Funding its customers

Lewis’ theory that N Brown is using cash to fund customer credit seems credible to me. And increased lending may be sufficient to explain why cash flows lag earnings over the last decade.

In 2011 the company had ''519.6m in receivables'' (i.e. money owed by customers) on its balance sheet amounting to over half the company’s assets.

Net cash from operations fell from ''91.7m to ''54.7m mainly because of higher receivables, and another cash-eating policy: higher stock levels to improve customer service.

I suppose he’s right, the provision of credit is another income stream for N Brown, so while it depresses current cash inflows as the company extends more credit (two thirds of purchases are on store cards) and waits for the money to come in, come in most of it should. Last year income from credit was ''195m, 27% of total revenues.

But I don’t like this income stream for two reasons:

1. There are limits to how much N Brown can grow this way without getting more into debt, which would make me uncomfortable, or raising money from shareholders. Indeed there are limits to how much it can grow this way without putting its customers in too much debt. The provision for bad loans in 2011 was 7.4% of sales, down from 9% the previous year and…
2. The interest rate on its store cards is 39.9%. I think they’re a bad product and some of the opprobrium reserved for pay-day loan companies and other non-standard credit providers should be shared with store cards charging predatory interest rates. Maybe one day the government will curb them, or maybe one day consumers will regulate their own behaviour.

It complicates the investment case. I wanted to add shares in a retailer but it’s also a finance company. N Brown is not unusual in diversifying this way, I suppose it’s a symptom of how competitive retailing is, but I don’t like it.

I haven't yet made up my mind whether that’s a reason not to add a company that looks impressive in every other respect to the Thrifty 30 portfolio, but it’s cooled my passion and reaffirmed my predilection for simpler business models.