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Deep value investing is not risk-free. Premier Farnell (LSE:PFL) comes with considerable risks.
Profits have more than halved over five years
In addition, gross profit margin has declined by 5% points to 34.4%, and return on assets is down significantly. Something seems to have affected the industry because the arch-rival, Electrocomponents has also experienced profit and margin falls, but not nearly as severely at Premier Farnell. Is it just macroeconomic doldrums or something more fundamental?
Is this its Tesco moment, i.e. a resetting of gross margin and ROCE expectations at a much lower level due to a significant shift in the competitive environment? I cannot rule out this possibility, but there are some reasons to hope for a turnaround.
First, as far as I know the industry is not subject to the shock of new entrants pushing on prices, as Aldi and Lidl did in the supermarkets sector. The lowered margins seem largely self-inflicted caused by previous directors going for “top-line growth” and then finding themselves having to discounted stock to shift it.
Second, this week Electrocomponents published an encouraging trading update, with sales rising 3% and “we have continued to see a stabilisation in the gross margin with year-on-year decline reducing to 0.4% points [in the final quarter]”.
Perhaps the two major players recognise the importance of staying away from price competition.
Then again, I could be too optimistic and these two are about to enter a period of even greater price competition – implicit non-spoken “agreements” to high industry margins are delicate things.
Also there are many established larger firms whose product and service offering overlap with Premier Farnell, e.g. Arrow Electronics, Avent, Rexel, Mouser, Digi-key and Acal. These could pose a real threat to the margins achieved by PFL and ECM.
Despite my optimism, dawn is some way off – here is a statement from the 2016 prelims:
“Looking ahead, we expect global market conditions to remain variable and are not anticipating any near-term diminution in in the competitive pressures on our businesses. We are focused on implementing the actions…in order to stabilise our gross margin and reduce operating costs. Whilst we expect some gross margin decline, we anticipate making progress during 2016/17.” Not exactly brimming with confidence for the short term are they?
Disintermediation
Could supplier companies sell directly to PFL’s customers, cutting out the middleman? Anything is possible, and for some (volume) product lines it might make sense. But when the customer needs a range of 600,000 products to choose from and makes orders amounting only £170-worth at a time, it unlikely to be attractive for either manufacturer or customer to get together. It’s far better to have PFL offer the range and distribution capability as well as the expertise and advice forum.
Unbalanced Board
The board consists of people with sparkling CVs that might make a fund manager in the City happy. But the overall balance does not make me happy.
None of them has experience of working on the front line in this industry. The nearest is Mark Whiteling………To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
