Topps Tiles — Covering the bases…and walls

Management believes TPT’s competitive strengths of having a market-leading omni-channel proposition (in a market with limited disruption from technology), nationwide coverage, specialist expertise in ranging and sourcing of products, world-class customer service and diverse market exposure should enable the company to continue to take market share and expand into new and complementary product categories. It has an ambitious updated growth strategy, which includes further improving the productivity of the store base and leveraging its product expertise into other markets, such as online and commercial.

We look for a good rebound in revenue and profit in FY25 and FY26, following a weak FY24 due to the macroeconomic environment (evidenced in TPT’s H124 results and Q324’s trading update). We assume revenue growth of c 7% pa as TPT laps weak comparatives and the benefits of Mission 365 come through. The assumed growth rate is at the low-end of the required CAGR of 7–9% to reach the Mission 365 revenue goals of £345–385m. This indicates that greater growth is required in the later years of the plan. Following our expected halving of adjusted PBT (company’s definition) in FY24, we forecast a strong recovery of c 50% growth in FY25, followed by c 25% growth in FY26. This takes our FY26 estimate to £11.0m, implying greater growth thereafter to reach management’s goal of £30m by the end of Mission 365. We reduce our dividend estimates for FY24 and FY25, due to FY24’s weak trading, noting the dividend policy includes a maximum payout of 100% of adjusted earnings.

We look at TPT’s valuation from three perspectives: our DCF-based valuation, TPT’s prospective multiples compared to other retailers and the company’s own history. Our base DCF valuation, which assumes TPT achieves £30m of adjusted PBT by FY29, is 108p per share. Beyond the explicit forecast period, we assume 2% pa revenue growth to and beyond FY29. We also incorporate a lower reported operating margin in our terminal year of 8% (vs 9.6% in FY29) to allow for some cyclicality in our long-term valuation. Our weighted average cost of capital (WACC) of 8.5% includes a risk-free rate of 4.1%, market risk premium of 4.8% (source: Damodaran) and beta of 1.9 (source: LSEG Data & Analytics). We also compare TPT’s prospective multiples to other retailers and find that its EV/sales multiple (including leases of 0.6x) is in line with its peers. This is despite generating a higher gross margin and comparable operating margin, and TPT has the potential for a re-rating to more than 1.1–1.4x, if it achieves its financial goals. Relative to the company’s own history, its EV/sales multiple (excluding leases) is at a significant discount relative to its growth and margin potential.

Given the nature of its product and customer bases, TPT is exposed to the macroeconomic cycle and trends in spend on housing and projects. It is also developing multiple new business verticals, with a good, but not perfect, track record so far. Aspirations to move into further niche, but complementary markets present further execution risks. An active majority (29.8%) shareholder that has been very vocal about potential change represents an overhang to the share price given it has not been successful at gaining representation on the board due to conflicts of interest with its trading businesses. The majority of TPT’s products are sourced overseas and, therefore, it is exposed to foreign currency changes versus sterling.

Topps Tiles is the market-leading specialist retailer and distributor of wall and floor (internal and external) coverings, and related products (tools, grouts and adhesives), to retail, trade and commercial customers (architects, designers and contractors) in the UK.

Since its IPO in June 1997, TPT has grown its store base and taken market share on a relatively consistent basis. Since 2017, it has increased its addressable market on several occasions so it services the needs of commercial operators across many sectors, in addition to its core customers (tradespeople and homeowners). As part of TPT’s Mission 365, management is entering new product categories in complementary verticals: hard wall and floor surface coverings and related products.

Structural growth drivers include the increasing usage of tiles in more rooms in a house, the health and hygiene benefits of tiles versus soft floorings, the growing use of under-floor heating systems and rising consumer interest in home improvement. According to the Department for Levelling Up, Housing and Communities, the UK’s average housing stock is aged 70 years and, therefore, management believes there is a significant and growing need for repair, maintenance and improvement (RMI) spend.

TPT is exposed to the macroeconomic cycle (revenue declines in FY09, FY20 and FY24e) and trends in the residential housing market (see Exhibits 8 and 9) and business profitability and confidence.

TPT’s head office and main warehouses are in Leicester and it employed an average of 1,748 employees in FY23.

We described the development of the company in our initiation.

TPT reports revenue in three verticals, with the potential to add further verticals via M&A:

With the release of H124 results, management announced Mission 365, an ambitious medium-term (we believe up to five years) strategy and financial goals. TPT has increased its addressable market by 75% to £2.1bn (from £1.2bn) to incorporate hard wall and floor service coverings, and related products, in addition its traditional product categories. Management achieved its prior goal of growing TPT’s market share to 20% by FY25 two years ahead of schedule, so it has a good pedigree with respect to delivering on strategy and goals.

Mission 365 includes five key areas of focus:

In addition to the incremental revenue from the five areas of focus, management included some expected recovery in its markets to arrive at its long-term revenue goal of £365m (average of indicated range of £345–385m) with CAGRs of c 7–9%, if achieved over five years. The expected incremental revenue from market recovery/growth and pricing of £10m represents only 4% growth from the indicated FY24e market consensus at that time and looks conservative in the context of the 6% reduction in revenue we forecast in FY24.

Management is also focused on profit growth, with the goal of achieving a minimum of £30m of adjusted PBT, an attractive CAGR of just under 40% over five years from our FY24 estimate. The goal assumes an adjusted PBT margin of 8–10% across all three businesses, indicating adjusted PBT of £27.6–38.5m, if the margin goals are taken literally. However, TPT’s definition of adjusted PBT differs slightly to our own as we exclude share-based payments and amortisation of acquired intangibles.

Mission 365 is built on the belief that TPT’s ‘Leading Product’, with a high level of customer service from ‘Leading People’, will enable it to sell more products to additional customers.

Management believes its success in gaining market share has been underpinned by ‘industry-leading’ levels of customer service. The ‘Leading Product’ is both a building material, that requires technical knowledge, and a decorative item. Therefore, a key focus of TPT’s staff is to provide inspiration to customers by using in-store design tools (also available online) that help clients visualise how their rooms and exteriors might look.

Topps Tiles has two distinct, but related, customer groups that are both served in a common space, despite their differing needs. Homeowners visit stores infrequently and will go a store three or four times before making a purchase, while tradespeople tend to visit more frequently, even multiple times a week by the most loyal traders.

The Environmental Leadership ambition, to be carbon balanced by 2030, was established at FY21’s results.

‘Strategic Enablers’ is a new addition, reflecting the internal investment and operational changes required to generate the incremental revenue and profit growth. From an infrastructure perspective these include a three-year investment programme from FY25 in a new enterprise resource planning (ERP) system, warehouse management and store systems, customer engagement platform and trade app, as well as supply chain infrastructure (ie warehousing). The costs for warehousing (estimated at c £5m) and for new tills (required as a result of the ERP systems investment of £1m) will be capital expenses, while the cost of the other items (estimated at less than £3m) will be expensed through the income statement. In addition to the investment in infrastructure, management will increase its investment in marketing and new skills, including specialist central roles.

In the video below, CEO Rob Parker and CFO Stephen Hopson provide an overview of TPT’s new strategy and of H124 results.

Management believes TPT’s market leadership in wall and floor coverings (and related products) is due to having the most extensive range of tiles (c 2,000 stock-keeping units, SKUs), which are mostly exclusive to the company and are refreshed more regularly than its competitors.

Management aims to offer high-quality products that are innovative and exclusive to TPT. In FY23, 77% of the ranges sold were either own-brand products or exclusive to the company.

TPT’s addressable market increased by 75%, from £1.2bn to £2.1bn, by expanding into hard wall and floor surface coverings and related products. This acknowledges changes in customer behaviour and new product categories introduced in recent years following M&A. TPT’s more traditional core products, such as ceramic tiles, are being used in more ways inside and outside the house and homeowners are choosing hard surfaces across more of the home at the expense of carpets. The majority of the product categories are new to TPT but some are sold in small quantities already.

According to management, TPT’s product innovation credentials stem from the company’s strong relationships with its suppliers as TPT works collaboratively to develop its own brand and exclusiveproducts. TPT imparts insights on new customer trends and ideas and the suppliers provide the technical knowledge and production capability. The company has been proactive in leading many manufacturing and design innovations in the tile market. For the new product categories, management has either sourced product ranges or established the supplier relationships.

In TPT’s core categories, there are around 20 long-term strategic partners, from which the company sources around two-thirds of its tiles every year. TPT also has relationships with over 100 other tile suppliers. The new categories can be sourced from existing suppliers or from suppliers with whom TPT had a historical relationship.

TPT currently sources globally. Historically, the most significant countries have included Spain, Italy, Turkey and Brazil, but sourcing naturally moves to take advantage of the suppliers’ abilities and regional changes in costs. In recent years, supply from Egypt and India has increased as management sought countries less exposed to input cost pressures, such as gas, which is a significant cost in the manufacture of tiles. This flexibility led to a significant reduction in supply from the strategic supplier base to 66% of the total in FY23 from 73% in the prior year.

As most tiles sold in the UK are imported, TPT and all of the other retailers are exposed to changes in FX rates relative to sterling. TPT manages its euro and US dollar exposure by purchasing forward FX contracts for its anticipated purchases in six months’ time.

Omni-channel is the divisional name (since FY22) for the group’s core and largest trading business, Topps Tiles. Online and physical presences are equally important as almost all sales involve a store and many customer journeys begin online.

The store rationalisation from FY17 involved a reduction or elimination of stores in towns and cities where there were too many locations, with the aim of migrating a good proportion of sales to the remaining stores. At 304 stores, management believes the number of locations is about right. 80% of the population are within a 20-minute drive of a Topps Tiles store, which is more important for trade customers than for retail customers, as the latter are more likely to travel further when upgrading their houses. With three times as many stores as the next largest tiles specialist, management believes TPT’s store base represents a competitive advantage versus all peers, offline and online. The company also enjoys flexibility in its store base, with an average unexpired lease term of three years.

The success of the rationalisation portfolio can be seen in the general ongoing improvement in sales per average store, before the recent macroeconomic-induced downturn in trading. The £760k annualised in FY23 was 30% higher than FY19’s (pre-COVID-19) £585k and the £689k for H124 remains well above FY19. TPT saw some benefit during COVID-19 due to customers spending more on their houses as they had to remain at home.

With a relatively stable store base, management anticipates that future revenue growth will come from increasing customer numbers, leading customer service and ongoing management of the estate to maximise sales. Category extensions and continued innovation should be a consistent driver of increasing its customer appeal.

Although many may think of Topps Tiles as a consumer-facing retail brand, it is more of a building merchant as trade customers represent the greatest proportion of group revenue (since 2015), with over 61% of sales in H124 (up from 59% in H123 and 59.6% in FY23). Trade customers provide more frequent and repeat custom and are an influential link to homeowners (through product recommendations and purchasing via the trade customer). Despite making strides in attracting greater spend from trade customers, management believes there is an opportunity to increase revenue even further by improving the digital experience. A new sales and operations director has been charged with developing and improving TPT’s trade website and app, for which usage is low by industry standards. These should lead to: 1) smoother customer registrations and transactions; 2) an improved customer loyalty scheme; 3) an increased trade credit offering; and 4) tailored marketing. Management believes these initiatives can add £15–20m incremental revenue over the long term. This would represent c 11–15% of Omni-channel’s FY23’s base trade revenue and, in absolute terms, is equivalent to the new revenue generated from trade customers between FY19 and FY23. As trade customers enjoy volume-related discounts to retail price, there is a natural dilution to gross margin as their importance to TPT grows.

TPT’s Online Pure Play vertical was created in FY22, following the March 2022 acquisition of an initial majority 60% stake in Pro Tiler Tools (PTT) and the May 2022 launch of the internally developed brand Tile Warehouse (TW).

The vertical was created to access complementary markets to the core Omni-channel vertical (ie customer bases that operate solely online and are not already customers of Topps Tiles).

PTT is a highly entrepreneurial online specialist retailer of tiling-related consumables and equipment to trade customers via five different brands: protilertools.co.uk, northantstools.co.uk, premiumtiletrim.co.uk, flooringmaterials.co.uk and warmfloorstore.co.uk (the last two were launched after the acquisition of the initial stake). The new brands provided TPT with a significant expansion of its existing product categories and extended it into new categories. Additionally, the platform enables TPT to grow into other areas of online trading. TPT provides PTT with buying scale, a flexible supply chain and financial resources and know-how to support growth.

PTT has been kept at a relative arm’s length from the rest of the group to retain the entrepreneurial spirit of the business.

PTT was established by a family of tilers in 2010. On the acquisition of the initial 60% stake, the founding parents retired and their two sons now run the business. The stake was acquired for £5.3m on a cash-free, debt-free basis. The remaining 40% stake was acquired for £8.7m in May 2024, making the total effective acquisition multiple 5.1x EBITDA. As required by IFRS 3 (due to the continuing employment of the two sons), the estimated present value of the remaining stake was being expensed over the accounting periods to May 2024. FY25 will be the first full year that sees no profit dilution for the group from the expensing of the acquisition, although this has been treated by management as an adjusting item, and minority interests.

PTT has demonstrated exceptional growth since acquisition, with revenue growing from £9.3m (in the 12 months to March 2021) to £25m for the year ending March 2024. Management believes PTT has the potential to add a further £20–25m of revenue in the long term. From a profitability perspective, PTT is already delivering a profit in the targeted 8–10% adjusted PBT range.

Established in summer 2022, the digital brand launched with a narrow range (c 400 SKUs) of competitively priced quality products to appeal to a new customer base, the value-conscious consumer. Management believes that the Topps Tiles store format has less exposure to value-conscious customers than its competitors and has greater exposure to more affluent customers. The management team was changed at the end of 2023 and the business has subsequently delivered strong growth on all metrics and the revenue run rate (almost three times higher at end-H124 than at end-FY23).

Management anticipates that TW represents a revenue opportunity of £15m for the group within five years (ie in FY27), from a market currently estimated to be worth £100m pa. The brand benefits from leveraging the group’s supply chain and infrastructure, but incremental investment in online marketing to support TW’s development will lead to small operating losses in the first few years.

The commercial market includes both new builds and refurbishment of commercial properties (such as education, leisure, office, retail and transport buildings) and new build residential housing.

The appeal of the commercial market to TPT is apparent given it is worth more than 80% of the residential market, and the quality of product is important to its customers given likely more extensive wear.

The core customer focus is on selling to architects, designers and contractors via a travelling sales team, whose role is to develop corporate relationships, and a showroom in Clerkenwell in London.

The strategy has been to build a presence in a market that is fragmented and regionalised. While the Commercial vertical has provided mostly good revenue growth, management admits progress has been more challenging than originally anticipated, not helped by the external macroeconomic challenges. Nonetheless, by the end of FY22, Commercial had established itself as a top-five brand. Its success is demonstrated by its list of clients, which have included Berkeley Group, Burger King, Greene King, Heathrow, Hyatt, M&S and Radisson.

The commercial market operates in a very different way to retail (relationships with corporates and their multiple suppliers are key; lead times are longer, up to 24 months; and decision makers at every stage of a project’s delivery have to be managed) and is vulnerable to changes in different macroeconomic drivers (eg business confidence, corporate profitability and capital expenditure plans).

Since TPT entered the commercial market in FY17, revenue growth has mostly been strong albeit lower than management anticipated. Since H220 it has been negatively affected by the COVID-19 pandemic and more recently from H123 due to macroeconomic weakness. These external pressures led to operating losses until management’s business improvement plan, completed at the end of FY23, has significantly improved profitability so that the business has reported operating profits in both H223 and H124 despite the challenging operating environment.

Commercial is expected to benefit from the third of the five key areas of focus of Mission 365: developing incremental B2B sales. Management believes it can better leverage the group’s three complementary brands to generate incremental sales of £25–30m from B2B customers. As such, management no longer has a stated revenue goal for Commercial, having previously estimated it represents a £20m+ revenue opportunity in the medium term, below the original estimate of £25m.

As already highlighted, TPT is exposed to two key different groups of customers – homeowners and businesses/corporates – whose spend is influenced by different external drivers.

Changes in consumer confidence and the health of the housing market are important indicators for the outlook of spend on residential RMI. From a volume perspective, the purchase of a house is an important trigger point that make consumers consider refreshing their kitchens and bathrooms. Demand is also supported by the natural upgrade cycle of a room, which management estimates at around seven years, and then tends to trigger the refurbishment of another room as its relative freshness/attractiveness is made apparent. Changes in house prices can make homeowners feel more or less affluent and therefore influence their willingness to spend on their house. High house prices and the frictional costs of moving are likely to stimulate refurbishment of an existing property.

In Exhibits 8 and 9 we show the long-term (FY06 onwards) relationship between Topps Tiles revenue (ie Omnichannel) and the number of property transactions and average house prices.

In the H124 results, management pointed to improvements in a number of important macroeconomic indicators such as GDP, real wages, inflation, mortgage approvals and consumer confidence, which have yet to have a discernible impact on trading. This was further evident in the Q324 trading update when revenue declined by 6.9% year-on-year.

The overall macroeconomic picture appears to be improving as evidenced by recent changes to growth expectations by a number of forecasters. In its July 2024 World Economic Outlook, the International Monetary Fund (IMF) marginally increased its forecast real GDP growth for the UK in 2024, by 0.2% to 0.7%, which is certainly an improvement from 2023’s 0.1%, and it expects a much better rate of growth of 1.5% in 2025. We should highlight the IMF’s medium-term forecasts are for below-trend growth, as for many developed economies. Closer to home, in its recent quarterly updates (the last was published in August), the Bank of England has, in the main, increased its estimates for UK GDP growth, real post-tax labour income, household consumption and the household saving ratio for 2024 and 2025.

There has been a notable improvement in UK consumer confidence in recent months, with month-on-month improvements through Q224 and into July following a stuttering start to the year. The overall indicator in July 2024 was at its highest level since September 2021. Within the aggregate, all of the constituent indicators were higher than 12 months ago including the climate for major purchases indicator, which has lagged the recovery in the other indicators.

In the property market, the trends in the key indicators are volatile but with a general underlying year-on-year improvement. From a volume perspective, most importantly, mortgage approvals have increased year-on-year in every month since November 2023, whereas month-on-month trends have been a bit more volatile. There remains plenty of scope for improvement as the c 60k mortgage approvals in June 2024 are well below the long-term (since October 1986) monthly average of almost 82k. The overall improving confidence and improvement in the number of approvals has begun to feed through to the number of housing transactions, with year-on-year increases in April and May 2024, the first since November 2022, before declining again in June 2024.

With respect to the potential wealth effect from houses, the Nationwide average house price has registered year-on-year improvements in every month since February 2024, having been negative for every month from February 2023. The recent increases mean that in absolute terms, the July 2024 average house price of c £266k is only c 3% below the peak of c £274k since the start of the COVID-19 pandemic, which could be helpful in making homeowners feel better off.

In addition to improving consumer confidence, there appears to have been a broad improvement in similar indicators for businesses in recent months, which is naturally supportive of capital investment.

Non-executive chair: Paul Forman. Paul was appointed as chair in July 2023. His prior experience includes chief executive at Essentra, Coats Group and Low & Bonar and non-executive director of Brammer. He is also senior independent director at Tate & Lyle and chair at FSI.

Chief executive: Rob Parker. Rob joined the board in 2007, serving as CFO until 2019, when he was appointed as chief executive. His previous roles before joining TPT included senior finance roles with the Boots Group and Savers Health & Beauty.

Chief financial officer: Stephen Hopson. Stephen joined the board in November 2020 from Molson Coors Beverage Company, where he was director of central finance for Western Europe. Before this, he spent five years at Travis Perkins, including three years as finance director for BSS, and also held senior finance roles at Mitchells & Butlers, where he was responsible for investor relations among other functions. Stephen is a CIMA-qualified management accountant and holds an MBA.

We see the main sensitivities as follows:

The challenging macroeconomic environment has had a significant impact on the overall RMI market and TPT’s financial results for most of FY24 to date. Our new estimates for FY24 and FY25 take into account the ongoing weakness reported through Q324. We also incorporate the benefits from Mission 365 in our estimates for FY25 onwards.

We forecast an overall reduction in revenue of c 6% to c £247m in FY24, a similar rate of decline in H224 as reported for H124. This takes our FY24 revenue estimate back towards FY22 levels, albeit there is a different mix: a greater contribution from Commercial and Online Pure Play but a lower contribution by Omni-channel. In our prior estimates we had assumed a slightly better H224 to give an overall revenue decline of c 4%. Looking into FY25 and FY26 we assume a good rebound in revenue growth of c 7% in each year as the company laps weak comparatives and the first benefits from Mission 365 come through. The assumed growth rate is at the low-end of the required CAGRs of 7–9% to reach the indicated range under Mission 365 of £345–385m if achieved by FY29. This suggests greater growth in the outer years of the plan.

Management believes the group gross margin will trend down by 2–3pp to 51–52%, from FY23’s 53% by the end of the Mission 365 strategy. This is due mainly to changes in business mix (ie the growing contribution of Commercial and Online Pure Play, which have lower gross margins (30–40%) than Omni-channel (high 50s)). The continuing focus on managing operational costs and product mix are expected to derive further benefits to the group gross margin, of 2pp, to offset the anticipated 2pp decline from expanding into the new product categories.

The key to achieving management’s target of adjusted PBT margins of 8–10% will be driving leverage of the operating cost base. Management expects underlying operating costs will decline to 42–44% of sales from c 47% in FY23 and our projected c 50% in FY24. On a reported basis, expensing the acquisition of PTT has affected PBT by a cumulative £8.7m from FY22 through H124, equivalent to just under 30% of accumulated adjusted PBT over the same period. To deliver Mission 365, management is beginning a three-year system investment programme that includes a new ERP, warehouse management and new store systems as well as the new customer engagement and trade app. As these items are being expensed they therefore provide support to margin recovery in the outer years.

Following our expected halving of normalised PBT in FY24, we forecast a strong recovery of c 49% growth in FY25 followed by c 27% growth in FY26. This takes our FY26 estimate to £12.4m or £11.0m using the company’s definition of adjusted PBT, implying more significant growth thereafter to reach management’s goal of £30m by the end of Mission 365.

With no financial debt the net financial charge mainly relates to IFRS 16 liabilities.

TPT’s tax rate is typically a couple of percentage points above the UK standard corporate tax rate due to non-deductibility of certain expenses, notably the non-deductibility of the expense for the purchasing of the remaining stake in PTT. As the minority has been bought in, we would expect this to normalise, and the group will also benefit from the elimination of the minority charge from the recent completion.

The historical dividend policy was to distribute 50% of adjusted post-tax earnings, but this changed to a target to increase the payout ratio to 67% over the period from FY21–23, up to a limit of 100% of adjusted EPS. The policy was designed to provide flexibility although the board indicated it did not intend to reduce the dividend due to short-term macroeconomic issues or performance. Interim dividends are typically one-third of the full-year dividend. We forecast a lower dividend of 1.5p/share for FY24, versus 3.6p/share for FY23, and then it gradually increases to 3.25p/share in FY25 and 3.6p/share in FY26 with our anticipated recovery of profits. The company has paid a dividend in every year since its IPO, except for FY09 during the global financial crisis, and payments were disrupted during the outbreak of the COVID-19 pandemic (no final dividend in FY20 and no interim dividend in FY21).

TPT’s free cash generation has been variable over the long term, in absolute terms and relative to revenue, due to the changes in profitability and working and fixed capital intensity. We have included the long-term trends in Exhibit 20 but note that comparison of post FY20 figures versus pre FY20 figures is complicated by the introduction of IFRS 16 accounting for leases.

The variability in working capital has been due to rationalisation of the store portfolio (now completed), the effects of slowing and growing revenue during the COVID-19 pandemic (building inventory etc) and the changes in business mix with the move into the commercial market. Management has indicated a working capital inflow of c £7m in FY24 due to the year end falling before the end of September, and expected to reverse in FY27, and that working capital should flex in line with revenue growth during Mission 365.

In working capital, inventory (c £35m at H124 versus net assets of £19.8m) should be considered non-perishable and therefore presents a lower risk of markdowns and therefore low potential risk to gross profit. At the end of H124, inventory represented 108 inventory days (relative to cost of goods sold) versus 107 days at the end of FY23. There has been a good reduction in inventory days over the long term from 120–130 days, helped by the acquisition of PTT where inventory days are much lower than the rest of the group, 62 days at H124. Trade and other payables (c £43.6m at H124) have typically been equivalent to 60–80 days of the total costs of goods sold and operating expenses outside the years that were affected by the COVID-19 pandemic. Trade debtors at £6.6m are relatively insignificant.

In recent years management has kept a tight rein on capital investment, and as a result depreciation of fixed assets has been running at higher levels than capex in recent years. In total management has indicated that capex will be c £6–8m in FY24, we include the higher amount to be conservative, and in FY25 we include an extra £2m for the indicated investment, and we assume the remainder will occur in FY28. There will also be a cash outflow of £9.8m in H224 relating to the purchase of the minority of Pro Tiler Tool comprising £8.7m for the share purchase and £1.1m of dividends.

Prior to the sale and leaseback of the company’s head office and central warehouse in June 2020, TPP typically operated with a net debt position, but since then has been in a net cash position before considering the effects of IFRS 16. At the end of H124 its lease liabilities totalled c £89m, a c £5m reduction from the position at the end of FY23 of c £95m.

In addition to the net cash position, the company has a revolving credit facility of £30m, which is committed to October 2026 with extension options for a further year. The facility was undrawn at the end of H124.

The recent trading downturn and anticipated recovery have naturally reduced our estimate of the company’s return on capital employed. Using the company’s definition of return on capital employed (adjusted operating profit divided by average net assets and leases less cash) our forecast for improving operating profit means the company’s return on capital employed will approach FY23 levels by FY26.

Below we show our DCF-based valuation, which indicates strong upside potential, and how its prospective multiples compare with a selection of quoted peers and relative to its own history, favourable in both instances.

To capture the growth opportunity from the new verticals we value TPT using a DCF. By FY29, we grow revenue to the low-end of the indicated range for Mission365, £345m, and adjusted PBT (company definition) reaches c £30m, the ‘low’ figure that management has committed to as part of the plan. This equates to a reported operating margin of 9.6%. Beyond the explicit forecast period we fade down our revenue growth rate to 2% pa through to our terminal year, FY33. We also reduce the operating margin to 8% in our terminal year to allow for some cyclicality. In addition to consistent fixed asset and working capital intensity, we include an imputed outflow for right-of-use assets.

We use a weighted average cost of capital (WACC) of 8.5%, which includes a risk-free rate of 4.1%, market risk premium of 4.8% (previously 5.5%, source Damodaran), a beta of 1.9 (source: LSEG Data & Analytics) and a terminal growth rate of 2% to derive a valuation of 108p/share. The sensitivity of the valuation to changes in the WACC and terminal growth rate are shown below. Achieving more than the low-end of management’s goals would be supportive of a higher valuation. Increasing FY29 revenue to £365m (the middle of the indicated range) would increase the valuation to 116p/share.

TPT does not have a pure direct comparator so below we show how its growth rates, profitability and multiples compare with two sets of peers: manufacturers and distributors of products that are exposed to the same end-markets, and retailers that are exposed to changes in consumer spending on the home. All figures are annualised to TPT’s September year-end, using a simple average for those with different year ends.

Consensus is forecasting a challenging year to September 2024 for the majority of companies due to the external macroeconomic environment with declines in both revenue and profit forecast, before rebounding in FY25. We note TPT’s gross margin compares favourably with the medians for both sets of peers, while its operating margin is comparable with the median of the retailers. Its relatively high ratio of gross margin (c 54%) compared to operating margin (c 4–5%) suggests it should demonstrate better-than-average growth in operating profit on a revenue recovery.

TPT’s prospective EV/sales multiples (including leases) of 0.6x for both FY24 and FY25 are comparable with the retail peers despite it enjoying a higher gross margin and comparable operating margin than the median.

We can see in Exhibit 24 there is a clear high correlation between prospective FY25 EV/sales multiples versus forecast operating margins when comparing only the retail peers. When we include the other peers, the R-squared drops to a still-respectable 0.82. The key takeaways are that TPT’s current multiple for FY25 is c 10% below the 0.7x implied by the line of best fit for its forecast profitability and, more importantly, there appears good reason to expect a re-rating to an EV/sales multiple of 1.1–1.4x if it reaches its Mission 365 margin goal.

The re-rating and expected growth in sales (total growth of 48% if it reaches £365m) suggest handsome potential returns. An EV/sales multiple of 1.1x on sales of £345m indicates an EV of £390m and a multiple of 1.4x on sales of £385m suggests an EV of £522m. When discounted back for five years at an estimated WACC of 8.5% (above) these would represent current share prices of 108p (similar to our DCF) and 153p per share, respectively if we assume the current capital structure.

Referring back to Exhibit 23, with respect to P/E multiples TPT is trading at a premium to the peer median in FY24 but at a discount in FY25 when there is some recovery forecast for all companies. Its high dividend payout ratio provides a more attractive dividend yield than the majority of its peers.

Since its IPO, TPT has a good record of revenue growth, but profitability has been more variable. The exhibits below attempt to put TPT’s current valuation and growth prospects in perspective relative to its own history.

In Exhibits 26 and 27 we show TPT’s prospective EV/sales multiples relative to its historical high, average (figure quoted) and low multiples in each year. To make the comparison over the long term more valid, we exclude IFRS 16 liabilities from net debt so the figure will differ to those in the prior section. While we recognise the different drivers of valuations at different stages of TPT’s development and economic cycle, we can see from both charts that it has typically traded at a higher multiple than its prospective multiples when it has historically reported similar rates of revenue growth and profitability according to our forecasts.