Card Factory: Be Greedy When Others Are Fearful

Disclaimer: We are shareholders of Card Factory.

How would you like to invest in a UK greeting cards retailer with its entire store base closed because of COVID? Yes, you have read that sentence correctly. And no, we have not gone mad. Pinch your nose and let us introduce you to Card Factory.

Elevator Pitch

Card Factory is Britain’s leading specialist retailer of greeting cards, dressings and gifts, with an estate of over 1,000 operated stores. It was set-up in 1997 to provide a lower cost, higher quality card  alternative to incumbent chains. Key to this formula was to vertically integrate the supply chain in order to lower production costs, shorten lead times and get more relevant card designs. These efficiencies were then passed onto the customer and allowed Card Factory to undercut competitors on prices by 50% to 70%. The business model was successfully rolled-out across the UK and the company went on to capture 33% of the market by volume (20% by value) in less than 25 years. Speaking of the market, it is important to understand that there is an ingrained culture of sending cards in the UK, with approximately 87% of adults purchasing cards and each person sending on average 20 of them per  year[1]. It is a macro-resilient industry, as demonstrated by its growth throughout the GFC[2], and volumes have been rather stable despite increased online communications (down only 5% since 2012). Online penetration so far is low at 14% and is essentially focused on categories unavailable in stores. Given the highly experiential component of a card purchase (touching and comparing) as well as the c.£5 average basket value, we expect it to stay low in the longer-term. We therefore believe that Card Factory’s business should come back to near historical levels post-COVID and potentially better (two of its biggest competitors are in administration and plan to significantly reduce their footprints). Do not mistake us, Card Factory is far from being a good business, it has flat to slightly negative like-for-like sales while costs creep up by 2-3% per year, meaning constant margin pressure. On the other hand, everything has a price and despite its challenges, the company should generate c.£45-£50m of free cash flow in the medium-term (for a £110m market capitalization). Mr. Market however hates uncertainty and is so focused on the group’s near-term cash burn and debt load that no matter the price, it is simply unwilling to buy the business. Unsurprisingly, Card Factory trades at 2x normalized earnings. Our work on cash burn indicates that the business has enough liquidity to last until end of May with its stores closed while our analysis of COVID new cases, hospital ventilator beds occupancy and vaccinations indicates that the UK lockdown should be lifted by early/mid-April (an announcement is expected in the week of the 22^nd of February). We believe that this is a typical case of ‘time-horizon arbitrage’, where high uncertainty is mistaken for high risk. This set-up provides one of the best risk/reward we have ever seen, with immediate and tangible catalysts that could propel the shares significantly higher: If we are right, we believe the stock can quadruple and trade at 8x normalized earnings (Card Factory traded at 11x-12x earnings in 2018 and 2019) for a 12% free cash flow yield. If we are wrong, the business will need to raise up to £40m (c.35% dilution at current prices) to make it to the other side of the lockdown. At a similar 8x P/E, the shares would still end up being a 2.5 bagger.

Argentex: a low-cost high-service FX provider ready to take on high-cost low-service banks

Disclaimer: We are shareholders of Argentex. 

Elevator pitch:

Argentex delivers tailored foreign exchange (“FX”) advisory and execution services to UK corporates engaging in non-speculative, commercial currency transactions. As a riskless principal broker, the company only acts as an intermediary and makes money on the spread between the rate it executes the trade at and the one passed on to the client. It has a market capitalization of GBP140m and generates GBP29m of revenues from spot, forwards and options. Banks have 85%+ of the market today but this is eroding fast: FX is a marginal vertical for them – most of their money is made on equity/debt raise and M&A – and therefore client service is poor (FX desks are cut every year) and pricing uncompetitive (150 bps for a spot trade vs. 20bps at Argentex). As one of the best capitalized independent FX broker in the UK (GBP20m net cash as of Sept-20) and with a large, highly incentivized salesforce, we think Argentex can disproportionately benefit from this market share shift and grow at 25%+ p.a. for at least the next 5 years. Argentex’s economics are excellent, with 40%+ EBIT margins and 90%+ ROIC (adjusted for cash required for collateral purposes during the year). With little need for capital reinvestment, we think the company has a clear path to a 29% FCF CAGR, reaching GBP 38.8m by March 2026. Applying an 8% FCF to EV yield leads to an intrinsic value of GBPx 510 per share, or a 33.1% IRR on capital invested from current levels (GBPx 122 per share). Additionally, the company has just entered the European and Australian markets, providing for material upside optionality if it can replicate its model successfully. Finally, insider ownership is high with the three Founding Partners owning 25% of the company. They have significant knowledge and experience in FX markets and are all involved in the day-to-day operations of the business (2 co-CEOs and 1 Managing director).