Description

“Life is like a box of chocolates, you never know what you’re going to get.”  At first glance, CARD is the least appealing chocolate in the box.  After all, it’s:

• A UK microcap retailer

• 100% reliant on brick & mortar stores for EBITDA (online ops not yet profitable)

• In a no-growth end market

• Not paying a dividend

But take a bite and you’ll find:

• It’s grown by taking market share every year since founding in 1997 (ex-Covid)

• The competition is weak

• A solid balance sheet (now able to resume dividends or repurchase shares)

• Its ROCE is so good the numbers look silly

• It’s run by a highly-competent CEO

• It’s cheap, even for a UK microcap retailer: ~6x LTM FCFE

Please note: 

FYE of January 31st  (FY24 is basically CY23 - January isn’t a big month for card sales).

Trades on the LSE main board, not the AIM

All figures are adjusted to remove the effects of IFRS16

UK greeting card market

The average Brit sends over 20 cards per year.  1/3 of all cards sold (both online and off) are sold by CARD,  1/3 are sold in supermarkets, and 1/3 are sold by all other players (Clinton Cards, Paperchase, Moonpig, Funky Pigeon, Thortful, et al).  The UK single-card market is roughly £1.4 billion, with another £0.2 billion coming from boxed cards.  

By value, CARD is also the market leader, with 20% of the market, followed by Clinton Cards and Paperchase at 9% and 2%, respectively. The remaining players are grocers and other high street retailers (57%) and then online specialists (12%).

While Baby Boomers continue to buy the most greeting card units, Millennials have spent the most money on greeting cards since 2015.

Covid-19 saw online players take a lot of share, especially Moonpig Plc (LSE: MOON).  CARD was late to online due to the previous CEO’s ineptitude, and temporarily lost share due to lockdowns.  Today, MOON has about 2/3 of UK online sales vs CARD in the single digits, but CARD is investing heavily in online now.  I’ve noticed that shopping on the website is a much smoother experience than it was just a short while ago.

Around 65% of cards sold online are personalized, compared with less than 10% of those sold in retail stores (e.g. family photo sent to your relatives).  The average online card price is about 2x that of offline, so 7.5% of volume = 15% of market value, down from a peak of 19% during Covid.  The rising cost of postage in the UK makes cards somewhat online-resistant.  A 1st class UK stamp now costs £1.25 (= $1.58) … up 68% in the last 4 years.

(Above data comes from OC&C Strategy Consultants via Moonpig Plc - CARD has also hired OC&C and the data CARD presents show a larger share gain by online sales during Covid.  I’m not yet sure why.  I think the Moonpig numbers are probably more accurate.)

Let’s face it – most greeting cards are a rip-off.  Why?  Because Hallmark and American Greetings (hereafter, AG) control most of the distribution and they’re greedy.  (This is true in the US as well.)  This is a sector ripe for disruption, which is what CARD has been doing for over 25 years now.  From the low-end to the mid-range of price points, CARD sells equivalent-quality cards at half the price and still earns pretax margins in the low-teens.

Weak competition is one of the secrets in life.

Warren Buffett

Most card sellers in the UK buy their cards from Hallmark and AG, who supply all the cards and the displays but take around a 40% cut.  With CARD at a 20% share by value, and growing at just ~1% of the market per year, Hallmark and AG don't want to cut price, as they’re margins would suffer so much that they’re better off milking a declining but high-margin revenue stream (reminds me of PitneyBowes vs Stamps.com back in the day).

The Clinton Cards retail chain is owned by the same family that owns AG.  Clinton's has been in administration seven times, and keeps getting bailed-out by AG to preserve the distribution channel.  Since being saved by AG in 2019, Clinton’s has shut 156 stores.  Now, 38 of the remaining 179 shops are also slated to close.

There were 106 Paperchase stores in the UK and Ireland before Covid-19, and now there are none.  Their IP was bought by Tesco (a grocery chain) in January 2023.

Business model

CARD operates the only vertically integrated model at scale.  They design 75% and print 80% of their own cards at their printing facility in the UK, which is 20km from their headquarters.  New ranges can be produced in as little as 4 weeks and quick-selling lines can be replenished in just days.  A few years back they installed an electronic point-of-sale (EPOS) system, and last July they finished installing a new ERP system.  Putting this all together, you have a company that sells far more cards than any competitor, which knows right away what the sales trends are, and can react to them faster than anyone else.

CARD leases all of its stores, with an average lease term of only ~3 years.  Less than 1% of stores are loss-making.  Working capital is negative.  Thus, the business is basically financed by the landlords and their suppliers.  

As you can see, the ROCE is so good as to look nonsensical.  I’ve tried to bring the numbers down-to-Earth by also calculating with gross PP&E (ex software) rather than net PP&E.  15% of that gross value is land, 27% is leasehold improvements, and 57% is plant, equipment, fixtures, and vehicles.  Their printing facility is part of that 57%.  Since CARD is just now doing its first store refresh since it was founded over 25 years ago, I suppose they might be over-depreciating those leasehold improvements and fixtures a bit to save on taxes.

50% of sales come from cards – almost all single cards vs boxed cards.  Single cards are the most profitable items: product margin (i.e. revenue minus COGS) is 84%, party stuff (e.g. gift wrap, bags, balloons, etc.) 63%, boxed cards 57%, ancillary products (e.g. stamps, carrier bags) 6%.  About 50% of COGS is in USD - not really the cards but the other stuff, which is mostly made in China.  CARD hedges its currency risk and this hasn’t been much of a problem in the past.

Stores:

• 1,043 stores in the UK and Ireland as of July 2023 (maybe 1,050 today).

• 1,149 partner locations with Aldi and Matalan in the UK, plus The Reject Shop in Australia.

• Recently acquired 23 stores in South Africa for £2.2m

• 4 franchised locations just opened in Dubai and Abu Dha  

Brief History & Management

Founder Dean Hoyle opened CARD’s first store in Wakefield in November of 1997. He sold the business to PE firm Charterhouse in 2010 for £350m when it had 430 stores and around £200m in revenue, with pretax profit of £30m.  CARD then went public in May 2014 at £4 per share.

In late 2008 they acquired 80 stores from a bankrupt competitor, and in 2009 they acquired their printer to get to the business model they have today.

Former CEO Karen Hubbard succeeded Richard Hayes in January 2016, and her tenure was a disaster. The company was over-leveraged and underperformed operationally for over 4 years.  Then Covid hit in 2020, and Hubbard was forced out that June.  Finally, in December 2020, CARD announced a new CEO: Darcy Willson-Rymer, who joined on March 8, 2021.

Darcy is about 58 years old.  Previously, he ran UK operations for Starbucks and KFC, then tried to turn-around Clinton Cards in 2011-2012 but was unable to save it from bankruptcy.  He then became CEO of Costcutters (a private convenience store/supermarket chain) for 9 years.  He left with sales at a record high and a big jump in profits.

Darcy steered Costcutters through a crisis when its main supplier (Palmer & Harvey) collapsed in 2017.  P&H gave Costcutters 24-hour notice that they were pulling the plug on their relationship, yet within 24-hours, he and his CFO managed to strike a deal with a co-op and make sure that the stores were supplied and open on time.  (Note that Darcy has since brought that CFO over to CARD.)

Due to Covid-19 lockdowns, stores were open for only 48% of 1H21 (ended July 2020), and 60% of 1H22 (ended July 2021).  CARD was forced to do a refinancing deal with its banking syndicate that required it to raise £70m in either equity or subordinate debt.  As a new CEO, I think Darcy could have just done a deck-clearing equity raise and few Board members and/or large investors would’ve complained much.  Instead, he managed to squeeze every last bit of cash out of the business, paid down a bunch of debt, and got the banks to agree to waive the requirement to raise new capital.    

And while they were doing all of this, CARD installed the first of a two-phase installation of a new ERP system, and it went off without a hitch.  I hope all of this demonstrates why I’m comfortable with management. 

3 initiatives unveiled at the May 2023 CMD

The initiatives are: stores, online, and partnerships.  Maintenance capex for CARD is ~£12m a year.  Starting in 1H24 (Feb-July 2023), CARD began spending on growth capex for these initiatives at the rate of another ~£12m per year.  The goal is to boost store revenues by £80m at a pretax margin of 25%, online revenues by £30m at a margin of 27%, and partnership revenues by £80m at a margin of 13% margin, translating to ~£29m of additional net income by FY27 (basically, CY26).  

Thus, the total annual capex budget through FY27 (~CY26) is now around £8m for stores, £3m for online, and £13m for infrastructure & printing capacity.

Initiative 1) grow and improve stores

CARD plans to grow the store count by 90: 77 in the UK and 13 in Ireland, increasing store sales to £520m in FY27.

Meanwhile, management has been offsetting cost inflation through a combination of productivity and price.  The UK’s average National Living Wage increased 11.1% in FY23 and 9.3% in FY24.  CARD didn’t raise prices during FY16-20.  But after rolling out the EPOS system, they experimented with price increases in test stores and saw only slight declines in volumes, and so they began raising prices on certain cards beginning in FY21.  Sometimes the price point was raised, other times CARD has used a “shrinkflation” approach where they’ve taken costs out of cards without changing the price point.

Phase 2 of the ERP program was completed in 1H24, providing CARD with the ability to view stock in all areas of the business and enable integration with future partners, both in the UK and internationally.  In addition, wifi is being introduced in all stores, along with wireless points of sale so that staff can take payment on the shop floor and reduce lines at the register.  Finally, CARD made significant investments in store managers during FY22, including talent reviews, an increase in pay rates, and a new sales incentive which was aligned to the step-up in the accountabilities of that role.  Store manager turnover has since declined from 9% to 3%.

As a result of all this, CARD has managed to reduce its COGS as a % of revenue, while containing wages to 24%.

In addition, the company is rolling out 3 “waves” of store improvements, largely to boost the sales of gifts.  70% of greeting cards sold in the UK are given to someone along with a gift.  Currently, just 17% of CARD’s customers that buy cards also buy a gift while in the store, so management wants to increase that attach-rate.  Their design team is now focused on creating card+gift combinations.

• 1st wave shifted about 7% of space from cards to gifts and celebration essentials, and was completed in January.

• 2nd wave is a “display reorganization” which moves cards to the perimeter and gifts to the middle of the store, across from related cards.   50 stores were scheduled for FY24 (ie ~CY23), with the rest to be done by FY27.

• 3rd wave is an update to store design, which will be used in new stores and a select number of full refurbishments.  The costs of this are in-line with existing refit costs.

Initiative 2) Online

In 2011, CARD bought gettingpersonal.co.uk, which is focused on gifts.  It typically does around £16m in sales at a 16% EBITDA margin, but lost £1.5m in FY23.

CARD scrambled to launch its own online channel during Covid, and so the job wasn’t done as well as it could be.  Online grew to about £11m in sales during Covid and made a small profit.  In FY23, it did £9m sales and lost £2.2m. 

As mentioned, they’re now investing about £3m per annum over the course of the next 4 years.  The next couple of years are expected to be loss-making before turning profitable around FY26 (~CY25). 

Customers can now place an order online and pick-up in store - a service called Click & Collect (CNC), which was fully rolled-out across the UK in April 2023 and is included in online revenue.  At first, CNC was a 3-5 day service, but this should reduce to next-day or even same-day now that Phase 2 of the ERP system is online.  CARD can now see exactly what it has in-stock at each store, allowing them to do ‘picking’ in store vs shipping the order to the store.

The cost of a first class stamp in the UK has risen by 68% in the last 4 years alone.  CNC means customers can avoid the cost of postage, which now adds over 12% to the average order value for online sales.  As mentioned above, CARD can also now avoid the cost of postage on CNC order. 

So far, 9% of CNC customers make additional purchases when collecting their orders in-store, and the basket spend of these customers is typically 25% higher than the average in-store basket.

Initiative 3) Partnerships

I expect around £15 million in partnership revenue in FY24 (ended this January), which would be the first £10 million of the planned £84 million increase expected to come through FY27.  Growth is expected to be back-end weighted over this timeframe, and will require a number of new deals to be signed. 

There are three models for partnerships.  The first is wholesale, with products in store, either Card Factory-branded (as with Matalan today) or white-labeled (as with Aldi).

The second model is franchising.  In addition to 4 existing franchise stores (Isle of Man, Gibraltar, etc.), CARD recently signed a deal with Leeward Trading Enterprises to open circa 36 Card Factory-branded stores over the next 5 years in the Western part of the Persian Gulf.  This comes at little to no cost to CARD.  The first 4 opened in 1H24.   Note that the CEO has lots of experience in the franchise business model from his time at KFC and elsewhere.

The Middle East is a good fit, since the average selling price of cards is around £4.20 compared to just £1.11 for CARD in the UK.  Also, the Middle East has a strong gifting culture, with an average of 90% of customers buying a gift when they purchase a card.  

Valuation

Currently, CARD is capable of generating over £50m of FCFE in a normal year, but Covid-19 and its after-effects obscure this.  In the financials above, I’ve made a number of adjustments to make this more clear.  So as you can see, CARD is trading at 6.1x LTM (Jul’23) adjusted FCFE, and 5.9x EPS.  Even if none of the 3 aforementioned initiatives pan out, the shares are just too cheap.

Moonpig is CARD’s biggest online competitor.  Like CARD, it’s a good business with high FCF conversion.  But in recent years, Moonpig’s growth has largely come by acquisition.  Its EV/EBITDA is 9.7x with almost 2 turns of debt vs CARD at 4.9x with 0.7x turns of debt (all on estimated CY23 numbers).  I’m not sure this discrepancy makes sense: by Moonpig’s own estimates, online is going to take only 1% of the market for single cards each year through CY26 (ie 15% to 18%).

Upcoming catalyst?

In the FY23 Annual Report, management said the following: 

The Group remains prohibited from making distributions under the terms of its financing facilities until such time as the CLBILS and Tranche 'A' of the term loans are fully repaid. ...The final maturity date for Tranche 'A' of the term loans is 31 January 2024 … the Board envisages recommencing dividend payments at a level of 2-3x dividend cover based on profit after tax

CLBILS and Tranche’A’ are the last pieces of the onerous debt that CARD was forced to assume during Covid.  The former was fully repaid on 9/25/23, and only around £8m of the latter remained at 7/31/23, so I assume this was paid off in January.  I suspect that management will announce a plan for returning capital at the upcoming FY24 earnings release on April 30th (no guarantees, though).  At the target 2-3x cover, this would imply a dividend of 4.5p to 6.7p (4.8-7.2% yield) on the diluted share count.

But might they do a buyback instead?  From the latest earnings call:

There's a question here around - does management think the share is undervalued and any thoughts on buyback rather than dividend. I think that is a debate that will continue forever.  And clearly, we will -- we consult our shareholders.

Also, there’s a chance CARD could rejoin the FTSE 250 index, which is rebalanced quarterly.  Based on today’s market caps, CARD would need to trade to 11.3x FY24 (~CY23) earnings to be included - not inconceivable, especially if dividends resume or buybacks begin.

I’m not a smart man, Jenny, but I know what value is.

Catalyst

CARD resumes paying dividends and/or buys back shares - might announce this at upcoming April 30 earnings 

Potential to rejoin FTSE 250 Index

CARD could start using ChatGPT to write the drivel on the inside of each card and change its name to "AI Card", causing the punters on Reddit to go bananas.