NCK the quiet achiever, page-9

"If there is any mistake in my understanding about NCK, please do not hesitate to tell me. I genuinely welcome any kind of criticism."

@travelightor,

The quality of this company's financial statements are pristine, Reece-esque, even, with a lot of evidence of prudent and conservative application of the accounting standards.

Running a range of diagnostics over the accounts reveals a company that has strong product and service offerings that come to the fore even in a relatively congested market place, and whose management operates with laser-like focus on the things that matter in terms of the creation of value for shareholders.

But my issue with NCK is the same issue I have with any retailer that relies on the leasing of premises in order to conduct their business: the operating leverage is acute.

In isolation, pronounced operating leverage is neither here nor there to me, but when it is combined natural business cyclicality, when that combination doesn't cause joy, it causes problems.

By way of demonstration, the way I have looked at NCK in the past is on the basis of per store profitabililty:

Looking at the cyclical trends here:

Revenue/Store ($m) (%change on pcp in brackets)
2005: 4.02
2006: 3.40 (-15%)
2007: 3.43 (1%)
2008: 3.15 (-8%)
2009: 2.87 (-9%)
2010: 3.50 (22%)
2011: 3.39 (-3%)
2012: 3.22 (-5%)
2013: 3.44 (7%)
2014: 3.67 (7%)
2015: 3.66 (0%)
2016: 4.48 (22%) [implied by recent guidance and UBS and Macquarie broker forecasts]
2017: 4.55 ( 2%) [based on UBS and Macquarie broker forecasts]


EBIT/Store ($m)
2005: 0.82
2006: 0.60 (-29%)
2007: 0.53 (-9%)
2008: 0.36 (-33%)
2009: 0.24 (-33%)
2010: 0.56 (132%)
2011: 0.55 (-2%)
2012: 0.35 (-36%)
2013: 0.45 (29%)
2014: 0.51 (13%)
2015: 0.56 (10%)
2016: 0.76 (35%) [implied by recent guidance and UBS and Macquarie broker forecasts]
2017: 0.76 (2%) [based on UBS and Macquarie broker forecasts]

There are a few observations worth making here, I think.

Firstly, significant swings in EBIT/store emanate from just modest changes in Revenue/store.

Secondly, we are currently at unit store Revenue and profitability that are at record highs. Whenever I come across records being set in cyclical businesses - either on the high or the low side - it always make my contrarian instincts sharpen.

For when the records are set on the low side, I sharpen my pencil with the prospect of buying in mind.

Looking at NCK makes me feel a little bit the opposite: I worry about mean reversion in some of those numbers.

Now I know that there is the overlay in NCK's case of an aggressive store rollout, that will ultimately defray any cyclical moderation. Meaning its not really a pure cyclical story this; rather, its really a growth story with a cyclical underlay.

But the numbskull in me still can't shake off the niggling thought of the NCK store base generating $600,000 of mid-cycle EBIT per capita, and at 75 stores that works out to be $45m of EBIT in 5 years' time (however long it take sot get to 75 stores), compared to $35m of EBIT today.

Even if the stock holds its current 9x EV/EBITDA multiple, that works out to 25% increase in the value of the company. Over 5 years.

That's a so-so, but not a mouth-watering, investment return, I don't think.

And to the extent that the market might - as is its wont - apply a more modest multiple should it perceive the business hitting ex-growth status as the 75 store count approaches, the return will be correspondingly reduced.



And another thing that bears remembering is that these sorts of retailers, with fixed cover charge ratio's (FCCR) close to 2.o times, are not just operationally leveraged, but financially leveraged, too. So there's double leverage at work.

Meaning, the fact that the company runs on negative working capital, as well as a net cash balance, can sometimes induce a bit of complacency.

For example, despite company being highly profitable during the GFC, and despite the cash balance remaining relatively unchanged at $6.0m, the FCCR slid away quite quickly, from 2.1x in 2007, to 1.5x in 2009. It compelled the board to first cut the dividend, then suspend it altogether. Similarly, in 2012: despite 9% increase in Revenues, the FCCR slumped from 2.0x to 1.6x. Again, the dividend needed cutting.

The leverage needs watching, lest it bite you in your financial caboose while you are busy counting your store numbers.


Don't get me wrong; I don't hate the stock.
It reminds me very much of ARB, CSL and REH in many ways.
But, like ARB, CSL and REH, it has warts (the difference, I think, is that NCK's warts are in places that are a bit harder to notice).

I'm mostly being the devil's advocate you were calling for.