Dixons punishment overdone

How could investors have been so pessimistic about Dixons Carphone, yet not pessimistic enough?

With a flourish

Mostly because it’s now clear that Britain’s biggest electricals retailer and one of the largest in Europe was disingenuous about risks to the outlook. It said as recently as 28th June that it was “well positioned to flourish”. Finance director Humphrey Singer noted electricals continued to deliver “very solid results”, at the time. A stock price decline of some 30% this year up till Wednesday’s close showed the market remained sceptical. Well, the source of Thursday’s double-digit percentage dump was mobile phones, not the generator of most DC profits—electricals. But management had given a clear impression since the Brexit vote that it was comfortable with the outlook.

Punished

Top execs have this year pointed to Dixons’ resilience and work done to rationalise stores, reduce costs and offer products less susceptible to vagaries of consumer confidence. With little pressure on sales of fridges, TVs and other big ticket items in the UK and Nordics, from which the group generates most profits, CFO Singer and CEO Sebastian James have shown no inclination—till Thursday—to caution that the City’s expectation of £500m in profits was too optimistic. Suddenly though, the group sees profit before tax of £360m-£440m this financial year. Cue a spectacular bout of stock market punishment for inefficient guidance.

Too much

Still, even though the stock settled on Thursday well off a deeper 34% decline, the 23% loss, or £510m in market-cap terms, is way more than the £140m forecast cut that equates to the lower end of Dixons Carphone’s new range. In short the market was giving Dixons the benefit of the doubt before, but it’s now taking no prisoners. It’s ignoring cash on hand by the end of year that was forecast to be £288m before Thursday, up from £138m the year before. Also, note Dixons’ loss-making online rival AO World is valued at almost 6 times book value vs. DC on less than 80%. Furthermore, whilst there are one-off hits from Dixons changing to a subscription model for its main software product, to adjust for last year’s payment from Sprint and pain from reduced EU roaming charges, core retail profits are seen in line with 2016. With revenues, market share and profitability and margins steady at that core, the path to a firming profit outlook post 2017 is intact as well. Overall, we see scope for Thursday’s share price overreaction—way below post Brexit vote lows—to unwind further.

• Opportunistic buyers will now be poised to capture the ‘gap-fill’ normally expected by traders whenever transactions skip a wide price range to create ‘dead air’ on a chart.
• Buyers may have to wait a while. It took more than two months for the post-Brexit vote gap to be (mostly) filled. And the stock subsequently headed back lower afterwards.
• The Brexit shock is well baked-in now though. And momentum as measured by slow stochastics oscillator (see the sub-chart) rebounded whilst oversold on Thursday.
• The close above the day’s worst bodes well; clear resistance confirmed at the low on the day after Brexit, less so.
• Dixons downside is now tough to put a floor under if selling continues, but if prices get into the air above Thursday’s 190p high, a bounce is possible. Sustainable or not.