On December 10, Vita Group Limited (VTG) announced the closure of the remaining Next Byte stores and gave a guidance update (we commented on this last year – see Upgrading VTG, portfolio holdings unchanged, 21 December 2015). During the holiday break we were able to sit down with Vita Group’s Chief Financial Officer, Andrew Leyden, to put some further colour to the announcement and see where to from here for the operator of Telstra Stores.
Firstly, we would like to point out after our conversation we continue to maintain our hold call on the group. The company is in great shape with a clean balance sheet supported by good cash flow. This was further emphasised by Leyden. It is our belief the company still has further easy runs ahead.
These easy runs are going to come in the form of optimising the current network of retail Telstra stores. Right now there are 360 Telstra stores across Australia. Vita Group own 100, Telstra own 80 and the other 180 are independently owned. Telstra has capped the number of stores VTG can own at 100 as they do not want to leave themselves too reliant on VTG no matter how successful the team are at running these stores. VTG management have a strong relationship with TLS management and they may hold talks on increasing the limit.
The optimisation of these stores comes from the sale or closure of weaker, but still profitable stores, in favour for more profitable ones. VTG management look to cluster the stores by geographic location helping to lower the cost base and have a strong management network in place. Currently the retail stores make up 86 per cent of the group's profit. If management are able to stick to their knitting by weeding out less profitable stores and rolling out highly effective people and process to new stores, we can see this as the growth driver for the next 24 months.
Another catalyst for shorter term growth will be increasing institutional coverage. Currently three research houses cover VTG, but as coverage increases and institutional buying starts, look for the share price to enjoy some upward buying pressure.
The next steps for long term growth remain relatively unproven for VTG. Beyond the retail stores there are the Telstra Business Centres, which focus on small to medium business (SMBs). There are currently 18 business centres around the country, with VTG looking to expand and leverage off the existing network of stores through the benefits of scale.
It is this sector VTG management are looking at to drive growth over the next three to four years which will allow time for the Enterprise business to gain traction. Currently the Enterprise business has developed relationships with the Queensland Police, with a deal to supply the force with iPads, and also with the RSPCA.
Both the business centres and enterprise business need time to develop and remain uncertainties to us. We are comfortable with the short term as VTG continue to do what they have successfully done in the past – but the easy runs will eventually dry up. VTG is in a commanding position with a strong balance sheet and healthy operating cash flow. Over the next few years the company will have the opportunity to leverage this in order to invest longer term growth, of course this will come with some risk.
Once again to emphasise we like the business and remain happy to hold but as we watch the future unfold if given the chance on material price increases we may consider to take some profit. We will continue to watch the progress of the business and enterprise components.
The conversation with Leyden primarily focused on the forward looking strategy but we did touch on a few other points which followers may find useful. The notes are below:
● Former director and joint chief executive David McMahon no longer owns shares in the business. This removes the uncertainty around his previously significant holding.
● There is a split in earnings between the first and second half of the year due to seasonality (eg. Christmas). Additionally, new product launches (such as the iPhone 6) will tend to pull forward or hold back earnings depending on the timing. They typically will not see an increase in earnings just a shift. People will either hold back on a purchase and plan change or bring one forward to coincide with a launch. This is to a lesser effect with interim product launches, for example the iPhone 5S.
● Management have occasionally floated the idea of a takeover/buyout to Telstra (TLS).
● There is a cashed up balance sheet here. The company is not opposed to taking up the right opportunity outside of TLS if one is identified. The cash on the balance sheet is also used for store acquisitions and greenfield expansion.