Godfreys: multi-bag or garbage bag

This vacuum cleaner retailer is likely to produce spectacular returns, but we’re not sure if they’ll be gains or losses.

We alerted you a fortnight ago, in Retailers going cheap, that we have started looking at some bombed out discretionary retailers.

They don’t get much more bombed out than Godfreys (ASX:GFY), the purveyor of vacuum cleaners. If you needed more reason to avoid IPOs of retailers then look no further. Godfrey’s has been an unmitigated disaster.

It listed in late 2014 at $2.75. The prospectus painted a picture of rising margins, strong cash generation and growth through store expansion. But we now know that those lofty margins were unsustainable and the feasibility of further stores is questionable.

Management also missed the trend to stick vacs, and competition has since intensified.

Godfrey’s trades 75% below its listing price today.

Despite these challenges, with rock-bottom expectations, Godfrey’s doesn’t have to prosper for it to be a great investment. Muddling through could be enough for it to multiply.

Part of Godfrey’s attraction, though, is its large footprint. With 223 stores, investors get lots of revenue for each dollar invested ($4 to be exact). This gives optionality should margins ever expand.

Godfrey’s accounts also state that it has $192m of franking credits. This would be very valuable but I’m assuming it’s a typo. A $26m business is unlikely to have generated this amount organically and the previous owners are even less likely to have left it behind. Although, I find it extraordinary for a typo of this magnitude to be in two years of annual reports.

Many of Godfrey’s stores are company owned too, and management has recently set about refranchising them. This strategy will be highly cash-generative, as the inventory and shop fittings on Godfrey’s books is sold to new franchisees. A recurring franchise fee then follows.

If this strategy is successful then Godfrey's is likely to be quite cheap. Even after normalising earnings for a less buoyant property market. 

But it’s hard to know whether a franchised network is the optimal strategy or just the only one that gives them hope of servicing their debt. At $23m (equal to 1.6x earnings before interest, tax, depreciation and amortisation) on top of lots of store lease liabilities, Godfrey's debt could turn a stumble into a complete wipeout.  

One of the most important parts of investing is finding asymmetric return profiles. That means "heads I win, tails I don't lose much". 

Asymmetry typically means stocks that have limited downside and lots of upside. But it can also be found in stocks with bankruptcy risk that have the prospect of 'ten-bagging' (but these need to be managed with small position sizes). 

With upside and downside about the same, Godfrey's is neither, so it's a pass for us.

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