Kogan downgrade

Kogan had a sizeable downgrade today. As is usually the case, when the business update starts with this much preamble, you know you are likely on to a hiding.

By page two, we get to the heart of the matter. Street earnings were at circa $70m, and guidance is (now) for $58-$63m. Quite a miss.

The issue is a good demonstration of the supply side concerns we’ve been discussing in broader asset allocation considerations. When raw material input prices are bouncing around, it can be very difficult to manage your margins. So to with delivery times, freight costs, and inventory management.

But, could we have seen today coming?

Here’s Kogan’s level of inventory as of the February result. A huge increase.

That’s warning flag number one. KGN management comment that they (the business) doubled in size because of the material increase in consumer demand, however that’s precisely why we scale the size of the inventory build by proportion to sales. There was no reason for the inventory as a % of sales to increase so markedly. They look like two different businesses, bolted together.

The inventory build ate all of the operating cashflow, and, through the joys of accrual accounting, meant that earnings looked robust, whilst cashflows were anaemic. That’s flag number two.

The way the problem resolves itself is by liquidating inventory. Creditors need to be paid, trade financing needs to be paid, and warehouses need to have stock moved off the dock (otherwise they charge you what is wonderfully known as demurrage).

And that means sacrificing margins in the next period.

Which is exactly what’s happened. To get rid of that stock, KGN will keep discounting, crunching profitability. The market update puts it less dramatically, noting that underlying profitability will remain “challenged” in the near term.

The share price has now given back most of the COVID windfall, of high online sales and bored consumers with nothing to spend the money on…

…and valuations have returned swiftly from one of the most expensive, to one of the cheapest.

Not one for us, but, interesting nonetheless and a good read through to the other high flying discretionary retailers.

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