United Carpets

One of the benefits of keeping some cash on hand is that you're able to take advantage of opportunities to buy businesses that have seen their share price depressed by irrational selling.  United Carpets looks like one of those opportunities. 

United Carpets is a company that popped up on a few screens I've been doing over the past year.  It has a healthy dividend yield, net cash, not obvisouly distressed trading, yet its P/E multiple was around 6-7x trailing earnings.  This is cheap, but in the darkest corners of the AIM market not ridiculously so for a small cap, so I added it to my watchlist rather than buy it outright.  Since then, I've watched it fall from 8p to 5p over the course of a few months, but on Tuesday it fell from 5p to 3.1p on heavy volume.  Normally this means something like a set of bad results, but there was no published news either from the company or from Bloomberg.  It's main listed competitor, Carpetright, has also not published any negative news.  Getting interesting...

UC only owns a few retail outlets outright, most of its revenue is derrived from franchise fees.  A quick browse of the web suggests this amounts to 10% of sales plus a fixed fee for advertising.  In other words, its not dependent on the profits of its franchises, and this has helped it maintain profitability throughtout the downturn, unlike larger rival Carpetright.  There are a couple of downsides to this arrangement.  First, it's not as exposed to any pick up in the housing market (and we're surely closer to the bottom than the top).  Second, its continued profitability is partly down to its franchises, who might be loss making themselves ( anyone who's look at the Coke bottlers or McDonald's in any detail will understand the importance of system-wide profitability).  However, according to the interim report it appears as though only one of UC's 82 stores closed in the last 12 months, so clearly the owners aren't struggling so much they are forced to close.

Valuation
Trailing 12m profits are around 580k, but as results in the 1H of this year were weaker we could be looking at full year profits of 500k.  The market cap at the price I managed to buy was £2.9m, implying a P/E around 6x earnings.  Current trading is said to be a little better (SSS up 4.4% in past 11 weeks) so its likely full year profits will be higher than this.  600k doesn't feel unreasonable, still below the 800k achieved last year.  This would put the business on 4.8x earnings.

This is cheap, but the strength of the balance sheet suggests we should also be willing to strip out the cash from the market cap.  Current assets are higher than current liabilities even excluding £1.7m of cash, bringing down the price we are paying for the 'earnings side' of the business to just 1.2m.  Now the P/E looks a fairly ridiculous 2x! 

I'm normally happy to strip the cash out of a business when you've got a sensible management team in place who are aligned with shareholders, and the high insider ownership gives me some comfort with this.  Up till this year UC were paying a 0.75p dividend (a 21% yield!) and I expect they will be keen to resume this once trading picks up a little.


Summary
This looked too good an opportunity to pass up and I purchased £2900 worth of shares, a fairly comical 70,000.   This makes it a fairly large percentage of the portfolio, but then again you don't often get a chance to buy a solid business on 2x! 

UV