Topps Tiles Investment Appraisal

Table of Contents

Background

News

Financial Analysis

Ratio Analysis

Valuation

Risks

Investment Case

Bibliography

Appendix 1: 5 Year Summary (Accounts)

Appendix 2: 5 Year Ratio Summary

Appendix 3: Financial Ratios Calculations

Appendix 4: Valuation Summary

Appendix 5: Industry Breakdown

Appendix 6: RiskGrade Calculation

Background

Topps Tiles Plc is the UK’s largest tile and wood flooring specialist and is based in Enderby.

Since opening their first professional tile centre in 1963 they have seen tremendous growth and success, offering customers high quality products at value prices (Topps Tiles, 2010).

Listed on the London Stock Exchange in 1997 the company is a constituent of the FTSE Small Cap Index.

Topps Tiles has 321 stores currently operating within the UK and with plans for further expansion they look to become a dominant presence across the country and a market leader within the DIY industry.

News

Topps Tiles Plc, the UK’s largest tile and wood flooring specialist, released pre-close trading statements on company trading for the 53 week period ending October 2nd 2010. The Board of Directors will publish preliminary results in late November. It is thought that figures released will report UK revenues in the region of £182.4 million, up by 2% on the previous year (£178.8 million in 2009), with pre-tax profits in the range of £14.5-17.1 million. Like for like revenues from UK stores are expected to highlight a 1.7% increase. However, in 2010 Topps Tiles have lost 41% of their share value, underperforming the 2% rise in generated revenue. The business is currently valued at £105 million. RNS 4704T (2010) & Thomson Reuters (2010).

DIY Week (2010) reports the DIY leaders for 2010 in their annual round up of top performers in the DIY retail sector. Although Topps Tiles is not considered one of the key 6 players (i.e. B&Q, Homebase, Wickes, Argos, Focus and Screwfix) in the DIY market, the company has performed well amongst its competitors, taking pole position for operating margin and coming in 6th for net margin.

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Figure 1.1: Tables to show the percentage of Operating and Net margins within the DIY industry

Source: DIY Week (2010)

Topps Tiles was hit hard by the economic recession. During the 2010 trading period the company has reported that consumers remain ‘subdued’, with little sign of any return in consumer confidence. Consequently, shares slid 8% in the first half of 2010. The firm has however seen an increase in market share as major competitors cut back on and close stores (Lynch, 2010).

Dawber (2010) reports that the price earnings ratio in 2010 is 10.2 times. This figure has declined sharply from the previous year (94.0 times in 2009) despite trade revenue increasing during 2010. The decrease can be attributed to the fragile recovery in the housing market, the lack of consumer confidence and the suspected government cuts within the public sector. Topps Tiles hopes to attract brave investors.

Financial Analysis

Over a five year timespan (2005-2009) drawing directly from Topps Tiles’ Annual Accounts (see appendix 1), an outline of the raw financial situation is, as follows:

Turnover grew for four out of the five years studied translating into a 20% increase in income; this figure is in contrast to the 2008-2009 period where sales dropped back approximately £22 million, or 10% year on year.

There are two significant points to investigate when looking at expenditure:

- Operating expenditure can be seen by the continual rise in cost of sales growing 15.5% over the five year period from £67.1 million to £77.6 million.
- The company took out a £110 million loan in 2006 to fund two stages of a 3 for 4 reverse share split, share buyback and to pay back previous long-term debt. It is this long-term liability that reflects in the annual interest payable to be around £10 million per annum.

Drawing from this we can see that, notwithstanding the recessionary period, turnover increased at a faster pace than cost of sales. We can infer that increasing efficiencies and economies of scale are being taken advantage of. We can also make a point that share consolidation and buyback schemes are normally taken by companies that are confident of their growth and future plans.

Significant changes to the balance sheet are limited with the exception of a £110 million loan taken out in 2006, of which ap­proximately £90 million remains outstanding. This has caused the company to fall into negative equity, thereby potentially affecting profitability over the medium term.

The suspension of the dividend in the year ending 2009 is a direct response to plummeting profit after tax figures in that year; this could have had a causal negative effect on the share price. The resumption of the dividend once profitability is again healthy should trigger share price appreciation.

Note that HSBC is forecasting annual dividends of 0.11p in 2011 and 1.51p in 2012. (HSBC, 2010)

Dividends by Year

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Source: iii.co.uk (2010)

Ratio Analysis

Ratios are used to evaluate the performance and financial health of a company (Weygandt & Kiesso & Kimmel, 2005). A comprehensive analysis of a few financial ratios can build up a large and clear picture of a business (Broadbent & Cullen, 2003). It can offer clues to fundamental conditions that may not be evident from individual component inspectation of a particular ratio (Weygandt & Kiesso & Kimmel, 2005).

Ratio analysis compares numbers to each other; it expresses the relationship between them and can be presented as a percentage or proportionate (Proctor, 2006; Broadbent & Cullen, 2003).

For analysis of Topps Tiles performance for last 5 years were investigated the following groups of ratios: Profitability, Efficiency, Liquidity, Financial Gearing and Investment Over a five year timespan (2005-2009) the following financial ratios have indicated the following:

Profitability Ratios

Profitability ratios express businesses ability to generate earnings compared to expenses over a certain period of time (Lopes, 2010). They make possible measurement of financial performance of a company, test the management efficiency and are for potential investors (Broadbent & Cullen, 2003).

A graph to show profitability ratios for Topps Tiles over a five-year timespan.

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Gross Profit Ratio

An average value of 61.4% with a standard deviation of 0.018 showing a steady position through the period, reflective of the stability of the industry and the company’s ability to pay operating expenses and develop the business.

Net Profit Ratio

An average of 11% with a range of 16 percentage points is reflective of an increased debt position and need to service the debt as well as an increase in cost of sales and impacts of the recent economic downturn.

Return on Shareholders’ Fund

Decreasing pre-tax profits combined with recent negative equity positions on shareholders funds stemming from a long term loan taken out in 2006 totalling £110.0 million which was used to help fund a £122.4 million cash return and share capital consolidation, has seen ROSF move negative in 2006 from 75% to -65%, lower pre-tax profits in 2009 brought this figure to -9%.

Ratio Analysis

Return on Capital Employed

An average of 68%, combined with a range of 62%; whilst peaking in 2007 dropped significantly in 2009 to 26% the main factor is the large decrease in earnings before interest and tax (EBIT) in 2009 due to lower sales volumes.

Efficiency Ratios

Efficiency ratios measure how proficient the management is using ‘working capital’ (current assets minus current liabilities) (Broadbent & Cullen, 2003). It analyses how the assets are used and controlled within the company, how effectively the suppliers are paid and whether the firm is undertrading or overtrading on its equity (D&B, 2010). Efficiency ratios are critical to ensure the survival and smooth running of the company. The appropriate control of efficiency ratios aims to keep the overall value of working capital to a minimum, which will improve profitability without affecting sales revenue (Proctor, 2006).

A graph to show efficiency ratios for Topps Tiles over a five-year timespan.

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Inventory Turnover Period

Without available competitor statistics the inventory turnover period provides little in terms of relative value but too much stock could imply that there is a lack of demand, overstocking, or products are poorly sold. It took Topps Tiles 129 days to sell its stock for the year ending 2009 down from a five-year-high of 146 days.

Age of Receivables

On average it takes Topps Tiles’ customers 8 days to pay outstanding invoices, perhaps implying that the inventory sold is not very expensive otherwise customers would take longer to pay.

Age of Payables

As at year end 2009 it took 144 days for Topps Tiles to pay its outstanding trade debts. Companies prefer to have as long as possible age of payables. There is no easily accessible competitor to compare to, but comparing the age of receivables to age of payables it seems Topps Tiles takes 18 times longer to pay suppliers than it itself is paid. This is important for Topps Tiles’ cash flow and something from which Topps Tiles can draw an advantage.