Dixons Carphone meets low first half expectations

Dixons Carphone shares, nursing one of the retail sector’s deepest losses this year, are surging 8% higher on Wednesday, on relief that the group’s first half profits scraped in in line with forecasts. The stock price reaction also reflects a degree of regained confidence in management’s ability to track outcomes more adequately, after a perplexing forecast downgrade that, on the face of it, looks avoidable. Low expectations that have duly been met—just—are also flattering the share price. The group still has some way to go to convince the market that profits will grow again before too long.

First half profits before tax were £61m, against a range of forecasts that we assessed as £61.5m to £63m. That was still a sobering 58% collapse against same point in the year before but largely priced in by the stock already. That allows shareholders to celebrate robust underlying electricals sales across the group, up 7% in H1. These show that Europe’s biggest seller of white goods is maintaining share in its most profitable businesses. Confirmed strength in Dixons’ main market means views on its future positioning may not need to be revised too radically after all. A solid start to the trading year, again, throughout Dixons’ offerings, could even provide enough momentum for an upward surprise at April year-end. The advance of like-for-like sales in the most closely watched region, the UK and Ireland, is also encouraging, as is the measured two percentage point sales differential in H1, at 4%, vs. 6% in the first quarter.

Most important on the positive side are fruits of Dixon Carphone’s efforts to tighten cash management. These included reduced capex, but also low hanging fruit that really ought to have been grabbed earlier—improved stock management and even switched timing of working capital allocation.  The outcome is half-year free cash flow of £169m, against £69m at the same point a year before. Cash flow has been a lingering concern since the group’s formation three years ago. Cash generation by the main components of the group, whilst separate entities, peaked at £560m in 2013/14. Having had over two years to bed down the combination, the group still only managed to achieve £349m in 2016/17, with growth declining by 46% in the second half. (Please see Figure 1. below).

Source: Thomson Reuters and City Index

After the buzz from Dixons’ bumper Black Friday passes, we rather expect a watchful attitude amongst shareholders on matters like cash flow growth and lapses of alertness in the mobile business to keep a cap on the shares in the third quarter. We note the group revealed further impact from lower roaming charges that contributed to August’s profit warning. Dixons disclosed on Wednesday a £58m hit from changes in valuations of “network receivables”, together with the effect of changes in contract terms in third party insurance products. The ‘network receivables’ will be disliked by investors the most. This year’s profit downgrade was partly driven by scrapped European Union roaming charges, which slashed revenues over the life of mobile phone contracts. But the EU’s move didn’t come out of the blue and Dixons really ought to have foreseen the effect earlier.

The group has also nudged forecasts down further on Wednesday. It now sees full-year headline pre-tax profits within the range of £360-£440m, giving a midpoint of £380m. Whilst the shortfall to market forecasts is slight, it’s another mismatch that will keep investors wary. Dixons recognises that the mobile phone division “needs addressing”, and said it would “update the market in due course”. Doing so, even belatedly is likely to be welcomed by investors, though it may take longer for complete confidence to return.