During recession, up-market fabric designer Colefax is being run for income not, growth.

Creator / Landlord / Distributor / Broker

Colefax designs luxury fabrics and wallpapers under its Colefax and Fowler, Cowtan and Tout, Jane Churchill, Manuel Canovas and Larsen brands. About 12% of revenues come from decorating.

Bargain / Turnaround / Cyclical / Stalwart / Growth

Some of this year’s 50% decline in profitability was to be expected, the company’s decorating division earned exceptional profits last year thanks to the completion of major contracts and Colefax had warned the performance would not be repeated in 2012. In fact, 2012 was an exceptionally bad year, the decorating division made a small loss, and the company expects an improvement in the year to April 2013. But profits in its much bigger fabrics division also fell 25%. Colefax’s third biggest market, the eurozone is in economic distress and the company has absorbed some of the cost of cotton, linen and silk price rises dating from 2010. It would have been worse had the US dollar not appreciated 20% over the year because fifty per-cent of fabric sales are in the US.

Expectations

Executive chairman David Green does not expect a weak recovery in its biggest market, the US, and a hitherto sturdy performance in the UK, to compensate. In a competitive market, he is scaling back new product development to preserve cash flow, and presumably the dividend and buy back programme. Yesterday Colefax announced it is seeking to buy-back 11.5% of the shares by inviting shareholders to tender them, reaffirming that at least while economic conditions are challenging, Colefax is being run for income, not growth. Turnover is, essentially, flat over the last seven years.

Threats

competitive position – weak / neutral / strong
In terms of competitive advantages, the listing particulars (1988) say the expertise of its interior designers is used in product design. John Fowler (who died in 1977) invented the "English Country House" style and decorated Buckingham Palace, The Bank of England and numerous stately homes. His reputation must live on in the company he co-founded. But there are countless brands of fabric and wallpaper, with Colefax occupying a niche at the higher end of a very competitive market.

finances – weak / neutral / strong
Excluding the debt implied by sizeable operating leases, Colefax had no debt and a cash balance of ''8.5m in April 2012. Even after capitalising lease payments using a multiple of eight, debt is a modest 36% of tangible assets so it looks as though Colefax can afford its buybacks and survive more economic distress.

management – weak / neutral / strong
Chairman and chief executive, David Green owns 32.4% of the shares and has the experience and motivation to continue the company’s success.  He’s overseen the growth of Colefax and the acquisition (in the 1980′s and 1990′s) of its brands. Although he’s 66 years old, he appears to be committed to the business, and will tender little more than 2% of his shareholding in the forthcoming offer, when he could tender up to 11.5%.

valuation – cheap / neutral / expensive
Despite profit halving the share price hasn’t fallen nearly as far. Perhaps investors recognise Colefax’s many qualities. The shares aren’t obviously cheap or expensive on an adjusted 7 year earnings yield of 8%.

Thrifty 30

I won’t be adding more shares to the Thrifty 30 portfolio this time. While I still think Colefax is a good, well managed company the business is more cyclical than I appreciated and the shares aren’t obviously cheap. That leaves me feeling neutral towards the tender offer too. If management is not confident about investing money in expansion, returning capital to shareholders is the right thing to do but with the shares at around fair value, a special dividend would give investors the opportunity to invest in more undervalued companies. Since the Thrifty 30 has spare cash and I’m short of ideas at the moment, I’ll let the portfolio’s investment in Colefax ride and not tender shares.

The Thrifty 30
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More posts on Colefax
Colefax annual reports
Colefax worksheet.