Seeking Alpha
Profile| Send Message|
( followers)  

Unlike the US, Britain's economy is still at the bottom of the cycle. Unemployment is at the highest rate in 16 years, with close to 2.7m Britons out of work. Unemployment is forecast to continue rising in 2012. Austerity measures imposed by the Conservative government will cut an estimated 710,000 jobs from the public sector by 2017 according to the Office for Budget Responsibility. A quarter of million public sector jobs have been lost in the past year alone. These measures may have helped the UK avoid a sovereign debt crisis, but along with weakening demand from Britain's biggest export market - the Euro zone, growth remains anemic in the world's 6th largest economy. The UK economy contracted by 0.2% in Q4, moving it closer to its second recession in three years. This makes the recent performance of UK Automotive retailer Halfords PLC (OTCPK:HLFDY) all the more remarkable.

Halfords, formerly owned by Private Equity group CVC Partners was floated on the London market in 2004. This retailer of automotive, leisure and cycling products sells its products in 466 retail stores throughout the United Kingdom and Ireland. What impresses me about this retailer is not only its stability in revenues in the period 2008-2011, but also its operating efficiency:

Annual growth(%)

2008

2009

2010

2011

Revenue

7.20

1.50

2.70

4.60

Operating Profit

8

3

15.10

7

Earnings Per Share

13.60

10.90

22.20

8.80

Dividend

9

5.30

25.80

10

The Business

Halfords operates in four areas:

  • Auto Parts
  • Auto Maintenance
  • Leisure
  • Bikes.

The car maintenance segment provides a strong and reliable core customer base, with the defensive market dynamics of the car maintenance market proving robust during the downturn. Car owners in general are less willing to take their cars to original brand workshops at auto dealerships beyond the three year mark, but this trend has strengthened under current economic conditions. Bikes have also become a serious alternative to cars in urban areas. The appeal of lower carbon emissions and higher fuel costs are driving bike sales. Halfords already accounts for 1 out every 3 bikes sold in the UK.

Halfords does not operate in a crowded market sector. The only other UK retailer which focuses its operations on the four product markets in which Halfords operates is privately held Motor World. Halfords' 2011 turnover was more than twelve times larger than MotorWorld's, and has a more comprehensive store portfolio with convenient out-of-town sites, whereas Motor World operates mostly from older Main street locations.

Meaningful M&A

In February 2010, Halfords acquired Nationwide Autocentres in a £73.2m cash deal. Since then the entire network has been rebranded. Halfords Autocentres is now the largest independent chain of auto service maintenance centers in the UK, with over 240 locations. Surprisingly, this only gives them a 1% market share of this £9bn a year market, so the long term growth potential is compelling. Something the company recognizes. The auto maintenance market is highly fragmented in the UK, spread across independent repair shops and franchised dealers. The number of independent operators is also declining, which will allow the company to move into the vacuum and leverage both the Halfords brand as well as the purchasing power in auto parts from Halfords retail. Sixteen Autocentres were opened in 2011, 30 more are planned for 2012. Long term, the company sees potential for 600 centers nationally, as economies of scale will allow them to compete for commercial business. I should add that acquiring Nationwide Autocentres was neither dilutive to shareholders or earnings in 2010. In fact, Halfords shares rose 12% on the day of the announcement, recognizing the acquisition as a good fit with Halford's existing business.

Solid Financial Ratios

· The company is cheap - P/E = 8.85

· The company generates lots of cash.The dividend is also well covered - Price to Free Cash Flow [TTM] = 33.65

· Payout Ratio = 59.97%

· EPS - 5 Yr. Growth Rate = 11.25%

· Dividend 5 Year Growth Rate = 11.53%

· Modest debt levels. Total Debt to Equity = 50.64

Ready for the Recovery

The two main things I like about the business are its financial ratios,(operating health of the business) and how it has grown earnings under extremely challenging trading conditions. Management understands defensive retailing. This was underlined when David Wild was appointed CEO in 2008, joining Halfords from Wal-Mart.

CapEx outlays in 2011, while modest, will position Halfords for any recovery in the UK economy. These include a national distribution center and investment in IT infrastructure and web presence. With over 14,400 products now available online, Halfords multichannel strategy has grown significantly year on year, with online sales growing by 36.4% in 2011. The "Reserve & Collect" and "Order & Collect" programes have been effective in getting customers into stores, with the multichannel offering outperforming average industry growth rates.

Although any meaningful recovery in the UK will largely depend on the successful resolution of the euro-zone crisis, there are tentative signs that that the UK's outlook may be improving. U.K. home loans rose in January, the fourth successive monthly increase, along with consumer confidence, which is at a five month high. With manufacturing returning to growth in January and an expansion in services accelerating, the UK may avoid recession. Retail sales are volatile however, with no traction in month on month increases. Regardless, Halford's trading performance during 2008-2011 inspires confidence in their ability to grow earning going forward. Negative sentiment towards the UK retail sector is our opportunity, allowing us to pick up this defensive retailer at under 9 times earning with a 7% yield.

The Small Print

Shareholder remuneration in 2011 included a £0.22/share payout , as well as a £75m share buyback. Dividends are paid twice a year. There is of course currency risk. With GBP/USD trading under its historic mean, I believe downside risk in currency exposure is minimal at these levels. Although there is an ADR listing, it is illiquid. Readers are advised to buy the shares in the UK market, where daily volume averages 500,000 shares. UK dividends are paid out free of withholding tax, making this ideal for retirement accounts.

Source: Halfords Is A Defensive Retailer With A 7% Yield