Stockwatch: follow heavy director buying in a bombed-out stock?
This company lost the confidence of investors, but it now looks like a watershed moment and management is backing it firmly with its own cash. Analyst Edmond Jackson gives his opinion.
1st November 2024 11:01
by Edmond Jackson from interactive investor
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Retail e-commerce group THG Ordinary Share (LSE:THG) – formerly The Hut Group - is a mid-cap where “bargepole treatment” easily comes to mind.
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Since flotation four years ago, its stock has collapsed from an 800p high to around 47p, and persistent financial losses are expected to drop below £100 million only in 2025. Capitalised development means heavy intangibles, hence £272 million negative net tangible assets. There is £354 million net debt, but at least free cash flow turned positive last year.
Indeed, I took a “sell” stance at 195p in November 2021 on the grounds of a worsening macro context into which THG was vigorously expanding. Last November, I mitigated this to “hold” at 62p after the CEO proclaimed each division was delivering improved performance and the stock had initially jumped 30% over 70p. I did, however, caution that there were better choices.
Source: TradingView. Past performance is not a guide to future performance.
Yet the directors have recently bought determinedly. The founder CEO put £10 million of his own money into an equity placing and open offer last month at 49p, which raised around £95 million “for general corporate purposes” with nearly 15% dilution. The CFO put in £75,000, still plenty significant for a professional rather than wealthy entrepreneur; and the CFO’s view counts. Last Wednesday, around £400,000 of stock was bought in the market by a five further directors at market prices of 46p to 47p.
Admittedly, Balderton Capital reduced its stake from 8% to 6.4% a few weeks ago, although institutions are not unknown to bail around the low.
It is material concerted buying that flags THG as deserving at least another look. The market’s ingrained scepticism meant the stock could not close up even 1% though, at 46.7p, in response to the latest purchases.
What might be a trigger from the operations narrative?
There seems to be nothing in the 2024 numbers. THG’s main revenue generators are consumer beauty and nutrition products; beauty rose just 5.2% to £775 million in the nine months to 30 September and only 2.3% in the third quarter, while nutrition fell 11.6% to £434 million over nine months and by 13% over the third quarter. Management still proclaimed “improving trends” from nutrition during the quarter, so you may excuse me a sense of déjà vu.
The directors appear to have conviction that a demerger of the group’s digital commerce solutions side Ingenuity will be transformational – at least to some degree. It can seem like THG is divesting its growth engine given Ingenuity’s revenue rose 13.5% over nine months to £124 million, advancing to 15% in the third quarter with £44 million.
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Yet a strategic and operational review last September concluded: “The demerger of Ingenuity facilitates the simplification of THG’s business model, as a cash-generative global consumer beauty and nutrition group, with an improved balance sheet, capital expenditure and cash-flow profile.”
A prompt £95 million capital raising implies nothing special about cash flow in the near term. Ingenuity is expected to have an equity value around £100 million, although it could be better explained how such a divestment is to be accounted for – to the benefit of THG.
A 17 September announcement states clearly, the group will, post de-merger, consist of the beauty and nutrition products, rather than, say, a legally separate e-commerce logistics business that is equity accounted for.
It’s unclear quite how the alleged £100 million equity value of Ingenuity is to be credited to THG as a group, hence its shareholders. Perhaps that was in a specific circular.
Anyway, this strategic change asks us to look forward, to a scenario where capital expenditure on Ingenuity is no longer absorbing cash generated by beauty and nutrition, albeit premature to offer any pro forma scenario.
Ingenuity is said to be better able as a standalone business to win customers in the wider e-commerce market beyond THG beauty and nutrition. But what is the point of teasing with this if it is no longer part of THG group?
It is not hard to appreciate why THG has generally lost the confidence of investors, if only by its communications alone, but the facts are that this does look like a watershed moment and the THG directors are backing it firmly with their cash.
Consumer outlook for beauty and nutrition is also key
Director dealings do not guarantee anything; they only reflect belief. What they cannot reflect – beyond this strategic change – is consumer discretionary spending where THG derives half its revenue from the UK followed by Europe, the US and the rest of the world.
Call me cautious but my reaction to this first Labour Budget is wariness. Greater taxes on the wealthy combined with higher national insurance contributions for employers – affecting private sector wage rises – seem unlikely to boost confidence.
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Independent forecasters also say the tax rises so far do not support Labour’s spending plans. Consider also what extent of debt the financial markets will allow the UK to pursue.
So, while the domestic consumer situation might not be so bad, it is the agile value operators who seem likely to thrive best – cue the Chinese operators Shein and Temu, where the Budget failed to address their advantage in terms of VAT. I have no sense of how their beauty products compete on quality with THG, or whether price will be more critical in the next two years.
The second half is ‘the most profitable and cash generative’
THG was profitable in the first half of 2024 only in terms of £52 million adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) on £911 million revenue. This is quite artificial given around £80 million annual development spend, capitalised then written off, but should reduce with the divestment of Ingenuity.
Yet the statutory interim loss was £84 million before adjusting items, on £934 million revenue. The net loss was £121 million after a £33.7 million net finance cost on £352 million net debt. This charge seems particularly high even considering £335 million leases.
Around £2 billion annual revenue is the big opportunity here, given the stock trades on a price/sales ratio of just 0.4. Can margins be recouped? In 2015, THG achieved a 5.3% operating margin on £334 million revenue. Revenue grew substantially to 2022 then slipped, but it’s not clear if this involved any loss of marketing edge – or Chinese competition, like I considered in my last piece on Boohoo Group (LSE:BOO). Has a headwind for margin recovery vs cheap Chinese prices, at least on beauty products, set in?
THG - financial summary
Year end 31 Dec
| 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | |
| Turnover (£ million) | 334 | 501 | 736 | 916 | 1,140 | 1,614 | 2,180 | 2,239 | 2,045 |
| Operating margin (%) | 5.3 | 3.3 | -0.5 | 1.8 | -1.7 | -30.0 | -6.3 | -22.1 | -9.1 |
| Operating profit (£m) | 17.8 | 16.6 | -4.0 | 16.6 | -19.7 | -482 | -137 | -496 | -185 |
| Net profit (£m) | 13.5 | 10.8 | -10.1 | 0.8 | -44.2 | -533 | -138 | -540 | -248 |
| Reported EPS (p) | 1.2 | 1.0 | -0.9 | 0.1 | -4.1 | -66.2 | -12.6 | -49.1 | -19.2 |
| Normalised EPS (p) | 1.2 | 1.0 | -0.9 | 0.1 | -1.2 | -42.4 | -1.9 | -18.7 | -14.1 |
| Return on capital (%) | 7.4 | 3.7 | -0.6 | 1.8 | -1.8 | -25.6 | -5.2 | -21.2 | -9.2 |
| Operating cashflow/share (p) | 3.8 | 6.9 | 1.5 | 4.2 | 5.0 | 9.4 | 2.1 | 3.4 | 10.9 |
| Capex/share (p) | 3.4 | 13.9 | 6.6 | 7.3 | 16.6 | 29.8 | 17.2 | 16.1 | 9.7 |
| Free cashflow/share (p) | 0.4 | -7.0 | -5.1 | -3.2 | -11.6 | -20.4 | -15.1 | -12.6 | 1.3 |
| Cash (£m) | 142 | 174 | 187 | 235 | 312 | 774 | 537 | 474 | 418 |
| Net debt (£m) | 40.7 | 134 | 220 | 294 | 476 | -11.2 | 302 | 540 | 577 |
| Net assets (£m) | 63.3 | 144 | 319 | 385 | 468 | 1,145 | 1,756 | 1,302 | 1,022 |
| Net assets/share (p) | 5.8 | 13.2 | 29.4 | 35.5 | 43.1 | 91.9 | 128 | 92.0 | 70.5 |
Source: historic company REFS and company accounts
A strategic partnership was declared last June with Frasers Group (LSE:FRAS), which made a £10 million strategic investment in THG, hence is implicitly on-side with the e-commerce logistics demerger, and Frasers’ involvement should benefit beauty and nutrition. THG sold its luxury products websites to Frasers at an undisclosed price, having achieved only a “broadly breakeven” outcome on £43 million revenue in 2023. Again, it is premature to figure the upshot for revenue and profit.
Leads to a ‘highly speculative’ conclusion
From their dealings, insiders clearly believe the demerger is a watershed moment and positive for value. The consumer environment remains uncertain, however, and THG will need to show further how it is going to recoup margin even if divesting Ingenuity helps.
There is a case here for speculators to consider a starter position and see what evolves. Follow the directors. However, there’s a way to go before an investment “buy” case can be substantiated, therefore overall I retain “hold”.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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