When I last wrote about flooring and carpet manufacturer Victoria (LSE: VCP), I commented that “momentum appears to remain strong”. I suggested that the share price still looked “reasonable” despite the stock having risen by about 1,000% since boss Geoff Wilding took charge in 2012.
Was I right? Well, the shares have since fallen by nearly 10% amid a wider market sell-off. But they rose on Wednesday after the company said that its full-year results should be ahead of expectations.
This revised guidance applies to the year ended 31 March. It means that for the fifth consecutive year, the performance will beat analysts’ forecasts.
Should you buy?
This company shows how value can be created for shareholders with a successful buy-and-build strategy. A rare combination of strong management, good timing and attractively-priced acquisitions has enabled Mr Wilding to transform the firm from a sleepy manufacturer into an £870m growth business.
Importantly, this has been done without high levels of debt. The group’s last-reported net debt of £98.6m only represented 1.8 times earnings before interest, tax, depreciation and amortisation (EBITDA). That looks reasonable to me given that profits are still growing strongly.
By manufacturing and distributing floorcoverings, Victoria avoids the risk of running retail stores and has achieved a high level of geographic diversity. Nearly 60% of earnings are now generated outside of the UK.
Management has advised shareholders to expect “further acquisition-led growth focused on Europe” and analysts expect earnings to rise by a further 50% during the 2018/19 year. With the shares trading on just 16 times 2018/19 forecast earnings, I believe this remains a growth buy.
A dividend-growth choice?
One thing Victoria lacks is a dividend. Mr Wilding’s focus is on reinvesting cash in further growth. So far this approach has been successful, but if you need an income from your shares, you might be tempted to consider UK-focused DFS Furniture (LSE: DFS).
This group, which owns brands including DFS, Sofa Workshop and Sofology, trades on a modest P/E of 10 and offers a forecast yield of 6.2%.
Be careful
However, I believe there are good reasons for this cheap valuation. Retailers like DFS often have a high proportion of fixed costs, which stay the same regardless of sales. This leads to a high level of operational gearing, which means that a small change in sales generates a larger change in profit.
That seems to be happening here. Sales excluding acquisitions fell by 3.5% to £366.5m during the half year to 27 January. But underlying EBITDA before acquisitions fell by 7.4% to £30m over the same period.
What’s going on?
DFS says that it’s facing “challenging market conditions”. The group expects to deliver an improved performance during the second half, helped by the recent acquisition of Sofology. My concern is that the balance sheet looks weak to me.
Current liabilities of £245.4m are more than double current assets of £114.3m. The group also has borrowings of £185.6m. This situation is sustainable while sales remain stable and customer deposits continue to flow. But if sales dry up at any point, I believe this business could rapidly run out of cash.
In my view, the DFS dividend is too generous and should be cut to speed up debt repayments. As things stand, there’s not enough margin of safety for me to want to invest here.
