is a sad business. It ain’t Ikea, which has the supply chain, brand, meat balls and scale advantage—not to mention it’s private so we cannot invest.
Here’s the 2 cents after glancing at DFS’ financials:
- High expenses, rising faster than revenue. 2019’s gross profit kinda stalled.
- Large goodwill—a half a billion pound —thanks to its private equity owners and acquisitions.
- It IPOed in 2015 because Advent, a private equity owner, needed to cash out. The stock has performed poorly since then.
- Leverage just increased to over 4x from ~2x because of new lease accounting rules. Yup, accounting hurts.
Companies like DFS will mention the word “digital” from the beginning, so you may think they are a “digital” company because “digital transition consultants” were paid too much money to help DFS be ready for the “digital” world. But it’s 2019 and everyone has a website.
Advent, a private equity company, bought DFS for £500mm in 2010 and IPOed it in 2015. Because private equity firms need to cash out when the times are good.
DFS’s top line has been growing. Notice that in the FY2019 press release on page 1 they talk about revenue, free cash flow and not operating expenses:
Maybe because they have been spending a ton of for that sales growth. As a result, its operating profit has been heading in the opposite direction year after year .
Also, gross profit—gross sales less cost of sales—stalled in 2019 compared to 2018 at around £500mm +/- a few million. Maybe people don’t need so many shiny new .
Selling, general and administrative expenses are and they are not trying to sell you a Peloton bike for £2,000+ and a monthly subscription. They sell furniture. How often does one need to buy furniture? Ikea sells mugs, pencils and all that junk you put into you large blue Ikea bag on the way to the checkout. You didn’t need all that extra stuff but a few spoons and a poster were so cheap. And Ikea does meatballs. DFS don’t sell meatballs as far as I’m aware. And what if people also buy chairs on Amazon?
Note to DFS - “brand contribution” is a not a metric.
There is a lot of goodwill—around £500mm. Most of its assets were goodwill, they are hidden in intangible assets in 2019’s press release. It’s not a software company, so did they come from overpaying for expensive sofa companies?
The Group holds significant goodwill in the business following the acquisition of the DFS Group in 2010 by Advent and the DFS Group’s subsequent acquisition of The Sofa Workshop Limited and, more recently, Sofology Limited. In addition, the Group has recognised the value of the respective brands of Sofa Workshop, Dwell, DFS Spain and Sofology as intangible assets.
Goodwill is a not real. It’s a plug variable to balance Assets on one side with Liabilities + Equity on the other side.
Who here loves accounting? As Professor Damodaran explains, goodwill can mean:
a. Misvaluation of existing assets: As we noted in the last section, if existing assets are misvalued, there will be goodwill even in the absence of growth. Consequently, the more existing assets are misvalued, the greater will be the goodwill.
b. Growth potential: Goodwill be larger, when you acquire a firm with greater growth potential, since the market value will reflect this growth potential but book value will not.
c. Overpayment by the acquirer: There is substantial evidence that acquirers over pay for target firms and this overpayment is attributed to multiple factors - managerial self interest and hubris, over confidence on the part of managers, and conflicts of interests. Whatever the reason, this overpayment, if it occurs, has only one place to go and that is goodwill.
In addition, its leverage—net debt over EBITDA presented by DFS themselves—jumped two-fold after IFRS 16 rules on lease accounting kicked in. DFS put it on Slide 14 in the bottom right corner for you.
This stock chart is very :