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Frasers Group - resolves Belgian tax claim

Sophie Lund-Yates, Equity Analyst | 24 April 2020 | A A A
Frasers Group - resolves Belgian tax claim

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Frasers Group plc ORD GBP0.10

Sell: 464.80 | Buy: 465.20 | Change 13.60 (3.01%)
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Frasers Group has reached a commercial settlement with the Belgian Tax authority. As a result the €674m of disputed VAT and penalties have been settled for an "immaterial amount".

The group chose to resolve the matter now as it was affecting its banking lines and suppliers' credit insurance. Due to store closures as a result of Covid-19, the majority of new credit insurance cover has been withdrawn.

Frasers also announced that it has not been accepted as eligible for the government Covid Corporate Financing Facility.

The shares fell 2.6% following the announcement.

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Our View

The newly renamed Frasers Group, formerly Sports Direct, faces some real challenges. We're as yet unable to quantify the fallout from COVID-1, but we do know revenue and profits are going to be significantly disrupted.

We also wonder how the disruption is going to delay the group's transformation programme.

Prior to the pandemic, the group had been focussing a lot of energy turning around its eclectic mix of acquired retailers. Among them are big, but largely unloved names from up and down the UK high street.

Integrating the likes of House of Fraser, GAME Digital and Jack Wills into the Sports Direct family is part of Mike Ashley's vision to become a "multi-brand, multi-category" retail powerhouse. The problem is, it's not immediately clear whether the vision is actually all that attractive and heavy investment means there was no dividend on offer, even before coronavirus disruption.

But given Ashley owns over 63% of the shares, what he says goes regardless of any bugbears.

However, underneath the mismatched businesses lies a sound sports retail operation that generates tons of cash. We'd prefer if more attention was given to this area of the business.

The group's turnaround plan, the "Selfridges of Sport" initiative, calls for new freehold 'flagship' stores, displaying products in a more flattering environment. A better store environment should, in theory, allow the group to charge more for its products and heal Sports Direct's troubled relationships with the major sports brands as well. That gives Sports Direct access to more premium products, or so it hopes, which are more profitable.

Prior to the outbreak the new format seems to be going down well - although, possibly due to the challenging retail environment, it's hard to see evidence of that in the numbers. Underlying profits are being driven by self-help measures like cost cutting. While that's good going, it can't be relied on forever, and at some point the group needs these swankier stores to contribute more meaningfully to group performance.

Overall making Mike Ashley's vision come true probably means management giving the core business some more TLC. COVID-19 means that's unlikely to happen at the moment. Until things get back to normal it's hard to say what the implications are for the turnaround, or for that matter, the business at large.

At the time of writing the shares now changed hands for 11.8 times expected profits, below the ten year average of 14.8.

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Previous COVID-19 updates

COVID-19 means Frasers Group can no longer provide financial guidance for this year, and it no longer expects to deliver 5-15% underlying cash profit growth.

The outbreak is assumed to result in a significant impact, including reduced customer footfall. Year-to-date performance had been in line with expectations prior to the outbreak.

Frasers Group also announced it's suspending its share buyback programme with immediate effect.

This is in response to actions the government has taken in recent days, and the likelihood of further measures.

Half year results (16 December 2019)

Group revenue rose 14% to £2bn, however this includes acquisitions of GAME digital and Jack Wills. Without these, revenue declined 6.4%.

Underlying cash profits rose 15.1% to £181.2m in the first half, excluding the impact of acquisitions and exchange rates. That reflects reduced losses in the Premium Lifestyle and European Retail divisions. Underlying pre-tax profit reached £101.8m.

The core UK Sports Retail division saw revenue rise 6.7% to£1.2bn, but stripping out the impact of acquisitions, revenue was down 8.6%. Despite an improvement in margins from more profitable products, underlying cash profits dropped 5.3% to £140m, reflecting the cost of acquisitions.

Sports Direct continues the roll out of its elevation strategy, which will improve store formats in the UK. 10-15 of these rejuvenated stores will open during the year.

European retail revenues reached £365.5m, down 6.1% excluding acquisitions and currency movements, as the group moved towards higher priced, higher margin products. Underlying cash profits in the division rose 64.7% to £32.9m, reflecting lower operating costs.

Wholesale & Licencing achieved underlying cash profits of £16.5m, while Premium Lifestyle and Rest of World saw losses reduce 80.7% and 49% respectively.

Higher profits contributed to higher free cash flow of £162.3m. Net debt decreased to £254.4m from £378.5m, reflecting higher profits and the sales and leaseback of the Shirebrook warehouse, and is equivalent to 0.8 times cash profits.

The group continues to cooperate with Belgian tax authorities to resolve a potential €674m VAT bill. Sports Direct maintains this issue will not lead to any material charges.

Sports Direct said House of Fraser is "all but fully integrated" into the wider group, but further closures are to be expected.

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This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.