Investing in IKEA stocks

Not long ago we published an article analyzing the financial condition of Lego company. Although Lego stocks cannot be purchased on any exchange since the company is private, we found reports, evaluated the business, and calculated the rating using the Eyestock valuation model. This experience seemed very interesting to us, and we decided to continue. The next company we would like to fantasize about purchasing stocks on the stock exchange is the well-known furniture brand IKEA.

We don’t think IKEA stores and the business need any introduction. Instead, there will be a short real-life story about a recent move to a new home. One of the most memorable experiences during the move was assembling IKEA furniture for several rooms. The first experiment required a little more time, nerves and preparation, but the equipment of the remaining rooms went like clockwork. Ultimately, the assembly process was remembered as a pure pleasure and is still remembered only in a positive context. As a financier, in the best traditions of Mr. Peter Lynch, assembling another cabinet, I thought: “How brilliant this is, I wonder what IKEA’s indicators are? And what IKEA stock price could be?”

But before analyzing the financial indicators from the statements, we need to understand the corporate structure of the home furnishings company. Which legal entity should we look for reports? Founded in Sweden back in 1943 by Ingvar Kamprad, the company underwent major changes in 2012 and is now headquartered in the Netherlands, a structure that can confuse even the keenest mind.

IKEA is a franchise business. This means that many people and many companies with different owners work under the same IKEA brand. If we try to explain the structure of the company as simply as possible, its business is divided into 2 parts. Inter Ikea is a company that owns the brand, production, and technologies. And Ingka Group is an operator of 537 stores in 31 countries. But everything is much more complicated in fact. It is believed that this structure was made specifically to protect the company from fragmentation or resale in subsequent generations after the death of Ingvar Kamprad, who passed away 6 years ago, in January 2018, at the age of 91. It is the reporting of Ingka Group that will be the object of our study. By the way, you can find it on the IKEA group website here.

When starting to analyze the numbers, it is important to understand what we are dealing with. IKEA is not just a furniture manufacturer or seller. This is a full-cycle company from its procurement of materials to recycling, which employs more than 160 thousand people!

We also see IKEA company that is extremely socially oriented. The environmental and social responsibility agenda is very important today, so the company’s report pays great attention to the details of production and the value that IKEA adds to people’s lives. Up to the number of cubic meters of water consumed for each region!

And now we get to the main figures of the report from the financial analytics point of view. Looking at today’s hero, which like Lego isn`t a publicly traded company and we are not able to buy IKEA shares at a stock market in the United States or somewhere else, we would like to understand: would an investment in their shares be justified if the shares were available? To do this, we want to go through IKEA’s income statement, balance sheet and cash flow statement and answer 4 questions that will ultimately allow us to conclude IKEA’s business investment attraction by Eyestock valuation model.

Question 1 about IKEA shares.
Whether IKEA has a competitive advantage and benefits from economies of scale?

IKEA’s annual revenue for 2023 amounted to 44.3 billion euros. Let us recall that last week’s hero in the private companies category, LEGO, whose final rating exceeded 100%, had revenue of less than 10 billion euros. Talking about IKEA it’s not surprising for one of the largest retailers in the world and one of the leaders in the furniture industry. But we do believe in numbers, not statuses and titles. After the company bears all the costs associated with producing goods and providing services, it is left with a gross profit of 14.6 billion euros. In percentage terms, this is 33%. It is called gross margin and such a value for a retailer is not even bad! Even though Walmart and Target are companies with slightly different specifics, their margins are lower — 24% and 27%, respectively.

However, if you subtract all operating expenses from gross profit, you get a less rosy picture. Unfortunately, IKEA does not disclose its operating expenses in detail, at least in its annual report for 2023, which is located on the official website. But it is easy to assume that the lion’s share of expenses, whose size is no less than 13 billion euros per year, is selling, general and administrative expenses. And this is almost 30% of revenue. Not a critical amount, but quite a good illustration of the fact that IKEA gets the palm in the industry at a very high price.

When revenue is cleared of all expenses, including taxes, 1.5 billion euros of net profit for 2023 remains, and this is even less than Lego, although the revenue of IKEA is 4 times more. The net profit margin is only 3%, and this suggests that the market advantage of the IKEA business model is practically reduced to nothing. Thanks to high cash flow and high-quality earnings, the final profitability score according to the valuation system that we are using at Eyestock was 20% of the benchmark 25% — which is not bad. But still pay attention to the negative dynamics of the financial performance indicators of the Swedish-Dutch giant.

Returning to the first question about competitive advantages, we can say that IKEA is among the market leaders, but its position is no longer as strong as it was 5-7 years ago.

Question 2 about IKEA shares.
Is IKEA a liquid and solvent company?

Here everything is much more optimistic. To analyze solvency, we need the company’s balance sheet. Unfortunately, the investment relationship department of the company does not spoil us with beautiful documents. Everything is quite concise and laconic. How much debt does the company have? There is no separate line about this in the report, but total financial income and expenses have a positive value of 196 million euros for 2023. This usually includes income from the placement of available funds and the costs of servicing loans and borrowings. In addition, the following illustration awaits us in the presentation:

We conclude that there is either no debt at all or it is so small that it can be neglected. After this, the calculation of the three key metrics by which we evaluate liquid and solvent IKEA is effortlessly fast.

IKEA passed the second test of investment attractiveness more successfully and currently has a 64% rating when 100% for us is a benchmark or an ideal company to invest in its shares. What remains ahead is the analysis of management efficiency and sustainability of development.

Question 3 about IKEA shares.
Can IKEA’s management successfully manage capital?

Or in other words, is the return on equity high? We know the value of capital from the report — almost 47 billion euros, and we also know a net profit of 1.5 billion euros. And what do we get when calculating the return on equity for IKEA? ROE is only 3%? For a second, the risk-free rate for the eurozone is now slightly lower. So what is the point of this business for shareholders, when you can get almost the same profitability without any risk? There must be some kind of mistake here. 

To double-check ourselves, we use a second performance indicator—return on invested capital, or ROIC. It differs from ROE in both a numerator and a denominator and allows you to find out the ratio of pre-tax profit to capital, which is directly involved in core or operating profit. NOPAT turned out to be 1.37 billion euros — this is easy to calculate based on the available data from the statements of operation. The invested capital turned out to be significantly less than the share capital, but not enough to demonstrate a high return on it. ROIC is only 5%, and this leads us to the conclusion that the company’s operating business is currently very low-performing.

Question 4 about IKEA shares.
Is IKEA sustainable?

At the finish line, all we have to do is find out how sustainable and predictable as a result business growth is. This is a very difficult question because stability and sustainability are very subjective values. However, at Eyestock, we have found a way to measure this aspect of business valuation mathematically. The company’s website has a sufficient number of annual reports, from which you can build a graph of changes in annual profit.

For public companies, we usually take two time periods: 2 years for short-term evaluation and 5 years for long-term evaluation. In the case of IKEA, we will take 10 annual reports and calculate the average net income growth rate. In 5 years it will be 85%, and over 10 years — 34%! Isn’t this huge for such a mature business!? Not at all. Keep in mind that these are averages and are subject to significant year-to-year fluctuations. For example, in 2022, net profit was very low due to a one-time financial expense of more than a billion euros and amounted to 287 million euros versus 1,579 billion euros a year earlier — in 2021. When the financial write-off did not occur in 2023, net profit recovered due to the effect of a low base growth rate was a cosmic 425%. But this is a kind of visual illusion.
You have to be careful with averages. But we won’t clean them up and justify them. However, when analyzing stability, we look not just at the average, but at its ratio to the deviation of growth rates, which is easy to find using the standard deviation function. And then we will see that the deviation of growth rates is not just comparable to the average value, but turned out to be several times higher. What does this mean from our point of view for IKEA’s business? The average growth rate of net profit is nominally high, but the predictability and probability of repeating a successful year is too low to call the company at least somewhat stable, and its growth sustainable.

Results for IKEA

Unfortunately, at the two final stages, the company scored only 11% according to the Eyestock valuation model, and the final rating is only 75%. Let us remind you that our Lego rating turned out to be much higher — as much as 122%. What does 75% mean? In fact, a very reasonable rating for a mature business in the consumer sector.

If we take a look at the shares of companies that could be classified as IKEA’s competitors, we find that our hero will be at the top of the list. Provided that the more diversified business of companies such as Walmart can be classified as competitors.

If we had the opportunity tomorrow to become shareholders of LEGO and IKEA companies, we would almost without hesitation buy the Danish manufacturer stocks, and we would closely analyze the hypothetical stock price of IKEA to minimize the risks of investing in them, as we usually do with shares of public companies at Eyestock.