The unacceptable face of retail

All about equity cash flow

With origins in mail-order, N Brown, which is mostly a women’s fashion retailer, may be adjusting to 21st century retailing more easily than its peers.

Some stats from Sharelockholmes.com:

And this is the exciting bit, at least for me. Many retailers fail to meet even that most basic of benchmarks of financial conservatism and, because they lease their shops and those leases aren’t recorded in the balance sheet, their financial situations are actually a good deal more precarious.

Normally I’d be looking at a company like N Brown and thinking about those leases. I’d be expecting to add them to the balance sheet, and discover the company’s equity is considerably less than half its assets (including leases).

But N Brown doesn’t have many stores. It owns some High and Mighty shops, and is trialling Simple Be concept stores, but in a January update it reported that online sales were close to 50% of total sales, up from 39% a couple of years ago. Most of its non-Internet revenue (I think) is from catalogues. And that means, few stores, and a relatively light lease burden.

In 2011, total obligations under non-cancellable operating leases were £23.1m. If we add that figure to total assets and liabilities we get total assets of £769.2m and total liabilities of £408.8m so shareholders equity (assets – liabilities) was £360.4m and the ratio of equity to assets was 0.47 or 47%. OK, slightly less than half but leases aren’t much of a worry at N Brown.

So all’s well then? Not quite, and if Sharelockholmes is right, it comes as a big disappointment. I’ve been building a great story about N Brown in my head as I run through my pre-analysis checklist:

The market has switched off this highly profitable company because its a retailer and we all know many high-street retailers are being annihilated by supermarkets and the Internet, while they’re tied into costly rental payments and upward-only reviews.

But N Brown is already an Internet retailer. It’s a kind of Next Directory aimed at larger and older women and since Next is another fashion/Internet success that’s a compliment. Even better, N Brown has very few leases. It’s a predator, not prey.

Virtually the last item on my pre-analysis check list is cash flow and according to Sharelockholmes.com in the thirteen years between 1999 and 2011 median adjusted earnings per share was 13p. Median cash flow per share was 10p, and median free-cash flow was 2p. Here’s the spreadsheet.

I can understand why, if a company is making big new investments, free-cash flow might be markedly below reported earnings, the cost of new investment isn’t fully reflected in historical accounting (it’s depreciated over time) but it is in the free cash flow figure.

But the (net) cash flow (from operations) figure ignores capital expenditure and I don’t know of a legitimate reason why it should be significantly lower than reported earnings over the long term. If I use the mean rather than median, and average over the last seven years the figures look a bit better but accounting profitability is still higher than cash profitability.

I feel I should check the figures in the annual reports, but at the same time I’m reluctant to go through a decade of them only to find out the data is right.

When I started researching N Brown, I was thinking the investment case was all about equity and it would be a strong one. Now I’m thinking it’s all about cash flow. And it’s weak.

Two words come to mind. The first is also the first word in a popular cocktail made from vodka, tomato juice and Worcestershire sauce. The second is ‘hell’.

The quest for the acceptable face of retail continues…