Card Factory a small giant

A hidden chapion trading at a value multiple

Company name: Card Factory plc

Ticker: LON:CARD

Price: £1.02

Market Cap £350m

Warning: The following article is for informational purposes only and should not be considered as investment advice. The author is not a registered financial advisor and does not provide investment recommendations. Any investment decisions you make should be based on your own research and analysis.

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Executive summary

Card Factory PLC (CARD) is my largest stock position, and with their results due next week, I believe it's worth considering investing in the stock today. The company is optically cheap, and once you consider how dominant they are in their business, it becomes extremely cheap. Card Factory absolutely dominates the single card category, selling 1 in 3 greeting cards in the UK and consistently taking market share from other players. It's been ranked as the number one value for money retail brand of all UK retailers for the last six years! Despite this, the stock trades for roughly 7x FCF/market cap and 5x EBITDAR/EV, making it an extremely cheap investment opportunity. It's a dominant, capital-light business with room to keep up mid single-digit growth for a long time.

Business model

Card Factory is the UK's leading specialist retailer of greeting cards, gifts, bags, and wrap, with over 1,000 stores and 1,900 distribution points, including partnerships with major retailers like Aldi in the UK and The Reject Shop in Australia. The company operates the only vertically integrated model at scale, providing significant advantages in reducing costs and being quick to react to customer demand. The design of greeting cards clearly benefits from scale, as the costs of designing a card can be spread out much wider, allowing Card Factory to offer a much wider selection at much lower prices than the competition. This allows Card Factory cards of similar quality to be almost 50% cheaper than those of the competition. Customers recognize this value, and the company has been ranked as the number one retailer of all retailers in the UK in the "value for money" category for the last six years. Before the pandemic, Card Factory accounted for 33% of the volume of greeting cards, yet only 20% by value, further underscoring the significant price difference between Card Factory and its competition.

Figure 1: Card Factory value proposition

As Figure 1 shows, Card Factory is in a league of its own when it comes to value for money compared to the quality of its cards. It offers similar quality to other specialists like Clintons and Paperchase (both of which didn't survive the pandemic unscathed) at a price even better than the hardcore discounting stores. As Figure 1 shows, Card Factory is in a league of its own when it comes to value for money compared to the quality of its cards. It offers similar quality to other specialists like Clintons and Paperchase (both of which didn't survive the pandemic unscathed) at a price even better than the hardcore discounting stores.

Figure 2: Value compared to range of selection.

This unique combination of range, quality, and value has made Card Factory a consistent market share taker and the number one place to go for greeting cards. They have even claimed the top position in some adjacent categories, like helium balloons.

Greeting Card market

Before we proceed, it's essential to address the greeting card market as a whole. While the market may be slowly declining, I believe it will stabilize eventually, given the timeless tradition of gifting greeting cards. Moreover, declining industries can still be attractive if a company can continue to take a more significant market share, just like Starbucks did with coffee. In fact, the industry economics could even improve if the demand declines faster than the shelf space dedicated to the category. This is what happened in the physical books industry. Fortunately, Card Factory has demonstrated its ability to take market share in this declining market with its low-cost model.

Regarding declining shelf space, this has been further accelerated by the COVID-19 pandemic. Many of Card Factory's smaller competitors, such as Paperchase and Clinton, have not survived unscathed. Paperchase has closed all its stores (around 100), and Tesco has acquired its intellectual property. Similarly, Clintons has a long history of bankruptcy, with store closures in 2009, 2012, and 2019, and is currently reducing its store count. Therefore, my thesis is that players lacking scale will continue to decline, and Card Factory can gradually increase its dominance while also taking market share from the limited selection of expensive cards sold at grocery chains.

Figure 3: Greeting card market

The only growing element of the market is the online sector, with publicly traded peers such as Moonpig benefiting significantly from the pandemic. However, it remains to be seen how these players will perform outside of the pandemic environment. Moonpig also has a considerable amount of debt and overhang from the original PE firm selling. If its stock becomes cheap enough, it may be an interesting acquisition target for Card Factory. Although its market cap is currently larger than that of Card I think this is unjustified.

Financials

Before the COVID-19 pandemic, Card Factory had a solid track record of revenue growth each year. The company's inventory is entirely financed by its supplier, giving it negative working capital. Additionally, Card Factory only owns its production facility and rents all of its stores, with rent expenses totaling £40 million per year. The remaining debt is £46.5 million, with roughly 5m in rent on this debt we get fixed charges of £45 million. However, with an EBITDA of £106 million and pre-pandemic capital expenditure of £11 million, the company has £90 million to cover lease and rent payments, providing a coverage ratio of over 2x. Given the predictability and stability of the business, this coverage ratio is more than sufficient.

Figure 4: Revenue and Dividends of Card Factory pre pandemic

Moreover, Card Factory is highly cash-generative and has paid a substantial dividend pre-pandemic, with dividends often reaching close to 100% of earnings without raising additional debt. Although the company ran more leveraged before the pandemic, with a debt to EBITDA ratio of 2-3x (excluding leases), it is now much less leveraged, with less debt than one year of cash flow. As a result of the low capital expenditure nature of the business and its historically low leverage profile, investors can anticipate returns from growth and substantial capital returns in the future.

Based on the financials of Card Factory, the normalized free cash flow (FCF) is expected to be approximately £50 million, and EBITDAR around £105 million. With a market capitalization of £350 million and an enterprise value of £500 million, the stock trades at 7x FCF and 5x EBITDAR. It is expected that almost all of the FCF can go towards future dividends starting in January 2024, resulting in a dividend yield of approximately 14%. 

Growth strategy

The company has identified several strategies to drive future growth, including expansion into underpenetrated markets such as Ireland and central London, driving sales in complementary products, forming new partnerships outside the UK, and increasing online sales to become more of an omni-channel retailer. In addition, I think the company can continue grabbing market share from other specialists in the industry.

While these strategies may not appear to be huge drivers of growth, the company has implemented a low-risk approach to pursuing them. The company slowly opens new stores, avoiding dilution of the current store base, and tests new smaller formats in central London before deciding to open more stores. To drive sales of complementary products, the company is experimenting with new store models that give these categories more space, and will roll out this model in more locations based on the results. The company forms new partnerships with other retailers such as ALDI in the UK and The Reject Shop in Australia, offering its card products to be sold in their stores. This partnership approach is low-risk as the company has spare production capacity in its own production plant, and can choose to only sell its designs for cards using external producers. Finally, the company plans to test new online sales models such as click and collect in a limited number of stores before rolling it out across the whole store estate.

Overall, the company has many avenues for growth and is pursuing these in a low-risk way. However, it is worth noting that the current management team's target of £600m in earnings by FY 2026 (representing 2025) may not be realistic. Even if it takes 10 years to reach this target, the stock remains attractive today as it does not require growth to be a good value play.

Valuation

Based on my analysis, I estimate that Card Factory's normalized free cash flow is around £50 million. The company can pay out 100% of this FCF, given its historically low leverage, resulting in a dividend yield of 14%. If the stock would trade at a dividend yield of 8% (12.5x FCF), it would trade at £625 million (80% upside), or at 6.6% (15x FCF), it would trade at £750 million (116% upside). Both of these valuations seem reasonable, especially considering Card Factory's dominance in its industry. Even in the worst-case scenario, we could still collect the dividend and get the 14% yield without the benefit of capital appreciation.

When I look at the upside potential of Card Factory, I get excited about the possibilities. Let's assume that we take the management target of 600 million of revenue and push it out 10 years, representing roughly only 3% growth a year, much lower than pre-pandemic levels. With an EBIT margin of 15%, which seems very achievable given the company's higher margins at a lower scale, we would get EBIT of £90 million. If we finally reach a multiple of 15x EBIT, the company would trade at £1350 million, which would be a 14% CAGR in the stock. The best part is that the company doesn't require much capital to grow, if any, so we can also get fat dividends while waiting. We would only need a 6% dividend to reach a return of roughly 20% a year for 10 years, making this an insane opportunity that doesn't require outlandish assumptions.

Shoutouts:

There are two great write-ups on Card Factory on VIC both with a similar thesis to my own. And the first one being the reason I invested (Although at a later time and lower price). I recommend reading them as well:

https://valueinvestorsclub.com/idea/Card_Factory_PLC/3378259577

https://valueinvestorsclub.com/idea/Card_Factory/7815082430