Should you avoid Card Factory plc after today’s 20% decline?

Card Factory

The share price of specialist retailer of greeting cards and gifts, Card Factory (LSE: CARD), has fallen 20% today after it released a trading update for the 11 months to 31 December 2017. The main reason for the company’s share price fall is that it has warned on profit for both the current year and the next financial year.

However, its sales performance over Christmas was relatively robust, and it remains highly cash generative. Could this therefore be an opportunity to buy it? Or should investors avoid the company at the present time?

Solid trading performance

In the year to date, Card Factory has delivered sales growth of 5.9%, with store like-for-like (LFL) sales up 2.7%. Both of these figures represent improvements on the prior year, with the company’s performance over the key Christmas period being relatively robust.

During the year, 48 net new UK stores were opened, with 50 net new stores expected by the end of the year. The company’s online sales remained strong, which shows that consumer spending levels remain higher than many investors had anticipated. Sales have largely been driven by lower margin non-card categories, such as gifts and dressing, with card sales stable year-on-year. With the company having a pipeline of new store opportunities, its sales figures could continue to move higher.

Potential difficulties

While Card Factory’s sales figures have been relatively robust, its margin pressures have remained significant. Its costs continue to rise and when coupled with the change in sales mix towards lower-margin gifts, it means that EBITDA (earnings before interest, tax, depreciation and amortisation) are set to be between £93m and £95m for the current year. This is lower than the previously expected figure of £98.5m.

Next year is set to be a similar story. The combined impact of foreign exchange and wage inflation is expected to result in between £7m and £8m of additional costs in the 2019 financial year. While some of these costs can be mitigated, it seems unlikely that there will be significant growth in profitability next year.

Potential turnaround opportunity

While today’s trading update is disappointing, Card Factory could deliver a successful turnaround. It expects cost headwinds to gradually ease unless there is a dramatic shift in the value of sterling. And with sales figures being robust and the company having a major new store pipeline, its performance over the long run could be impressive.

Certainly, consumer confidence in the UK could come under pressure as Brexit moves closer. Higher inflation may cause consumers to spend less on non-essential items, which could cause further difficulties for businesses such as Card Factory. However, with a price-to-earnings (P/E) ratio of just 11.6, the stock seems to offer a wide margin of safety. This suggests that the stock market has already factored-in the potential difficulties ahead, and it could be worth buying as a turnaround opportunity for the long term.

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Peter Stephens owns shares in Card Factory. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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