Executive Summary
Colefax Group (AIM:CFX), valued at £50m and 8.5x earnings, represents an under-the-radar compounder with a disciplined management team, a niche in high-end interior design and a history of disciplined capital allocation. With a fortress balance sheet and aggressive buybacks rapidly reducing the float, this is a hidden gem with clear catalysts for lots of potential upside, yet it trades at just 6x earnings ex-cash with no reason to assume returns to shareholders slow down!
Management Excellence
Under David Green, who has been Chief Executive of Colefax Group Plc since 1986, Colefax has grown its revenues from under £10m (and profits of under £1m) to close to £110m (CAGR of 6.5%) to profits of under £6m (CAGR of 4.8%). For a cyclical, these results are impressive especially when you consider no acquisitions have been made since 1998. The share price performance has grown at a similar level to profits (5% CAGR over a 36-year period). It is true that these returns are not eye-popping compared to the market, but I think that management have only recently understood how to maximise shareholder returns and returns will become more impressive with time.
I mentioned share buybacks above and it’s important to understand how they’ve been executed – between 2012 and 2024, there have been five tender offers and (most recently) a reverse book build that have reduced shares outstanding by at least 5% (in each case) at valuations at less than 8x EBITDA.
Recently, David’s son, Tim Green was made Commercial Director of Colefax – he joined the Group in September 2018 and became Commercial Director of the Fabric Division in April 2019. Prior to joining Colefax Group was Chief Executive of Tangent Communications, which specialised in digital communication and web design. It is possible that Tim will go on to lead Colefax when David retires and Tim’s background in digital communications could signal a shift toward modernising Colefax, opening new growth avenues.
Other senior management have been with Colefax for decades and it’s worth bringing them up:
1. Robert Barker – trained as a Chartered Accountant with Arthur Young (now EY) and joined Colefax Group Plc in 1989 as Group Chief Accountant. He was appointed Group Finance Director in July 1994.
2. Key Hall – joined the Group in 1993 to set up and run the company’s Los Angeles showroom. Made Chief Executive of the Group’s US subsidiary company Cowtan and Tout in 1999 + joined the Board in 2000.
3. Wendy Nicholls – joined Colefax and Fowler in 1975 and was made a partner in the decorating division in 1979. Was Managing Director of the Decorating Division from 1994-2021. Has been a Group Board Director since 1994.
Clearly, this management team have stayed very loyal to the company. In this sector it is very easy to acquire companies, leverage the balance sheet and “empire build” which I’ve noticed other companies do and destroy value for shareholders. This management team, on the other hand, has been very disciplined with zero interest to increase top lines at the expense of long-term profitability which is exactly why you ought to look past the cyclical aspect of the business and focus on the people running the business.
Business Model
Note there are two main divisions operated by management. The products division (90% of revenues) which has subsegments of Fabric and Furniture and the interior decorating division (10% of revenues).
If we double tap into the Fabrics segment, Colefax operate five brands –
1. Colefax and Fowler – luxury English brand renowned for its subtlety + classical elegance.
2. Jane Churchill – English brand with a reputation for contemporary elegance + artistic style and envisioned for modern living.
3. Larsen – modern US brand famous for its luxurious textural woven fabrics.
4. Manuel Canovas – iconic, quintessentially French fabric brand based in Paris + famous for its bold designs and vibrant colour palette.
5. Cowtan and Tout – high-end luxury US brand sold exclusively in the US market + renowned for its unique, elegant and colourful designs.
The Group currently has a network of 9 trade showrooms in the US (as well as others in London, Paris, Munich and Milan) and this is the main reason why Colefax has relatively high lease liabilities. Note that Colefax mainly sells to interior designers and retail fabric and wallpaper shops. The operational approach underpinning the Group’s portfolio of brands strategy is that each brand has a separate design studio but shares a common operational platform in terms of marketing, sales, sampling, warehousing, purchasing, IT systems and accounting which minimises costs whilst keeping the identity of each brand distinct and separate in the market. Fabrics and wallpapers are sourced from over 120 different high-end manufacturers around the world but based primarily in Italy, India, Belgium and the UK which means that Colefax are heavily dependent on the talent, expertise and reliability of said manufacturers.
According to one investor, Colefax’s 1988 prospectus (which I don’t have access to) revealed that “retail prices for its fabrics and wallpaper ranged from £15 to £30 per meter at the time” with today’s figures being between “£150 to £200 per meter” or a price increase of c.9% annually! Clearly, this is not such an awful business to be in! Whilst I don’t know exactly how many customers keep coming back, the annual report writes “regular repeat business is a key feature of the (fabrics) business.”
The Furniture segment (which is made up of the “Kingcome Sofas” brand) is one rare part of the business that suffers/benefits from operational gearing. Production takes place at a freehold factory in Newton Abbot, Devon which employs 42 highly skilled staff and this is the Group’s only manufacturing activity. Most of the furniture is made to order and financed by customer deposits. It is a relatively small part of the Group, accounting for approximately 3% of Group sales.
The interior decorating division is an ultra-luxury interior design business founded in 1933 and trading as Sibyl Colefax and John Fowler Limited, with projects funded by customer deposits and profits on decorating projects recognised on completion. There are five Design Directors and two Associate Directors each with their own portfolio of clients. The business is international with a broad geographical spread and the high-end client base means it is quite resilient to economic cycles. Note there can be significant fluctuations in sales and profits from year to year which sometimes can have a material impact on the Group’s results. Furthermore, I should mention that the Decorating Division includes an antiques business (accounting for approximately 8% of sales) will be significantly scaled back in the second half of this financial year following a decline in profitability in recent years.
If we look at the cash flows of the Group, you’ll notice that management are exceptional when it comes to working capital management over time. It is true that for the last three years free cash flow has been less than profits, but over the last five years the accumulated figures are almost identical! This is just one more example of how great management truly are. Cost management is another with gross margins never dropping below 50% in the last twenty years. Furthermore, even in the height of the GFC, Colefax were able to remain profitable and cash generative.
The share buybacks are obviously the prime example of excellent management. With outstanding shares of 5.9m and insiders owning c30% of the company, the float is really 4.1m. However, Schroders PLC hold another 21% and Rights and Issues Investment Trust PLC hold another 14% meaning that about 66% of the shares outstanding is not in public hands. Adjusted float is more like 2m shares meaning that investors will have to fight to get their hands on remaining shares, especially with the potential for more share buybacks.
If I briefly touch on Rights and Issues Investment Trust PLC, it is useful to note that this was run by Simon Knott (until 2022) – a relatively unknown, but highly successful value manager who achieved impressive returns over his career (greater than 10,000pc) – and I am incredibly happy to have Mr Knott’s vote of confidence in the company!
Why The Opportunity Exists
66% of shares are not in public hands meaning that the float is c.2m shares. Furthermore, given the tiny size of the company (£50m) nobody cares to look at it. Larger investors cannot buy it, institutions cannot really buy it, most fund managers are too big to buy it… which leaves only retail investors and small fund managers to fight for the scraps. This situation alone creates a unique opportunity with lots of upside potential with little downside (unless a large holder decides to dump their position – but even then, I think management would use the opportunity to retire shares!).
This odd situation is represented in the volume of shares traded being about 7k (on average). However, once adjusted for share buybacks executed on behalf of Colefax, actual volume is considerably smaller at approximately 1k. There’s no liquidity, little coverage, no reason for larger investors to get involved… but there’s still very much an opportunity for smaller investors accumulate shares at a discount to intrinsic value!
Furthermore, dreadful results for players in a “similar” industry – such as Sanderson Group PLC – or parallel industries (the likes of Victoria PLC and Headlam Group PLC) has meant that the market has assumed the draconian market conditions applies consistently to everyone which just isn’t true.
Currently, at a P/E of 8.5x, shares seem fairly valued. However, if we back out £15m net cash out of the valuation (assuming £3.6m for working capital purposes), we can say Enterprise Value is £35m meaning that on average profits of £5.4m, Colefax trades at 6.5x earnings. It would be more reasonable for Colefax to trade at an EV/Earnings multiple of 10x given the healthy balance sheet, best-in-class management and earnings stability. This works out to a valuation of £70m or upside of 40%. This, of course, fails to consider further share buybacks, better earnings or inorganic growth on the upside and worse market conditions on the downside. However, if Colefax’s margin resilience and capital allocation prowess continue, a 12x multiple would imply a £85m valuation (70% upside).
In essence, Colefax’s small size and quiet nature mean it has never been nor will be a “story stock.” There’s no promotional CEO, no aggressive IR team and no high-profile fund manager championing the stock meaning that, in layman’s terms, we’ve set foot into a breeding ground for mispricing.
Risks
Risks seem to be quite intuitive –
1. Downturn in the high-end housing market.
2. US Dollar exchange rate against Sterling.
3. Obsolete inventory.
4. Tariffs.
5. Competition.
6. Succession risk with David Green being 79.
7. Illiquidity.
However, if I viewed any of these to result in a form of permanent loss of capital, I wouldn’t invest. Here’s why each risk is not as great as it seems:
1. Of course, since interest rates spiked post-pandemic as inflation surged, housing has become less affordable. Colefax have probably benefited from homeowners that bought luxury homes at close to zero interest rates.
However, in the HY Report, Colefax mentioned that in the US (62% of fabric sales) “market conditions strengthened throughout the period reflecting ongoing improvements in high end housing market activity.”
The UK (16% fabric sales) continues to be a laggard as management cited “challenging” conditions that “reflect the impact of high interest rates on housing market activity and consumer spending.” Europe (20% fabric sales) also seems to be “challenging” despite interest rate cuts that may result in improvements with time.
2. Following the US election in November the US Dollar exchange rate has strengthened significantly and if sustained this will be beneficial for Fabric Division profits going forward.
3. This comes down to your faith in management. They have managed inventory well in the past (average inventory turnover hovers around 3x demonstrating efficient inventory management) and there is no reason to suggest that in a turbulent market they will be unable to do the same. Management cites tight purchasing controls and robust budgetary controls over new product investment for their strong results.
4. It is true that most of the fabrics and wallpapers that Colefax sell are manufactured outside of the US and tariffs are undoubtedly problematic. However, if Colefax’s brands are as strong as it seems to be, wealthy US consumers might not think too much about paying slightly more. Of course, this risk must be monitored carefully alongside the comments/actions of Trump.
5. While a determined competitor could invest in showrooms and build trade relationships, the combination of Colefax’s brand portfolio, cost efficiency, design expertise and reputable market presence creates a moat that cannot easily be encroached in the short to medium term.
6. Tim Green seems to be the likely successor to David and I suspect will be moulded to fit that role. I’m confident that given David’s passion for shaping Colefax – if Tim is not fit – he will choose a proper leader when he does step down.
7. Once you have bought shares, it is very hard to exit (and get a reasonable price from market makers). Therefore, one should be very sure about how much they set aside because it will probably be quoted at a loss. To an extent, you’re waiting for management’s next move and for that move to be digested by the market. Note that whilst illiquidity works against you when exiting, it works for you when management keeps reducing the float which will be discussed more below.
Furthermore, for those of you concerned about insufficient returns (i.e Colefax will not beat the market), worry no more. I believe that Colefax will beat the market for the reasons outlined in the catalysts section.
Catalysts
1. Share buybacks – basic arithmetic will show that if Colefax are able to throw off excess cash flow of a few million pounds/yr and use that to repurchase shares whilst maintaining/building a healthy cash buffer on the balance sheet, shareholders will benefit immensely.
In the last few years, Colefax have spent just under £20m cancelling shares. If from 2025 onwards, they spend £3m/annum (significantly less than historical figures) retiring shares, the results will be incredible. Assuming prices hover around £8/sh in 2025, they will retire 375k shares and decrease the share count by 6% to 5.54m shares. Maybe the share price increases to £8.5 in 2026, so the share count decreases by another 6% to 5.2m shares. If this continued for an extended period, shareholders will benefit greatly!
Whilst difficult to exactly predict how much Colefax will earn in the coming years, the asset-lite nature of the business model means that peaks and troughs are not so bumpy for management to navigate.
I mentioned illiquidity as a potential risk, but if management can structure purchases such that their buybacks coupled with the tight float force a rerating, it turns illiquidity into a potential advantage. There could be a potential buyback squeeze that shareholders benefit from, too!
2. Accretive acquisitions at reasonable prices. In this way, distress in the market benefits Colefax with their large cash balance that provides them with optionality. Should “strong” brands feel the pressure, management can “mop up” and drive a new portfolio of brands further into the next cycle.
3. Increased dividend that draws more shareholder interest. At the moment, the payout ratio is about 6% so there’s definitely more wiggle room. I don’t think many investors are familiar with the Colefax name at the moment and, perhaps, a higher dividend results in more positive attention.
4. Multiple expansion – compared to other larger luxury goods companies, Colefax trades at a huge discount in comparison to EV/Sales (0.5x for Colefax, 3-5x for larger companies) despite similar ROC figures in recent years. Even a modest revaluation to 1x EV/Sales would drive significant upside. Furthermore, once the market realises that it has incorrectly clumped Colefax with other losers, shares should rerate.
Conclusion
With management continuing aggressive buybacks, limited downside and a valuation disconnect, Colefax seems to reflect an asymmetric bet with many paths to rerating.
As usual, feel free to let me know if you have questions/thoughts.
Best investing,
HV
