Don’t get blindsided by a profit warning

Creating a buzz in St Pancras station

The stock market can be a brutal place. If you get on the wrong side of a profit warning, the market doesn’t tend to drag its feet – the verdict is usually swift and uncompromising.

By way of illustration, one company I keep an eye on fell by close to 40% on Thursday. Shareholders will have had their Easter weekends ruined. But what are the chances for resurrection?

I think the market can sometimes overreact to a profit warning, especially where blue chips are concerned. Yet the fortunes of our biggest and best companies rarely turn on a particular item of news.

They are large and diversified – which makes them able to withstand the occasional setback. So it’s certainly worth considering picking up shares in a blue-chip stock that gets clobbered for missing its forecasts.

With small companies, it’s a bit different. Here you don’t have the breadth and depth to the business, which means a profit warning can be a real game changer.

Let’s take a look at SpaceandPeople (SAL). The shares had been in a lovely uptrend, which had seen them treble from 50p to their high of around 150p in February.

Although they had drifted back a little recently, there was no hint from the share price that anything was amiss. And yet last week management announced a profit warning. As a result, the shares went down from 132p to 80p on Thursday. Sometimes, profit warnings can be great buying opportunities, but I am not sure SpaceandPeople will recover from the blow.

The market got this one wrong

SpaceandPeople manages and sells space in shopping centres and other public areas, like St Pancras railway station, for marketing events and kiosk retailing.

The promotional events, ‘experiential marketing’ in the jargon, are popular with landlords, because they engage customers and generate a buzz about the place. I saw the management three weeks ago, and they struck me as quietly confident.

SpaceandPeople can be seen as an outsourcing play. So like any outsourcer, SpaceandPeople’s success depends on it being expertly focused on an aspect of operations that its clients think of as peripheral.

So I can see the attraction of what SpaceandPeople has to offer. However, even before the warning, there was evidence that the business isn’t as solid as investors might have thought.

On the face of it, long-term exclusive contracts in major venues should provide good earnings visibility. But the UK retail arm saw revenues fall by 22% last year.

SpaceandPeople pointed out that kiosks offering to buy people’s surplus gold had been an important source of tenant demand which dried up as the gold price fell. This vulnerability highlights the fact that some earnings might be rather lower quality than the market thought.

What a difference a month makes

Management gave an upbeat statement less than a month ago and still strongly believed in two key drivers of growth for 2014 when I met them recently.

The first is that SpaceandPeople has a significant German business, which had been trading well.

The other big contributor to growth was a forecast for the new ‘S&P+’ operation to move from loss into profit. S&P+ represents SpaceandPeople’s attempt to “move up the food chain”. Its aim is to grab part of a client’s strategic marketing budget, rather than conducting ad hoc events

S&P+ could be a good growth extension for SpaceandPeople and the management is confident it will deliver good sales this year. However, part of the profit warning acknowledged that this would come with lower margins than the rest of the business.

In that statement, the core businesses are expected to deliver sales 13% below budget for the year as a whole and profits will be £1.5m, which is roughly half of what was expected.

When I saw the management recently, they spoke of a strong pipeline of new venues and bookings. However, they now say that translating this into sales in the UK is slower than anticipated and that promotions in Germany have lost sales, while new permits are obtained.

The buoyant German retailing arm has also slowed with lower than expected occupancy and a slowdown in the rollout plan.

It’s a long way back from here

Given that the problems are spread across the company, it looks like the management was simply too optimistic and too slow to adjust its sights. The fact that the warning came less than a month after an upbeat results statement and follow-up meeting with investors also suggests that communication and controls might not be as tight as they should be.

I should point out though that the management has been admirably clear in quantifying the shortfall and even suggesting a profit target for 2015, which shows a recovery to £2.0-£2.5m. The dividend will be held and SpaceandPeople has net cash on the balance sheet.

The shares have almost halved in line with the downgrades, which seems fair. The management has suffered a big blow to its credibility, which will take some restoring.

It could be that the business is just less predictable and lower quality than the market once thought. Nothing will be taken on trust from here and we will have to wait and see how closely trading unfolds against these revised expectations.

Unlike a blue-chip share down on its luck, I certainly wouldn’t advocate taking a punt on SpaceandPeople until we have some evidence things are back on track. With smaller companies, it’s just that much harder to take things on trust.


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