Interactive Investor

Stockwatch: founder places huge bet on this FTSE 100 company

9th December 2022 10:56

Edmond Jackson from interactive investor

This high-profile businessman is backing shares in the company he set up to go much higher. Analyst Edmond Jackson examines prospects as the UK faces a prolonged downturn.

What to make of Frasers Group (LSE:FRAS), the acquisitive mid-cap retailer chiefly known for Sports Direct? While its two-year chart can look like a bull trend, the second half of this year has seen up to 50% volatility in a circa 600p to 900p range.

Quite whether that marks a consolidation after rising from spring 2020 is unclear, but the all-time chart shows considerable volatility, and the stock is testing highs as the UK enters recession.

Yesterday the shares fell 9% to 815p after interim results to 23 October. Profits were flattered by Frasers’ policy of including property sales “above the line” on grounds that it is a regular activity.

Like-for-like sales for the main sports division slipped 3% and, while mostly due to lower sales at Game UK (a video games chain acquired mid-2019 for £52 million), it reflects my concern that retail empire-building is liable to mean varied performance.  

Rescued by stay-at-home and younger people 

Management says a large proportion of its customers continue to spend on clothes because they are living with parents, hence are protected from rising energy, mortgage and even food costs. Employment levels remain high. 

That is supported by QUIZ (LSE:QUIZ) reporting strong performance at its interims last Wednesday, and JD Sports Fashion (LSE:JD.) in September. Yet investors remain wary of Boohoo Group (LSE:BOO) and ASOS (LSE:ASC). Stocks that represent discretionary spending are being treated warily.  

I drew attention to Frasers as a “buy” around 700p last June, along a rationale that Sports Direct in particular could benefit from people trading down in a tougher economic climate. There is a long-standing culture of founder Mike Ashley running a tight ship and its methods may be apt for the times - despite appointing his son-in-law, his successor as CEO in May 2022. 

For example, unlike many online retailers being hit financially by offering free returns, Sports Direct has insisted customers pay postage (apart from faulty items) for as long as I can remember. 

Management re-affirms guidance for £450 million to £500 million adjusted pre-tax profit for its year to 24 April, and consensus politely targets 6% growth for 2024. In which scenario, the forward price/earnings (PE) is not much over 10x and in due respect, while operating margins are single figures, they are not far behind JD’s circa 7%.

Frasers Group - financial summary
Year-end 24 April

 2016201720182019202020212022
Turnover (£ million)2,9043,2453,3603,7023,9573,5074,691
Operating margin (%)7.74.66.04.34.9-2.16.4
Operating profit (£m)223148201161192-73.3301
Net profit (£m)27723020.111293.8-83.0250
EPS - reported (p)45.538.33.821.518.5-18.247.5
EPS - normalised (p)51.931.42.425.627.918.278.4
Operating cashflow/share (p)10.842.961.452.574.3103108.0
Capital expenditure/share (p)33.968.939.230.663.843.968.5
Free cashflow/share (p)-23.1-26.022.221.910.559.139.5
Return on total capital (%)12.38.59.26.36.4-2.65.7
Cash (£m)234205360448534457337.0
Net debt (£m)99.71823973799909721,112
Net assets (£m)1,3861,2231,1941,2471,2671,1931,287
Net assets per share (p)232218222232224230263

Source: historic company REFS and company accounts

There is no dividend, which could be due to Mike Ashley owning a 69% stake and preferring expansion. This near £4 billion stock also trades at 3.0x book value or 3.3x on a tangible basis. For valuation, earnings will therefore remain in focus. 

Premium lifestyle demand and expansion

Group revenue growth was 13% assisted by acquisitions, versus 4% organic. 

Like JD was able to cite robust performance in sports fashion, the fashion clothing side of Frasers has seen 25% growth – chiefly due to new Flannels stores and online growth. Organically it was 22%. 

UK sports retail has seen 12% growth after the acquisition of Studio Retail, otherwise a 3% slip due to Game UK weakness also a strong comparator of re-opening after the last lockdown in March 2021. 

While the international side represents only a fifth of revenue, organic growth was over 9% at constant currency, although reported revenue eased 6% after US retail operations were sold. 

A gross margin slip from 44.7% to 42.0% at the group level is blamed on Studio Retail, House of Fraser store closures and cost of goods inflation. The House of Fraser estate has reduced from 59 to 34 stores and although more closures are likely, recent changes in UK business rates policy should mitigate pressures. 

The House of Fraser purchase appeared to me to symbolise Mike Ashley’s maverick style, which risked the group being saddled with problem businesses. Quite whether its £90 million purchase in 2018 created value or raised the risk profile remains to be seen.

Recent purchases have been Missguided, I Saw It First and Gieves & Hawkes; and in early November Frasers’ equity stake in Hugo Boss AG (XETRA:BOSS) rose to 4.3%. Remarkably and via derivatives, it has a further 30% exposure equivalent to around £875 million.  

The CFO says more retailers will be bought in Britain and Europe in the months ahead, as recession forces smaller companies – especially those that chased sales - to seek financial support.  

It is indeed an opportune time and, as of 23 October, Frasers had £315 million cash, but it must ensure it does not become a sprawling retail conglomerate.  

Numbers benefit from £91m profit via sale and leaseback 

Strong profit advances – up 41% at the operating level, 39% pre-tax and 35% to £193 million net – are said due to “continually improving product choice in the core UK business”. 

Yet £91 million profit from property sales also contributed, despite being checked by £50 million property impairment also taken above the line. The CEO has a property background and this move may be astute, but sale-and-leaseback is an old chestnut to enhance profit. 

Also reflecting the benefits of share buybacks, interim reported earnings per shares (EPS) soared 64% to 41.6p or by 48% to 44.8p adjusted. 

While management’s narrative cites a 14% fall in operational cash flow to £390 million, the cash flow statement shows a plunge from £560 million to £172 million. This was said due to higher operating costs, new acquisitions and business rates relief in the prior period. 

The elevation strategy continues

Time will tell how appropriate it is in a recession. Flannels’ roll-out continues, with six further UK stores targeted to open in 2023 versus 45 currently. Opportunities in continental Europe are being assessed with brand partners.  

A £600 million new distribution centre and headquarters is also planned in Coventry: “a fully-automated operation with all the green credentials...”  

Mind how the balance sheet has seen debt rise from £375 million to £814 million, all long term, albeit alongside £660 million leases and £181 million near-term derivative liabilities, up from £21 million.  

The context is £1,382 million net assets and the interim net finance charge was only £25 million, helped by income and investment gains. 

Inventory has risen 22% to £1,467 million, which outstrips revenue growth hence may represent goods not sold – and a risk of discounting. It is a very typical aspect of retailers currently but seems also to reflect Frasers’ optimism. 

Mike Ashley makes £815K bet on stock being 900p by September 2023   

This morning heralds news of his 8 December spread bet on 100,000 shares plus the sale of put options on 300,000 shares with a strike price of 900p expiring next September.   

Clearly then, he regards the drop as a buying opportunity – or wants the market to believe so, as principal shareholder. 

His son-in-law CEO could get shares worth £100 million if market price reaches £15 for 30 consecutive trading days before 7 October 2025. Hopefully, it will not mean his making Frasers’ profile even riskier. 

It seems hopeful indeed if the UK endures a tough long recession, yet Frasers may still be better placed than most retailers. Hold.

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

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