Monday, 15 March 2010

Company Focus – Halfords Group plc – Animal Spirits for Farming the Recession

Economic downturns whilst broadly damaging, do of course play into the hands of those companies well suited to the more austere climate; especially those that re-orientate themselves to match not only periodic recessions, but the general shift of socio-economic and geo-economic trends to maximise their market appeal.

With an attitude of 'animal spirits for farming the recession', Halfords – the retailer of car parts, car accessories, bicycles, mobility products and now garage network owners - could well be starting their Board meetings with an adapted mantra from Orwell's Animal Farm...“2 wheels good, 4 wheels better!”

Since its formal 1902 origins in Halford Street, Leicester, its ironmonger founder Frederick Rushbrooke soon recognised the innate sales growth potential for products that revolved around personal mobility, serving-up bicycle parts and accessories to the Edwardian working classes.

Within 30 years the company had 200 'Halford Cycle Co.' shops nationwide, and in 1945 utilising depressed asset values, undertook vertical consolidation by acquiring its supplier The Birmingham Bicycle Co. Of course since the introduction of Austin 7 in 1922 motoring had become ever more prevalent amongst the expanding middle class, but in a post WW2 era when (petrol) rationing and coupons were still the order of the day, mass mobility in large part meant the bicycle and motorcycle.

Of course with such an expansive network of branches, the subsequent 1950s/60s re-growth of the British motor industry on the back of increasing national wealth witnessed a concomitant reaction from Halfords, balancing bicycle stock with that of car parts. At a still relatively austere time before cars became the commoditised almost disposable items of today, the personalisation of a car for the long-hold original owner or subsequent 2nd,3rd,4th,5th hand owners, servicing, repair and accessory items became the dominant income stream, with by 1968, 300 stores. Such an expansive retail network of course didn't go unnoticed by outside interests with either (vertically) synergistic operations (ie Smiths Industries) or indirect (lateral) complementary activities (ie Burmah Oil).

Burmah Oil acquired Halfords in 1969 whilst it was riding high on buoyant global oil demand, obviously seeing an opportunity to target regions of the UK sell petrol and parts, assisted by its motor-racing sponsorship in the early 1970s, associated with the likes of James Hunt. At a time when most young men were buying their first car, family men were upgrading their cars and executives were enjoying the then status of the company car, Hunt was the 4-wheeled David Beckham of his day and the created tri-lateral connection of him, Burmah Oil and Halfords made for a potent mix right-up to the 1974 oil crisis and Burmah Oil's over-reach and exposure.

Later owners included the Ward-White group, the Boots Group, CVC Capital Partners private equity who then publicly floated the company in 2004.

Since that time, a deeper strategic outlook has emerged seen with:

1. collaboration with Japan's Autobacs Seven Co
2. broader product outlook has evolved with greater segmentation of its retail-lines,
2a.enhanced with organically introduced or acquired branded identities
(eg Bikehut, Apollo & Ripspeed),
3. introduction of new product & service lines (eg electric wheelchairs & electric bicycles)
4. expansion of seasonal retail lines (eg caravanning and camping)
5. expansion of customer-lifestyle retail lines (eg car & home baby products)
6. 446 store network

Thus since the rational adoption of the edge-of-town superstore format some time ago, the company has been seen to stretch its retail scope and coverage. That was undoubtedly a necessary exercise, especially given the volume throughput levels Halford's could leverage when ordering mass volumes of the low-cost items that were made available from Chinese, Taiwanese and other production sites over the last decade.

The emergence of the CEE as a previously strong, now economically flat but stable, entity was also recognised, as a natural correlate opportunity with Poland and the Czech Republic given the trend of relative population migration between these countries and the UK. As a result Halfords seized the opportunity to open 5 stores in the Czech Republic and 1 in Poland.

This growth model whilst powerful may have been viewed as becoming less potent in the medium term, slowing its contribution to the bottom-line in the years ahead as sales volumes of non-essential consumer goods naturally decrease in recessionary times, both in the UK and in the CEE. And so the board rightly looked elsewhere for supplementary revenue that would have a natural fit to Halford's operational space.

Thus it came as little surprise to investment-auto-motives when it was announced on 18th February that the company had bought Nationwide Autocentres network of 224 outlets for £73.2m (7.2 x FY10 EBITDA) from its cash-pile, relative to a Group Net Debt of 1.1x EBITDA. It views the service and repair industry as worth £9bn annually, 56.8% of which is derived from servicing and MOT test certificate issuance – which obviously has a repair correlate.

The driving trends considered were:

A. recognition that car ownership periods were once again extending
B. thereby aging the UK's privately held 'carparc'
C. the public's dissatisfaction with the less than reputable independent garages
(that make up much of the nation's garage trade)
D the average person's inability to understand and repair their car
E. the opportunity to access SME & corporate fleet services demand.

Hence the recognition of the opportunity awaiting Halford's, the ability to sell an additional higher-value services to the current Halford's customer (keeping their car longer, out of warranty and into annual MOTs), and to attract new custom from disgruntled ex-patrons of the private trade.

Moreover, the present low-inflation / high-unemployment environment means that bought-in parts are being held at static cost and the required semi-skilled technician labour can be bought at low rates, the hand-over to Halford's also generating the opportunity to renegotiate new terms with present Nationwide employees. Moreover, the combined procurement volumes of standard car-parts via a central purchasing unit means that scale efficiencies can be utilised in driving down bought in unit costs and critically creditor terms, so in due course assisting cash-flow.

Critically since the new MOT regulations were introduced some years ago over-hauling the inspection system. The additional vehicle assessment hardware was duly acquired by MOT practioners to meet new DVLA standards, and critically interface with a DVLA central database. In short, much of the UK's garage trade has had to conform to the enhanced standards. With such a broad, capital intensive exercise already undertaken and in place for the years to come, it means that Halfords' ongoing acquisition path of the additional 200 garages can be done without the level of major capital expenditure to upgrade new sites typically required. Not quite, but largely limited to new corporate signage and internal/external decoration in accordance to the Halfords design standards.

The corporate ambition is to naturally re-brand the garages as Halfords Autocentres and open a further 200 stores offering “dealership quality at lower prices” - obviously in accord with the mood of the age and satisfying the needs of the old and new B2C customer-base (78%), and the newer B2B base (22%).

Autocentre's productivity levels will undoubtedly be an area that sees initial focus. Management has presented comparitive KPI figures for 2005 vs 2009, which were obviously designed to impress, and whilst that 4 year period saw sales growth, per job income rise, the productivity per technician rose only by 1.4 jobs (ie cars) per week – ie 0.35 of a job (car) improvement per year. This must surely be the next area for betterment, with possibly earlier and later opening hours and improved workflow through the garage, where basic engine bay servicing elements and similar can be done 'off-ramp'.

[NB the use of ramps for all vehicle work appears professional but often leads to temporary workshop slow-down, and part-moved cars to 'movement paralysis'. Moreover many less motivated technicians will use the excuse to slow their own workload, especially if on standard wage/salary, thereby seriously slowing volume job throughput].

Given the slow productivity improvement between 2005-09, consideration of work-flow re-organisation will probably be an initial focus of Halfords Autocentre management, possibly instigating additional hardstanding maintenance zones and possibly the idea of technician's piecemeal pay structure, with safeguards to ensure that technician's work standards are maintained and improved where there is a temptation to put job turnaround speed above job quality.

Furthermore, the auto-servicing arena is not completely foreign to Halfords, and presumably there are senior staff that served during its edge-of-town superstore expansionary period when it previously had an agreement to service and warranty repair Deawoo cars sold via the then new and separate GM-Daewoo network. That also presumably means that the typical 'flexi-warehouse' space of a typical superstore which once housed Daewoo service equipment (ramps, special tools etc) was replaced with normal retail shelving when Daewoo UK 'expired' . With a natural contraction of retail space required as a result of reduced consumer demand means that the space could be recaptured for car-servicing with the instillation of suitable partitioning etc.

Moreover still, many Halfords stores sit in close proximity to used car superstores. The sales of used cars has increased in recent years as new car sales slowed, and those fiscally constrained buyers will be seeking an option to the high costs of dealer servicing or the lost confidence of small garages – hence the very type of affordable maintainance Halfords Autocentres offers.

As for the continued roll-out of conventional Halford stores, it seems the most probable path will be the expansion of Poland given the country's bucking of the EU trend by maintained growth momentum, so one of the few growth stars of the present climate. Poland is also a large recipient of grey-market previously German & Czech registered vehicles. The possible slow/stagnation of Czech business for Halfords means that the assets (shop-fittings & products) of one of its lesser performing Czech stores could be easily transported over the border to set-up a second Polish store.

More investment-auto-motives suspects that just as the company Board has set-up shop in these 2 core CEE countries, so it will latterly expand the new Halfords Autocentre venture into these regions, riding the UK-Czech-Polish consumer cross-pollination and the growing trend that motorists will either choose not to self-service or self-repair their cars as their living standards improve, or that rising emissions regulations and advanced auto-technology will prohibit DIYers.

But for the near and medium term beyond the integration of its new garage network, David Wild and his lieutenants will be focused on maximising the per sq metre income from its stores relative to general and seasonal trends, rationalising the new garage network it has bought to improve operating margins and viewing how the 2 may be merged to create a powerful network of branches that offer practical & pleasure goods with a synergistic maintainance and fitment service.

Wild (CEO), Wilkes (COO) & Wharton (FD) will be hoping that Halfords' promotion efforts via BTCC motorsport sponsorship and TV advertising will underpin the promise of cross-selling in these re-orientated stores – where a customer can walk through the aisles, choose upgrade parts and accessories and have them fitted on-site or indeed during a routine service the client is tempted to view the equivalent of a new car dealer's options and accessories list, and so bump-up Halford's servicing margins...ideally an upgraded media system or perhaps a bike rack and maybe 2 bikes to boot! And beyond the family market is Ripspeed's client base of young men and women with few responsibilities and money to spend on performance and cosmetic kits for overtly pandered hot-hatches. Halfords may not have the kudos of say 'West Coast Custom', but just as Ripspeed brought glamour to its London customers in its hey-day, so Halfords could, if better managed, do the same by exploiting Ripspeed's(original) Mini heritage to the masses who currently drive (2000+ 'New') Mini, older models ripe for aftermarket personalisation.

And lastly, given the network expansion of Halfords' property interests, it will undoubtedly review the potential for operating an additional 'PropCo' operating model, so possibly enabling a new division to be created (if not already) that is able to convert any/specific leasehold properties to freehold and so capture the year on year improved valuation, set within the Group's asset-base.

The commercial property sector is indeed sitting in a trough at present, but unlike typical retail premisis on the high-street, in shopping malls or dedicated edge-of-town sites, it is suspected that much of Autocentres' premises will be based on urban light-brown, semi-industrial plots, with far greater (latter-day) change of use opportunities if/when considering plot sale divestment policy or in-house redevelopment such as corporate-assisted social housing.

George Orwell took the road to Wigan Pier to view the social impact of the depression era, and whilst in a very different world 80 years later, Halfords recognises the commercial opportunity by facing today's headwinds full-on, revisiting its past and expanding its future:

“2 wheels good, 4 wheels better!”...the type of animal spirits much needed today when 'farming' the recession.