Card Factory is the largest greeting card retailer in the UK with a market share of 33%. It is not as exciting as a tech business that trades at 20 times revenues, but an investment that will probably be more profitable in the mid-term.
What is special about Card Factory, is the vertically integrated design, production and retail model which makes it possible for them to offer their products at significantly lower prices than their rivals. Since the firm does not operate in a changing industry this will not pose a disadvantage over the long term. Beyond greeting cards, they also generate revenue through gift wrap, balloons and other gifts. They are active in more than 1000 stores across the UK and Ireland as well as online. Additionally, they serve more than 50% of Aldi’s UK estate. In Australia, they are operating through The Reject Shop as a partner; furthermore they are using franchise arrangements to operate in smaller territories. Their online results only made up around 9.7% of the FY21 sales (be aware of the fact that FY 2021 represents the year ended 31 January 2021) but through its rapid growth, it lessened the impact of the measures in conjunction with the pandemic.
Looking at the income statement, we assert that Card Factory currently is not profitable on a net income basis and even generates very little EBITDA – both due to store closures in connection with the pandemic and people being afraid to visit the stores – but maybe the situation is not as bad as displayed in the income statement. We will see.
Since December 2019, the share price dropped from 2.19 USD to a current price of about 0.80 USD. The recovery was temporarily stopped by the announcement of a £225m refinancing at worse conditions, exempli gratia covenant thresholds that include the return to 2.5x leverage (net debt / EBITDA) and 2x interest cover (EBITDA / interest expense). While the first condition was already met during the six months ended 31 July 2021, in order to return to 2.5x leverage, they will need additional quarters. I assume the condition will, as required, be met by January 2023, since pandemic related restrictions are easing in major parts of the UK. At the moment they would need around £100m in EBITDA in order to achieve 2.5x leverage (during the FY ended 31 January 2020 CARD obtained £85.6m in EBITDA) – but I expect them to make large debt principal payments that would lower the required EBITDA significantly.
However, as they state in their latest trading update, like-for-like sales were nearly flat during the last quarter compared to 2019. Therefore cash from operations should also be only slightly lower than in 2019. I think the revenues as well as the operating cash flows will appreciate in 2022 through increasing store visits – leading to an amount that is nearly flat compared to 2019. Thus I am assuming an 2022 OCF of £110m (which is ~£19m lower than the 2019 OCF). Regarding CAPEX, a conservative assumption could be £15m (roughly three times 2019 CAPEX; there will surely be postponed expenditures). Therefore, by subtracting CAPEX from our expected OCF, we arrive at £95m in free cash flow. CARD would then trade at a MC / FCF ratio of about 2.1.
As for the last twelve months, they accumulated free cash flows of £87.1m (MC / FCF ~2.3). They used £97.4m to repay debt, so there was a cash outflow when considering debt principal payments.
In my opinion, Card Factory will recover strongly from the current price. The market obviously assumes that the firm might not be able to achieve revenues comparable to those from 2019 and therefore will not reach substantial levered free cash flows during the next twelve months. I disagree. As I wrote earlier, they already experienced a strong recovery during the latest quarter. What is also interesting, is that they stated that there were less transactions made compared to the same quarter in 2019 but that the average basket value was higher. This could either be due to people avoiding less important store visits as they fear the virus or due to them generally preferring to buy online after they have experienced the comfort. Whatever the truth, I think the fear would diminish as people increasingly get used to the situation. The company should not suffer extremely from customers deciding to buy online since they also use this distribution channel. Competitors will likely gain market share but I do not expect the customer behavior to change dramatically.
Moritz99 