Sanderson Design Group (SDG)

A royalty stream with royal approval!

Happy Friday everyone! Before we kick off, I want to thank you all for your support - it’s truly humbling to see so many people signed up to the Substack. Anyway, here’s what you came for…if I had to put this investment in a box it would read ‘improving quality at a low price’. Enjoy!

Sanderson Design Group is a UK listed company that makes and sells branded fabrics and wallpaper. I first looked into Sanderson a few years ago and dismissed it as a low quality business with limited growth potential. But after recently revisiting the investment case, I discovered what could be a potential goldmine. It’s not immediately obvious, but Sanderson owns a small royalty stream, which is becoming increasingly valuable.

I’d imagine most of my UK based readers will have seen or heard of Sanderson’s products. Of the six individual brands, the oldest and most widely recognised is Morris & Co, established in the 1860s by the artist and designer William Morris. The namesake brand Sanderson also has a similarly long history and cultural significance. It even has ties to the British Monarchy, having held a Royal Warrant since 1923. Others include Clarke & Clarke, Harlequin, Zoffany, and Scion.

Here’s a brief overview of the three business segments. I’ve purposely kept this part short, so we can move onto discussing the royalty stream before anyone nods off. However, if you want a much deeper dive into Sanderson’s background and businesses, I’d recommend starting with this broker note from 2021.

1. Brands (~75% of consolidated sales).

   1. This segment sells fabric and wallpaper to thousands of wholesale customers (over 6,000 in the UK alone). Most are small, independent retailers, but the list includes some of the largest department stores, such as John Lewis, and decorator’s merchants such as Brewers.

   2. Fabric products represent three quarters of sales with the remainder coming from wallpaper. Sales are concentrated on the premium end of the market and Sanderson is one of the largest and oldest UK companies focused on this sector.

2. Manufacturing (~15% of consolidated sales).

   1. Sanderson owns two freehold printing facilities based in the UK. These make products for the Brands segment and also for third parties. Standfast & Barracks is based in Lancaster and manufactures fabrics. Anstey is based in Loughborough and makes wallpaper.

3. Licensing (~10% of consolidated sales). The focus of today’s writeup. Sanderson, as the licensor, grants the rights to use its brand names and designs to a third party (the licensee) in return for licensing fees. I’ll go into more details below.

A management shakeup kickstarted the growth of Licensing. In 2019, profits were tumbling and a new team, led by the current CEO, Lisa Montague, was installed. They immediately set about defining a new strategic framework based on four pillars - brands, products, customers, geographies. As with most strategic initiatives, the headlines were fairly woolly. But the changes implemented have led to tangible improvements.

As a business segment, Licensing aims to monetise a vast treasure trove of Intellectual Property. Sanderson owns several archives housing over 150,000 original samples of wallpapers, fabrics and other artefacts. For access, a licensee must agreed to pay Sanderson a percentage of any sales made, alongside a minimum amount, which must be paid regardless.

Since 2019, licensing has grown from a few minor agreements into an entirely new business segment. Today, Sanderson has over 50 licensing partners and its designs are being used on products including clothing, bedding, furniture, tableware, rugs and blinds. The largest partners include retailers such as Next and Sainsbury's (think Habitat & Tu) in the UK and more recently Williams Sonoma in the US. Alongside large retailers, there are many product specific partnerships including with Ruggable (washable rugs) and Blinds to Go (a subsidiary of Hunter Douglas). Most partners want to licence the designs of Morris & Co, but Scion and Clarke & Clarke are also gaining in popularity.

The financial improvements are obvious, especially at a segment level. Underlying performance, which adjusts for the minimum contractual payment, has been growing at double digits. The diversification and durability of this income has also been improving. At first, contracts with new partners were generally short, maybe a year or two, but more recently the company has been signing much longer deals of up to 5 years.

The beauty of this royalty based income is that it’s extremely high quality and requires almost no capital investment. Every pound received by Sanderson feeds down to the bottom line at very little cost to the company. At a segment level, these improvements are obvious. Yet, within the consolidated results you’ve got to look further up the income statement - where Gross Margin recently reached the highest level in over two decades!

At 105p per share, the current market capitalisation is ~£75 million. Including Net Cash of ~£15 million, the Enterprise Value is ~£60 million. In the year to 31st January 2024, Sanderson produced Operating Profits of ~£10 million and Net Income of ~£8 million. For a business with such a valuable and growing royalty stream, Sanderson is trading on a low multiple of profits.

The eagle eyed amongst you will have noticed that the Licensing segment alone accounted for the entirety of last year’s consolidated Operating Profit. The Brand and Manufacturing segments, with combined sales of ~£100 million, barely contributed. If we include a more usual (or normalised) Operating Margin for both segments of 5%, another ~£5 million would be added to Operating Profit. With this adjustment, the price now seems ridiculously low!

Perhaps this is too optimistic, especially because there’s some obvious risks. Within the Licensing segment there’s customer concentration. More than half of licensing income last year came from a handful of retail companies (think Next, Sainsbury's and Sonoma). Management are slowly diversifying the partnership base, but it’s difficult to ignore the ongoing importance of these large contracts.

Also, capital allocation is a concern. Particularly, because Sanderson has ~£15 million in Net Cash. In the past, management have guided towards a progressive dividend and a 30% payout ratio, which reduces this risk somewhat. However, a large and growth focused acquisition in an expensive market could easily destroy shareholder value. Management’s past actions seem shareholder friendly. However, they own very few shares and may ultimately struggle to think and act like owners.

Overall though, I think Sanderson is a rare find. It’s unusual to uncover such a cheap royalty stream, especially one with such potential. In the shorter term, the Licensing segment may remain somewhat hidden as the management team fight to turn around the Brand and Manufacturing segments. Yet, I think the longer term results will be worth waiting for. As the true potential of this under-appreciated and high-quality income stream could be huge.

Disclaimer. This article is for informational purposes only, and should not be seen as investment advice. Please do your own research before investing in any company mentioned.