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Vita Group Limited (ASX:VTG) shares storm higher despite 44% drop in profits

In morning trade the Vita Group Limited (ASX: VTG) share price has stormed higher following the release of its full-year results for the 12 months ended June 30.

At the time of writing the shares of the operator of Telstra Corporation Ltd (ASX: TLS) retail stores are up 5% to $1.10.

Here is a quick summary of how it performed in comparison to a year earlier:

  • Revenue from continuing operations increased 3% to $684.5 million.
  • Gross profit fell 13% to $211.3 million.
  • Gross margin shrank 5 percentage points to 31%.
  • Earnings before interest, tax, depreciation, and amortisation (EBITDA) fell 37% to $41 million.
  • Net profit after tax dropped 44% to $22 million.
  • Full-year dividend of 9.1 cents per share fully franked.
  • Earnings per share of 14.1 cents.

While this has clearly been a thoroughly disappointing year for the company and its shareholders, a sharp decline in profits was expected. Furthermore, it was an improvement on its first-half performance where revenue was down 4% and net profit after tax was down 48% on the prior corresponding period.

The result was also in the middle of its EBITDA guidance range of $38 million to $43 million.

Why was profit down significantly?

The vast majority of Vita Group’s revenue comes from the retail stores that it operates on behalf of Telstra. Unfortunately for the company, Telstra renegotiated its remuneration terms last year and this has had an adverse impact on its profitability.

While management is attempting to move away from a reliance on Telstra’s stores by expanding into new categories, this is a work in progress.

At the end of the period the company was operating 105 Telstra licensed stores, 23 Telstra business centres, one Fone Zone store, one SQDAthletica store, six Clear Complexions clinics, and one Artisan Cosmetic & Rejuvenation clinic.

What about FY 2019?

Management believes that Vita Group is strategically and financially well-positioned for the future. It expects the key ICT channel to continue to improve, generate cash flow, and strong returns thanks to its optimisation and productivity programs.

However, one key piece of information that could have a bearing on the future is Telstra’s updated strategy for small-to-medium business customers.

As a result of this strategy, Vita Group has entered a process to transition from the Telstra Business Centre model, and has applied to become part of the new, premium Telstra Business Technology Centre (TBTC) model in FY 2019.

According to management: “Vita is confident it will be successful with its application, which would see Vita operate fewer points of presence across significantly expanded territories. TBTCs will service small-to-medium businesses with more complex technology needs, offering whole of business solutions through highly trained consultants. Small business customers with relatively simpler needs will be serviced by the retail channel, utilising existing infrastructure, but with whole of business solutions.”

While I expect Vita Group’s experience and track record will mean it is successful in its application, it is worth considering what might happen if its application fails.

While I do like the company, I don’t like its reliance on Telstra. Especially given how much pressure the telco giant is under to cut costs.

Because of this, I intend to stay clear of the company despite how cheap its shares are and focus on retailers with more robust business models such as Premier Investments Limited (ASX: PMV) and Super Retail Group Ltd (ASX: SUL).

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Premier Investments Limited and Telstra Limited. The Motley Fool Australia owns shares of Super Retail Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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