Stockwatch: do JD Sports’ rosy forecasts make sense?

by Edmond Jackson from interactive investor |

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Company will benefit from lockdown sportswear boom – but investors should be clear-eyed.

What to make of an £8 billion company that guides annual profit 36% higher than consensus, yet its stock struggles to close up 4%? And versus gurus saying the euphoric stock market is poised for a crash, does this not show elements of caution? 

Against recent consensus for JD Sports (LSE:JD.) to make £295 million pre-tax profit in the year to 30 January 2021, management has suggested an outcome of at least £400 million.

I find this curious in light of annual revenue indicated to be up only 5%, as if operational gearing is involved and JD has adeptly coped with re-positioning costs while stores have had to close. (Royal Mail recently had a parcels boom but failed to capitalise due to extra handling costs.)  

A caution how operational restrictions clip profit 

Unfortunately, the pre-close trading update does not specify cost-and-margin reasons for profit out-performance, instead linking it to “the positive nature of demand through the second half”. The puzzle continues by way of a caution how “operational restrictions from the Covid-19 pandemic will be a material factor through at least the first quarter of the new financial year…the process to scale down activity in stores and scale up the digital channels…presents significant challenges”.

You would reasonably think management was presented with that challenge in the spring 2020 lockdown, hence an aspect of “one-off” adjustment challenge and costs. September’s interim results cited retail footfall being “comparatively weak,” together with higher costs for health and safety measures and online fulfilment. These saw profit before tax and exceptional costs ease from £159 million to £62 million, like-for-like. 

Then in October it did not look encouraging how JD’s executive chairman sold 40% of his stake at 746p raising £19.3 million and leaving him with 0.4% of the company. For what market adages are worth, you are meant to pay more attention to director sales than buys, especially the big ones.   

But the stock has re-gained last February’s 880p all-time high, if currently dipping to 860p, having its plunge below 300p in March.  

It is ironic how the second half year has shown JD smartly capitalising with online sales, yet going forward it still has to caution about constraints of “UK stores likely closed until at least Easter and closures in other countries possible at any time”. Thus, management’s best estimate is for 5% to 10% profit growth in the year to 29 January 2022. 

The outlook statement was however quite similarly checked at September’s interims, and recent consensus for £295 million profit appeared high enough versus “at least £265 million” as guidance. 

I find insufficient explanation how this profit out-performance arose, although it appears JD managed the online transition well and stores were not closed a similar length of time last autumn as seems likely now.  

Is the shift to sports fashion permanent? 

If JD’s bottom-line outperformance is explained chiefly by “positive second-half demand” then it begs a question. Were its customers benefiting from an extent of furlough support – as well as spending money that would have gone on eating/drinking out, or travel, for example?

If so, then JD’s recent trading has enjoyed an aspect of temporary support that will expire with furlough payments – with higher unemployment then checking consumer demand.  

A counter bull case, however, would be that once vaccines enable more socialising, younger people especially will want to pep up their image with quality fashion wear. 

There is aspect of social behaviour it is tricky to predict: which upshot for demand can diminish questions of margin and so on. If JD’s marketing remains adept, it can remain a financial winner overall. 

But you might also wonder if people have already now made the shift to owning more informal clothes for working at home.  

As to the risk of major sports-wear manufacturers getting their act together better online: I would say most genuine sports people have bought significantly online for at least the last five years. Much sportswear and gear is marketed this way, from warehouses, since ranges have expanded and made it tricky to maintain a full selection in-store. Admittedly, ‘fashionable’ sports-wear marketing may vary from this.  

I therefore believe JD holders should take heart there are reasons – albeit mixed – for sales to remain resilient. 

The chief question is probably stock rating  

I pencil in February 2021 normalised earnings per share (EPS) of around 37p, implying a forward price-to-earnings (PE) ratio of 23x with the stock at 860p.  

JD has actually sustained a PE of 20x or better, for nearly a decade, though it is possibly getting harder to sustain such growth rates as annual sales creep towards £6 billion. 

I first drew attention to the company back in August 2010. Then, at a pre-stock splits equivalent of 36.2p, the forward PE was only around 7x versus even conservative projections for earnings growth in the mid-teens.

As a long-term follower, I have noticed JD sustain around 20x pretty much since 2012 – due to its growth story being well-established and respected.  

Mind that since the 2018 financial year, EPS growth has moderated to 19% then 14% in the 2020 year. After about 10% growth in the latest year, guidance is for 5% to 10% profits growth to January 2022. You have to decide the extent this easing reflects the pandemic versus corporate size starting to weigh.  

Does global scale also enhance value? 

The UK component of sales is a modest 38%, versus 33% for the US and 24% in Europe. Currently this appears net bullish, despite Covid-19 compromising stores sales everywhere, given the Biden administration appears set to pass serial stimulus packages. The update already cites: “excellent performance in the US…capitalising on enhanced consumer demand consequent to fiscal stimulus which expired on 31 July”.

Yet I feel I am straining to quantify upside, more sketching scenarios. The fact is JD passed its interim dividend, and even a full restoration would offer negligible yield. 

The stock may however be becoming significantly like ASOS (LSE:ASC), which has for years sported a whopping PE versus highly variable earnings. Its fans would partly justify that for its global reach and “replacement value” (of building from scratch), hence what a trade buyer would likely pay. 

At which point I down tools, as subjective factors take priority from quantified analysis. 

Soaring trade payables are a concern 

JD’s August 2020 balance sheet was skewed in places. The £213 million bank debt of £313 million was greatly outweighed by £1.1 billion cash – which had leapt from £347 million over 12 months. However, as a stores group there were high leases: over £1.5 billion long-term and £273 million short-term. 

Intangibles being 30% of net assets were not a major concern. But I draw your attention to trade payables up 27% near £1.2 billion, versus trade receivables down 24% to £194 million.

From the outside it is very hard to guess what has happened. But a serious payables/receivables imbalance can mean profit enhanced by delayed payment (while money due is also chased up).   

JD Sports Fashion - financial summary
Year end 1 Feb

  2015 2016 2017 2018 2019 2020
Turnover (£ million) 1,522 1,822 2,379 3,161 4,718 6,111
Operating margin (%) 6.1 7.3 10.1 9.4 7.3 7.0
Operating profit (£m) 92.6 133 240 296 346 427
Net profit (£m) 52.7 97.6 179 232 262 246
EPS - reported (p) 7.0 10.0 18.4 23.8 26.9 25.3
EPS - normalised (p) 8.2 13.0 19.1 25.0 29.7 33.8
Price/earnings ratio (x)           26.2
Return on equity (%)   28.8 38.3 35.1 29.4 22.1
Operating cashflow/share (p) 11.9 23.2 28.7 34.8 38.8 87.7
Capital expenditure/share (p) 7.2 8.6 9.0 19.2 19.6 18.2
Free cashflow/share (p) 4.7 14.6 19.7 15.6 19.2 69.5
Dividend/share (p) 1.4 1.5 1.6 1.6 1.7 0.0
Cash (£m) 121 216 248 348 251 466
Net debt (£m) -84.2 -209 -214 -310 -125 1,563
Net assets (£m) 296 382 552 770 1,009 1,219
Net assets per share (p) 30.5 39.3 56.7 79.2 104 125

Source: historic company REFS and company accounts

Tilt at Debenhams poses a question over organic growth 

Last year’s £86 million acquisition of Footasylum plc was controversial, albeit small, and potentially justified by expanding JD’s clientele to a slightly older demographic.  

December’s acquisition of the US Shoe Palace business for £241 million equivalent also looked logical. This is a chain of 167 stores, principally in California and generating around £39 million equivalent, annual profit.

By combining fascias, the aim is to become “a prime destination for sneakers and lifestyle apparel in the US”. The business was low risk, having been established by the Mersho family in 1993 and with four brothers continuing to manage the business with input from JD. Unless they lose interest having become rich, this looks a sensible way to pick and proceed with takeovers. 

Yet JD’s discussions with the administrators of Debenhams – towards acquiring the UK business – was somewhat worrying, even though they terminated. Debenhams is a long-term troubled business.

Remains a wary ‘hold’ 

In recent years, I have moderated my enthusiasm for JD given rising risks besides potential reward from international expansion.

It looks to me as if this retailer will continue to capitalise on the less formal lifestyle Covid-19 is reinforcing, and this seems likely to persist. But in terms of financial analysis, I cannot satisfactorily explain the latest ramp-up in profit or justify a fair value target. On a simple basis the stock looks about as dear now as it was cheap back in 2010.  

Obviously, all stocks are rated higher now after central banks have destroyed interest rates and bond yields. But if the scenario changes adversely then JD’s downside risk would outweigh upside, hence I would avoid it with fresh money. ‘Hold’. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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