Kogan’s profit soars, but its share price still looks pricey
Between March and July this year, the share price of Australian e-tailer, Kogan (ASX: KGN), plummeted from $9.85 to under $5.00. The share price is now rebounding on the back of an impressive profit result. So, how should value investors view this fast-growing business?
We have previous highlighted our concerns, from March: “The online retailer Kogan has seen its share price rise almost 460 per cent from $1.50 to near $8.50. The company now has a market capitalisation of almost $800 million, despite reporting a 2017 after tax profit of just $8 million. In other words, the company is trading at 100 times last year’s earnings.”
We noted the analysts making very optimistic assumptions to arrive at the growth rates required to justify their predictions. We observed the new business lines being launched including pet insurance, life insurance and funeral insurance. We also observed the launch of Kogan Internet, while mentioning, “that most, if not all, existing listed Internet Service Providers (ISPs) are suffering from relatively flat growth and pressured margins.” And finally, we highlighted the October 2017 and February 2018 ASX announcements of directors selling shares.
Kogan’s recent profit result was a relatively strong one with the company announcing revenue of $412.3 million up 42.4 per cent and operating profit up 108 per cent on 2017, the latter having doubled three years in a row. Measured by EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) the $26 million reported, beat consensus analyst estimates. There were however some currency-related gains, and stripping those out revealed an operating profit that was only marginally ahead of expectations. The company’s net profit grew 87.7 per cent from $8.1 million to $15.2 million when adjusted for the amortisation of Dick Smith Assets, which have now been fully amortised.
Cash flow was strong with operating cash flow before capital expenditure of $31.7 million, producing an operating cash conversion ratio of 121.9 per cent.
Also strong was the growth in Active Customers of 433,000 (up 45.3 per cent) to 1,388,000 Active Customers at 30 June 2018.
Another highlight was the growth in Mobile and Internet services. Kogan Mobile produced a Gross Profit contribution of $12 million, equating to year-on-year growth of 233.3 per cent. The aforementioned Kogan Insurance, Kogan Pet & Kogan Life, along with Kogan Health, fall under the Kogan Insurance division. When combined with Kogan Internet, these new business lines achieved gross profit of $800,000. Of that number, $600,000 was generated by Kogan Internet.
The challenge with the above numbers is the implication that while management expect significant growth in 2019, the Insurance division contributed nothing in the second half of the year versus the first half. Also, of great interest is the slowing turnover of stock. In the first half of 2018, 93 per cent of the inventory was less than six months old. In the second half of the year, this number had fallen to 80 per cent of the stock being less than 120 days old. In other words, the proportion of stock over 120 days old has grown from 7 per cent to 20 per cent.
That leads me to wonder aloud about the ‘active’ customer base growth. Could it be that the aging stock is a function of the fact the same stuff is being sold to the same people? Could it be that the active customers include new mobile and internet customers who don’t shop with Kogan or don’t need the other merchandise Kogan sells?
In a small market like Australia, it is not hard to hit a ceiling in terms of new customers. The consequence is known as churn, and churn equals maturity and slowing growth rates. Unsurprisingly, some analysts are now downgrading their price targets.
And let’s not forget Amazon hasn’t really flexed its muscles yet.
The foreshadowed share price crashing from recent highs could be now producing one of those rare opportunities to buy a fast growing, capital light business at a relatively cheap price. It could also represent a pause on the way to maturity or, thanks to Amazon, oblivion. Perhaps the only way to gain an insight is to keep an eye out for director selling or buying.
For what it’s worth the shares still trade on 43 times 2018 earnings. If profits double next year, the shares will still be a relatively expensive 21.5 times forward earnings. They are cheaper than they were but we don’t think they’re cheap enough.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
