Retail gloom has dominated company headlines in the New Year. Dick Smith Holdings’ collapse and Woolworths’ decision to exit its troubled home-improvement chain, Masters, shows the damage when retailers get it wrong.
Economic headlines have been just as bad for retail. Rising concerns about China and the rout in global equities, if they persist, will dent consumer confidence and retail sales growth. They could also stop a nascent recovery in retail, evident in better Christmas sales, in its track.
Income growth that will hit a 50-year low in 2016, on Deloitte forecasts, cooling property markets in Sydney and, to a lesser extent, Melbourne will also weigh on the retail sector this year. Pessimists, clearly, have many arguments to avoid cyclical retail stocks.
But beneath the retail gloom have been some surprisingly strong retail performances over the past 12 months, according to Switzer Super Report sector analysis.
For example, car-repair chain AMA Group has a one-year total shareholder return (including dividends) of 133%. Car dealership AP Eagers has returned 87%, and car-parts supplier Burson Group has delivered an 80% total return.
Furniture retailer Nick Scali is up 57%; discount retailer The Reject Shop has recovered with a 94% total return over one year; Premier Investments has returned 20%; and discount fashion accessories group Lovisa Holdings is up 54%.
In travel retailing, Webjet has a one-year total return of 90% and telecommunications retailer, Vita Group, has posted an 80% return. Even laggards, such as Pacific Brands Group, have returned 38% over 12 months, after several years of poor returns or, in Noni B’s case, attracted a takeover.
Retail Initial Public Offerings (IPOs) and backdoor listings, where dormant listed companies buy private companies or their assets, have also featured. Baby Bunting Group has soared from a $1.40 issue price to $2.54, after raising $54 million and listing in October 2015.
Homewear retailer Adairs has risen from a $2.40 issue price to $2.65 after raising $218 million and listing in June 2015. Surfstich Group, a December 2014 IPO, has rallied from a $1 issue price to $1.67. Beacon Lighting Group, an April 2014 IPO, has more than tripled its 66 cent issue price. AhaLife Holdings, an online luxury goods retailer, has also attracted plenty of attention since its backdoor listing on ASX in July 2015.
There have, of course, been plenty of laggards as well, notably Woolworths and Myer Holdings. Among micro-caps, vacuum retailer Godfreys Group was smashed after a profit downgrade and several tech-based retailers have disappointed.
Nevertheless, sector analysis confirms two enduring truths about retailing. First, that investing in retail, as much as any industry, requires betting on management. Good retailers, hard to find, respond quickly to changing consumer tastes, spotting trends, and watch every cent. As Dick Smith’s demise shows, there’s little room for retail missteps.
The other truth is looking beyond macro headlines and focusing on bottom-up company valuations. Those who avoided retail stocks in 2015 because of a sluggish Australian economy missed some terrific price gains — just as those who avoid retailers in 2016, fearing a global economic recession and market meltdown, will miss solid, albeit slower gains from a small group of higher-quality retail stocks.
Challenges are building for retailers in 2016. Lower stock and property prices, at least in the first half, will make consumers feel less wealthy or inclined to reduce savings and spend. A declining Australian dollar over 2016 and its negative effect on imported white goods and electronics products is another strengthening headwind for retailers.
But better-than-expected jobs growth and probably an interest-rate cut from the Reserve Bank by June will help consumer sentiment, provided the global equities sell-off stabilises from here. Lower oil prices, assuming they are passed on in greater magnitude at the petrol pump, is a much-needed tailwind for retail spending in 2016.
On balance, expect sluggish, patchy retail conditions by geography and retail segment. Better conditions in New South Wales and Victoria will help offset tougher trading conditions in the resource states of Queensland and Western Australia. The trick is finding retailers with exposure to stronger growth pockets within the sector.
Small group of small- and mid-cap stocks appeal
I prefer small- and mid-cap retail stocks over larger ones. The market cheered Woolworths’ exit from Masters but the retailer has a long list of challenges, not the least of which is choosing the right CEO to clean up the mess. Myer, even around $1, is hard work, given the cyclical and structural challenges facing department stores. It could be a takeover target. Metcash is also best avoided, given challenges in supermarket retailing, which is the bulk of its revenue.
JB HI-Fi, an exceptional retailer, looks fully valued for now, as does Harvey Norman Holdings. Both face the threat of higher electronic goods prices as the Australian dollar declines against the Greenback and import costs rises. JB Hi-Fi would look more interesting below $20.
Among small- and mid-cap stocks, focus on segments within retail that have strong tailwinds: spending on fitness products, travel, and homewares, for example. Also, look for retailers with growth prospects offshore and that are beneficiaries from a lower Australian dollar.
Most of all, choose retailers with strong and stable executive teams and boards. Every retailer, of course, says it is well managed, so focus on the hard numbers – high, rising Return on Equity (ROE) over a long period – rather than CEO rhetoric.
Here are three retailers to buy during bouts of market weakness. Each suits long-term portfolio investors who are comfortable with small and mid-cap stocks.
1. Nick Scali
The well-run retailer has barely put a foot wrong in the last few years. An average ROE of 33% over the past five years is outstanding for any company, let alone a small retailer. As is Nick Scali’s (NCK) 22% annualised total return over five years.
Nick Scali’s other favourable traits include low debt, minimal share issuance, strong cash flow and a demonstrable ability to grow in good and bad retail markets. It has leverage to the housing market, which although having peaked should remain reasonably solid in 2016. And future interest-rate cuts could encourage consumers to buy home goods on credit.
A lower Australian dollar, which lifts furniture import costs and weighs on profit margins, is the main concern, although Nick Scali has so far managed this risk well.
On a trailing Price Earnings (PE) multiple of about 20, Nick Scali is not cheap. But it deserves a valuation premium and would look more interesting closer to $3.50.
Nick Scali
Yahoo!7Finance, 21 January 2016
2. RCG Corporation
The owner of The Athlete’s Foot has been a retail standout in recent years. A return on equity near or above 20% from FY11 to FY14 impressed, as did RCG’s astute acquisition of New Zealand footwear company Accent Group in March 2015.
RCG (RCG) again highlights the importance of bottom-up analysis with retailers. IBISWorld research this week said the footwear retailing industry would contract by an annualised 1.2% over five years to FY16, amid tough operating conditions. But RCG has prospered.
I rate RCG on three counts. First, it is one of few Australian stocks that have strong leverage to fitness trends. Fitness-related activities, from buying gym gear to fitness trackers, watches and, in RCG’s case, athletic and walking shoes, have excellent long-term growth prospects.
Second, RCG has cleverly differentiated The Athlete’s Foot by focusing on customer service and the form and fit of shoes as a key selling point. That, in turn, has helped maintain profit margins and customer loyalty, and mitigated the threat of online retailing as consumers see real value in properly fitted running shoes and good service.
Third, RCG’s executive team and board have a strong retail pedigree and have executed superbly. Like Nick Scali, RCG is not cheap after the recent share-price rally. But it has some of the best growth prospects of any Australian small-cap retailer.
RCG
Yahoo!7Finance, 21 January 2016
3. Premier Investments
My view that Premier Investments (PMV) is the pick of the globally focused Australian retailers, outlined in September for the Super Switzer Report, remains. Premiers owns the Just Jeans, Jay Jays, Portmans, Jacquie E, Dotti, Peter Alexander and Smiggle brands. The latter two, particularly Smiggle, are its big growth engines and have fantastic prospects.
Stationery chain Smiggle is emerging as one of Australia’s great retail exports. Premier said it wanted 200 Smiggle UK stores and $200 million in sales over the next five years, and investment banks last year hypothesised that Premier could have 450 Smiggle stores worldwide by 2024-25. It already has around 200. Parents with pre-teen daughters (including this author) understand the hypnotic power Smiggle’s colourful stationery has over this customer segment!
Peter Alexander also has interesting prospects as consumers spend more on bedroom wear, particularly as Christmas gifts or for other occasions.
Medium-term growth from Smiggle and Peter Alexander should offset weakness in Premier’s mature brands across teenage fashion and womenswear, which have less scope for earnings growth, given many costs have already been taken out of those businesses.
The market has mixed views on Premier Investments at the current price. Six broking firms have a buy recommendation, four have a hold and four a sell, consensus estimates show. A median share-price target of $12.50 suggests Premier is fully valued.
Premier can beat market expectations in FY2016. Smiggle’s offshore growth is the main reason to own Premier and the likeliest catalyst for a share-price re-rating as it opens more stores and grows faster than the market anticipates.
Premier Investments
Yahoo!7Finance, 21 January 2016
– Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at 12 January 2016.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
