Stockwatch: This share could make it big again

With some large challenges dealt with, delivering more consistent results should trigger a re-rating.

Has digital-led, specialist clothing retailer N Brown (LSE:BWNG) reached a genuine point of turnaround, such that its shares can rise more definitively?

The table near the bottom of this article shows a bumpy financial record and rising debt. However, N Brown has had a new CEO for 11 months and exited its 20 high street stores and US business to focus on being a digital operation.

Woes include PPI claims, which explains the ramp-up in debt, although claims have ended with the August deadline. A VAT dispute has also bumped up marketing costs. Latest interims show a 9.3% fall in product revenue and 2.9% rise in financial services (credit to boost sales), although combined womenswear and menswear brands have shown digital revenue growth of 5% and operating profit by 4%.

Britain remains stubbornly obese

With obesity once again in the news – a proposed snacking ban on public transport, and a reminder in the press that Britain is set for record levels of diabetes – you'd think a business focused on "underserved customer groups, size 20+ and age 50+" should be able to prosper if its marketing pitch is right.

Unless the demise of Bonmarche (LSE:BON) as a listed company was a warning, this age group is less enthusiastic at clothes purchases compared with a younger demographic driving success at Boohoo (LSE:BOO).  Bonmarche suffered from being stores-led though, and was snapped up by Edinburgh Woollen Mill owner Philip Day – a turnaround pro in retail.  On the face of it, capable management should be able to exact a worthwhile business at N Brown.

A lot of bad news is priced into the stock

At 107p, capitalised at around £285 million, N Brown shares trade on a 12-month forward price/earnings (PE) ratio of 4.3x if earnings per share (EPS) forecasts of around 23p for the year ending March 2020 and 2021 are fair.  That's roughly median, the recent years' trend, so at first sight looks doable.

It would also mean a 7.3% yield on the stock with 3x earnings cover, the dividend projected to edge up to 7.2p a share this year and to 7.3p in 2021. The historic annual cash flow trend behind that looks horrendous but, despite the hike in debt, the interim results show a sharp improvement in operational cash flow. The end-August balance sheet shows intangibles constituting 48% of net assets which compute at 109p a share – not the strongest balance sheet but not distorted either.  

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

My point being that unless the consumer environment worsens sharply and the extra debt proves stubborn to cut, N Brown need only deliver steadier more consistent results – roughly median EPS performance – for its stock to re-rate.  If N Brown's digital transition helps transform marketing, then better still.

By way of comparison, a lot of investors wrote off Trinity Mirror Group – renamed Reach (LSE:RCH) – which has shown an even worse decline in revenues, but its stock has nearly doubled since earlier this year as a turnaround incorporating digital has wrested results.  To be sure, Reach has benefited from remarkably strong, operational cash flow, and also exacted synergies from acquisitions, but remains relevant to considering low PE stocks where turnaround is viable.

In response to N Brown's interims, the share price jumped nearly 10% to test 110p, and I noticed a total 1.25 million shares bought in three tranches at 108p versus a market offer price then of 105.5p.  Easing to 107p keeps it in an 85p to 110p range since the springtime.  Showing the need for wariness towards chart break-outs, it re-rated briefly to over 150p after early-May prelims asserted a new digital strategy to return N Brown to "sustainable profit growth" backed by "five pillars".

New chief executive is addressing the challenges

To an extent, N Brown's issues may link to actions by previous CEO Angela Spindler, who departed in September 2018 after a veteran Tesco boss became chairman, with Steve Johnson becoming interim CEO and who is now permanent.  He joined N Brown in 2016, leading its financial services side after senior roles at Shop Direct, Sainsbury's and Halifax - hence a play on this stock is very much on his capability.

I quite wonder if his being appointed interim CEO at all implies the board wasn't convinced or sought a complete fresh view. However, the best outside talent wasn't forthcoming, as if seeing N Brown as yesteryear – but the chairman says that "having conducted a thorough and extensive search, Steve was best for the job".

A 9.3% first-half decline in product revenue is put down to a managed decline of the legacy offline business, a shift away from the US and store portfolio closure, while financial services revenue increased 2.9% to £150.6 million. The financial side needs proving as much as retail, mind. 

Brown suffered a major embarrassment in 2017, becoming liable for £40 million compensation for miss-selling insurance products (behind total £57 million exceptional charge in the year to March 2018 that also included store closure costs).  I also vaguely recall ethical criticism of the credit side although N Brown is not the only retailer "helping" its customers (and profiting) so. The new CEO needs to prove both sides of the group can hum, and without controversy.

A September update cited a 10-fold increase in PPI information requests before the 29 August deadline, saying it had paid out £108 million to date and admitted it was necessary to make an additional provision, which has turned out in the results as a "final" £25 million, hence a rising trend in net debt that's guided to a £460 million to £490 million range for the full financial year.

In the background, and another financial constraint going forward, is an historic dispute with HMRC over VAT recovery of marketing costs (sale of goods being standard VAT-rated versus financial services exempt).  Last November, a tribunal ruled a substantially higher portion of VAT is non-recoverable and N Brown guided for £6 million to £9 million a year, impacting its marketing costs from the current 2020 year.

Versus such constraints, it is encouraging that the interim cash flow statement shows that after working capital movements there's been a £28.4 million net cash inflow versus a £24.2 million outflow, like-for-like.

 Net gearing is up from 118% to 155% on a 12 months' view – hardly what you want to see in a turnaround situation where the UK consumer economy may be slowing.  A potential saving grace amid low interest rates is such debt being long-term, where finance costs shaved just under 20% of operating profit, not yet a stress threat.

The CEO projects "profitable digital growth whilst generating sustainable free cash flow...enabling us to bring down net debt, invest in the business and deliver shareholder returns...we have passed the PPI deadline and have agreed or settled all legacy tax cases which accounted for a circa £200 million cash outflow in the last five years."

So, while the stock remains under a cloud towards retail generally, it's entirely possible N Brown is over the hill of its challenges.

"Five Pillars" strategy set out last May

These seem practical marketing than revolutionary change, although every little extra helps.  In summary:

First: "maximise the UK market," having closed the international division and with a focus on four core brands: total digital growth of 4.6% on three womenswear brands and 6.5% in menswear.  The business is now 84% digital-oriented (otherwise mail order).

Second: "simplify the business to improve the customer experience" - an initiative that appears IT-led, streamlining digital sales e.g. via apps.

Third: "deliver better products," learning from digital reviews and weekly blind tasting sessions. "We have made good progress improving our branded portfolio...continued fit improvements...virtual technology enabling us to design and select hundreds of styles in less than two weeks...this will drive cost efficiencies."

Fourth: "trade smarter with data," which sounds a tad risky by way of personal information gathering, but they cite "good foundations in the last six months ...to improve customer insight."

Fifth: "inspire colleagues to further delight customers" - a crusade for vision, mission and purpose - though perhaps more significantly for motivation, aligning all employees to a reward framework of growth in operating profit, digital sales etc.

Risk/reward profile tips favourably

There's undoubtedly a speculative element here, and a no-deal Brexit is liable to compromise recovery. But my thinking is that if a deal isn't agreed and passed by 31 October, Brexit is less likely to happen at all: the Tory and Brexit parties will go their own ways in an election, resulting in a hung parliament. Meanwhile, the obesity crisis drives a growing need for out-size clothing, and a capable CEO should be able to wrest progress.  Buy.

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