Can Dick Smith survive underwhelming Christmas trading?
Dick Smith Holdings Ltd (ASX: DSH) provided investors with a masterclass in how to shed value when its share price tumbled 58% following recent revelations the stock was planning a $60 million writedown to inventories.
Following two profit warnings and a major writedown since late June, Dick Smith has shed over 80% of its value to hit an all-time low of $0.36.
To put that into context, compared to a market cap of around $500 million – based on an issue price of $2.20 back in December 2013 – the stock now has a market cap of $86 million.
With histrionics around the stock's dismal share price performance – after being brought to market by private equity – now the substance of Australian share market folk lore, the more pressing question for investors is whether there's value to be had entering the stock at current levels.
Given that the stock is now trading on a whopping 76% discount to its forecast 2016 intrinsic value ($1.54), it's easy to see why investors have been quick to tar speciality electronics retailer with the 'mark of the value-trap'.
But wait, that may not be the worst of it, until the current inventory review is finally complete, there's always the likelihood that management's profit guidance could be even worse than expected.
At this juncture, the bigger question is not whether to enter the stock at current levels, but whether you need to lock-in a loss on the shares you currently own before they fall any further, and deploy what little equity is left in the stock into the share market's next best opportunity.
Those who like the sector may wish to look at the knock-on effect that Dick Smith has had on the share price of its peers, which everything being equal should correct over time, and especially if Dick Smith finally collapses.
There's growing concern that with the company allegedly struggling to pay suppliers, it could become insolvent if sales don't improve over Christmas.
To put the state of its balance sheet, and the very real likelihood of Dick Smith's demise into context, it's important to note that its funding gap of $394 million is around 4.5 times its market cap.
Unsurprisingly, base on these numbers, the stock only has a cash flow ratio of 0.84, and earnings per share (EPS) growth which has been poor over the last two years since listing, and its forecast to decline.
In light of Dick Smith's share price, it's important to remember that price and value aren't mutually exclusive. In other words, the stock is trading on a price to earnings (P/E) ratio of 2.17 times for good reason.
Secondly, it's illogical to ride a share price down in the benign hope that it can recover over time, 99.9% of the time – these expectations are misplaced.
No matter how wealthy you are, you shouldn't be comfortable with the eventuality of holding onto any stock until such time that it's effectively worth nothing.
While Christmas is critical to the electronics retail sector, management was quick to flag a cautionary outlook for this all-important trading period. However, if it had been truly committed to clearing its inventory, it would have more aggressively priced what was so widely reported to be a badly needed 'fire sale'.
With Dick Smith having fallen unceremoniously out of ASX 200 index, the stock will struggle to receive the sort of broker coverage it has enjoyed in the past.
As cruel as it might be, it's important to remember that shareholders are at the bottom of the capital structure. Exit this stock while there still some value to be gained.