Despite these conditions, as a result of strong cost and margin control, we expect pre-tax profit for the year to March 2016 to be towards the lower end of the range of market expectations
The share price responded negatively declining 12% on the day. This follows a similar drop in November when management warned that sales were trending poorly and they needed a strong Christmas to hit guidance.
If you are interested, please read my original Poundland report entitled "Something's Rotten in Poundland" for further insight into the company and what ails it.
Share Price YTD
Q3: The Most Important Quarter
Management reported that core sales increased 29.4% including the new 99p stores, which contributed 21.1%. While total sales growth was positive year over year, declining traffic reduced same-store sales results. Management said:
"Whilst our Christmas and Halloween product offer was our strongest ever and December saw an improvement in sales growth, UK high street footfall remained below last year and this has impacted our overall sales growth," the firm said.
Further, they did not see the pick-up in sales they expected:
"We anticipated a pick-up in December because we had a very strong Christmas offer, and traditionally that's what we've seen," McCarthy said in an interview.
"Whilst we did have an uplift in December it wasn't the usual hike, and that was a function of depressed footfall. We weren't on our own but that's cold comfort."
This year more customers chose to shop online and traffic at upscale stores was down year on year. With fewer shoppers at boutiques and department stores, Poundland saw a corresponding decline in traffic.
Profit trends also remain concerning despite management attempts to reduce costs as the quarter went on. A weak Q3, an important quarter representing half of total annual profit, led management to indicate that earnings will come in at the low end of analyst expectations. So, despite increases in sales, despite more stores, and despite adjusting for unusual items, earnings for fiscal 2016 will be down year on year.
Analysts are far more optimistic for 2017 earnings, which will see some benefit of the 99p integration. Consensus forecasts 15 cents per share up from 9-10 cents forecast this year. The majority of stores will be converted to the Poundland brand by April and management reiterated its goal of £25 million increase in EBITDA.
Conference Call Takeaways
I listened to the conference call (no transcript available) and hopefully my takeaways are useful for readers.
- They view change in Christmas shopping behavior to be permanent and they are preparing accordingly for 2016
- More into promotional initiatives, such as Black Friday promotions, to be used next year
- Admit they could have done things better in hindsight with respect to December. Some new products sold out early, such as a selfie stick while others weren't enticing enough (e.g. exclusive to Poundland).
- Will look for the best brands and suppliers from both brands. Some products at 99p will be used at Poundland and vice versa.
- In the future, will look more at rationalizing supplier base more aggressively with the aim of achieving better terms
- Any buying benefits will be seen in fiscal 2017
New Price Points
- If management is unable to increase sales with higher traffic and basket, the topic of new price points arose. Management is cautious. Customers will see new product and categories but as for new price points, management hasn't done a full test yet.
- They are worries about the risk to the brand and perception if they prices are above a pound.
- The new multi-price store will help understand value at higher price points
The company is also seeing benefits from declining freight costs.
B&M Confirms Trend
Discount competitor B&M also reported weakness in the December quarter with same-store sales declining 0.7% compared with 4.5% in the prior year. Total sales increased nearly 24% as the company recently accelerated store openings.
In contrast, total Poundland core sales grew 6%. While the company didn't disclose same-store sales, the comments on traffic suggests they were also negative at Poundland. Analysts estimate the decline at nearly 5%:
Analysts estimated that sales at those Poundland stores that have been open for more than a year were down about 5 per cent against December 2014. Most cut full-year profit forecasts to March by nearly a 10th, to about £40m, and earnings per share to just under 9p.
The December decline is on top of the 3% decline estimated in November.
New Format; New Distraction
Amazingly, management has decided to launch another distraction. In addition to launching in Spain, improving existing operations and integrating 99p Stores, somehow they believe they have the operational capacity to launch a new brand. Also from the press release:
New multi-price format will launch in April 2016 in a number of the larger Family Bargains stores that were acquired with 99p Stores
Our plans to use the acquired Family Bargains stores to launch a new multi-price format are well advanced. We are developing a comprehensive range of exceptional value products. We are excited by the opportunity that this presents. The trial starts in April and we will give more information on progress and future plans at our interim results in November.
I think investors and those interested in Poundland should question management's intentions. Not only are they knee-deep with 99p but core Poundland operations are performing poorly with margins down and declining same-store sales. Further, they've yet to find a repeatable formula for success in Spain.
The last thing management should do is distract themselves with a new initiative. Instead, focus should be on:
1. Integrating 99p and achieving synergies
2. Improving core Poundland operations
The quarter did little to change my opinion of Poundland - it remains a business with too much excess cost. The high percentage of SG&A means there is little margin for error and, as same-store sales decline, investors may see meaningful earnings variability:
Mr. McCarthy says the company's gross margins - sales less the cost of acquiring goods - have been consistent at between 36.7 per cent and 37.2 per cent for 25 years, regardless of inflation and competition. However, he concedes a fractional swing in gross margins can turn profits into losses: "If margins move 0.1 per cent either way, it creates significant pain or pleasure."
This quarter was that error. Lower sales mean lower gross profit coupled with an inability to repeatedly manage SG&A well (in my opinion) means earnings will be ugly this quarter.
To achieve estimated earnings for 2017 (15.5p) - the number that bulls argue makes the business look cheap - Poundland certainly needs a bit of sales luck or finally to deliver a reduced cost structure.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.