. 

I am also noticing various strong rebounds on news items, some of which later fall back – such as Dignity (LSE:DTY) funeral providers. After the astonishing markets' rally since March, it seems traders remain bullish to pounce on great stories of the day.  

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Moreover, Halfords tends to have a weaker second half of the year. The superb weather that encouraged cycling from spring to September has reverted to more traditional rain. It also carries an intangibles-heavy balance sheet with some liabilities, which can add to volatility. 

So long as you bear these reservations in mind, it is worth paying closer attention. 

Latest guidance appears a re-rating on prior consensus 

Expectations had been for £24.7 million net profit in respect of Halfords’ year to April 2021, then £39.6 million in 2021/22. The table shows annual net profit declining from around £55 million in the last two years, which correlates with the stock losing a historic chart support level around 200p in July 2019 – down as low as 67p in last March’s sell-off. 

The market is therefore right to sense a potential turning point. If annual profits can recover over £50 million for earnings per share (EPS) of around 30p then – even after yesterday’s re-rating – the forward price-to-earnings ratio is a modest 8x.

Also in the table, one can see Halfords has a strong record for free cash flow that used to support a dividend around 18p. If it can recover anywhere near this once the Covid-19 crisis mitigates, current pricing implies a yield up to 8%. Hence the stock is logically re-rating in a sense the pay-out need recover only to 12p to offer a very competitive 5% yield. 

Such is the hope, obviously. Note also the annual revenue trend is no growth stock, and operating margins have deteriorated from high to low single figures. This is even before Halfords has benefited from cycling-related sales, which are low margin and capital intensive. 

I imagine it is mopping up quite a lot of existing business anyway, after many smaller cycling shops appear to have closed because they cannot afford high street rents or compete with the likes of online bike retailer Wiggle. 

Intangibles constitute 108% of net assets 

On data bank figures the stock appears to be trading around net asset value, as if any positive change in its narrative must trigger upside. 

Yet the last published balance sheet of 3 April had £395.7 million intangibles (no goodwill) relative to £365.8 million net assets, most likely accumulated from acquisitions such as Nationwide Autocentre (MOT’s, car repairs and servicing), Boardman Bikes and Tredz Bikes. 

Not to dismiss this value entirely but if the UK economy became impaired from Covid-19 and Brexit then it is liable to get written down. 

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Debt has jumped from £81.6 million to £179.1 million, if substantially offset by £115.5 million cash. A new accounting standard has recognised £332.8 million lease liabilities in the last financial year but there is a corresponding £349.9 million ‘right-of-use assets’ entry under non-current assets. 

Trade payables are over 4x trade receivables, up from 3x a year before, which concerns me in case payment timing issues have supported year-end profit figures. 

This could be how Halfords managed to report 8% operating profit growth to £67.2 million, before £13.6 million net finance costs meant a 9% fall in pre-tax profit to £53.6 million. From the outside one can never know, but I should flag this. 

So the balance sheet has cautionary elements making it a less reliable prop if sales deteriorate – say if unemployment weighs on enough people’ spending power as furlough support ends. 

Essentially a play on reduced public transport use

Halfords’ fortunes appear chiefly tied to public behaviour. After the lockdown compromised motoring, a liberation of sorts plus ‘staycationing’ revived those sales – and I imagine a one-off benefit of battery replacements at the autocentres.   

I am wary the surge in cycling can be sustained: by and large it constitutes people like me, who are not the die-hard cyclists seen out on cold Sunday mornings in winter, and perish the thought of cycling at all in pouring rain. Have you noticed how bad the edges of roads are becoming - subsidence and potholes - which councils are too cash-strapped to repair? 

My judgment has bias in that around 20 years ago I was twice separated from my bike due to potholes, incurring four months of concussion – despite wearing a helmet - and eight stitches above one eye. A friend also helmeted, was less lucky and suffered brain damage 18 months ago after coming off. 

Cycling this last September, I noticed a definite deterioration in road edges and probably I will not bother again until next year. Am I not typical of many recent new entrants to cycling? The thought of engaging rush hour traffic on a bike also fills me with horror.   

Yet the risks to middle-aged people – the key demographic - of using public transport even if masked, or enduring its dystopian experience, must mean cars and bikes enjoy an extent of switching from buses and trains. Despite cynicism over the ‘Boris bikes’ in London, they enjoyed sustained levels of use even pre-Covid.  

Time to take Halfords more seriously

Where the balance lies in transport use looks to be the main thing here. You can study the company’s past announcements, but are essentially taking a behavioural view for the next year – possibly more. I am wary that the disruption from Covid-19 will be mitigated even by a vaccine appearing. I think we are stuck with on/off restrictions for years, possibly. 

Its stock has unsurprisingly run into consolidation today, opening down about 10p but recovering to a 5p fall around 234p. I think US equities will drop and take other markets down if Trump is very sick with Covid-19 (or worse), even though liberals would say it is hard for the US government to get even more dysfunctional. 

A more positive stance on Halfords looks justified, bearing in mind it remains speculative. Also, the recent flow of surprisingly good news may ebb, hence for now: ‘Hold’.

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