Bonmarche (BON:LSE)

Bonmarché is a clothing and accessories retailer catering to women over 50 years old in the UK. After a good couple of years since listing in the AIM at 213p a share in Nov 2013, its shares hit a high of 318p a year ago, returning 49% over the two years. The company moved from AIM to the main market (LSE) in October 2015, owing largely to its growth story and performance in AIM. Since then it has lost over 72% of its market cap and the shares now trade at 87.5p. The latest fall of ~24% in the share price came just after the company reported like-for-like sales falling by 8% for the first half of FY17. At a LTM price to earnings ratio of just 5.6, the shares may appear dirt cheap, but the LTM P/E is deceptive. In my opinion Bonmarche is a falling knife.

Enterprise value calculation

Faltering sales

The company’s pitch as a growth story is faltering with like-for-like sales showing a downward trend since.

The extremely intense competition in the sector doesn’t show any signs of abating and it is difficult to see Bonmarche return to its glory year of double digit growth. With thin margins, the declining sales trend spells disaster down the line. 

Operating leases

Bonmarche was bought in 2012 by the private equity house – Sun European Partners – when its parent company Peacocks went bust. Sun used the standard private equity playbook, shutting down 130 worst performing stores and renegotiating the leases on the remaining 265 stores to get rents down by 28%. Spend on operating lease rents fell from £23.3m to £16.9m between FY13 and FY14. Approximately 30 per cent of the leases expire in 2017, this exposes the company to a high risk of substantially higher rents from FY17. The already thin margins will come under severe pressure if the rents go up. The alternative of stores closing doesn’t sound good as the stores where rents increase are likely to be the ones with good sales.

I calculate the off balance sheet operating lease liability to be £118m even without a significant rent increase in FY17. Any material increase will significantly add to the off balance sheet debt.

The falling pound will significantly erode margins

As per the prospectus filed in Sep15 when the group entered the main market, £47.6m of its costs were in USD for FY15; with total COGS of just over £135m for FY15, USD costs represent 35% of COGS. The pound has fallen close to 20% against USD since Brexit and all indications are that the pound could call further. Moreover, Brexit represents a permanent fall in value, representing a permanent increase in Bonmarche’s cost base. Running the numbers, allowing a 20% increase to 35% of its COGS represents a 5% fall in gross profit margins from the current ~24% to ~19%. With EBIT margins at under 6% even before the fall in pound, I estimate EBIT margins to fall to just over 1% in FY17, and continue to remain low. This doesn’t account for any increase in operating lease rentals, which could trip the company to a loss.

Significant capex plan for FY17

The group has been growing stores each year with capex averaging at roughly 3% of sales (averaging £5.7m over last 3 years). For FY17, the group is embarking on a major capex programme with a planned £14m expenditure which includes implementation of an ERP system. Even without any increase in operating lease rentals, I predict this will mean the group burns through ~£5m of cash in FY17.

Liquidity and viability

If sales continue to falter, operating lease rents increase significantly in FY17 and margins fall as expected, the group’s viability will be under threat. My cash flow projections indicate that expected fall in margins, a 28% increase in rents from FY17, and the planned capex spend, could lead to a severe liquidity crisis if sales continue to falter. The group has current cash balance of £13m with a £10m revolving facility. However, the revolving facility expires in Nov17 and may not get renewed if the business deteriorates further, or the terms of renewal may be more onerous.

Valuation

Even a fairly optimistic DCF valuation predicts a 100% downside. The below DCF assumes what I believe to be a fairly optimistic scenario where FY17 sales fall is arrested over the holiday period and sales begin to grow by 2% from FY18, gross margins improve gradually to 21% after the immediate fall in FY17 and no increase in operating lease rents.

Conclusion

As value investors, we love a bargain; and one of my favorite hunting grounds is a stock screen showing the fallen ones. But such a screen tends to be a mix of falling knifes and value buys (more of the former in my opinion). Bonmarche looks like a falling knife.