Interactive Investor

Stockwatch: is this FTSE 100 star running out of room to grow?

3rd September 2021 10:56

Edmond Jackson from interactive investor

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Our equities columnist considers the prospects of a high street heavyweight as it continues to rebuild after lockdown. 

Last January, I concluded warily on FTSE 100-listed JD Sports Fashion (LSE:JD.) given its challenges to sustain a growth stock profile as a circa £10 billion company.

Yes, it has a global opportunity to extend a powerful brand that any acquirer would have to pay up for, and it may continue to capitalise on a less formal lifestyle after Covid lockdowns.

But in terms of financial analysis, it is trickier to assert a fair value target. At 860p the stock justified a “hold” stance.  

When I drew attention exactly 11 years ago, it was at a pre-stock splits equivalent price of 36.2p – on a forward price earnings (PE) only around 7 times, versus forecasts for earnings growth in the mid-teens.

Since 2012, it has so far sustained a forward PE over 20x although JD’s current battle with the Competition and Markets Authority shows its growth story as less clear.  

Tussle with CMA is more a concern for what it says about growth 

Contrasting somewhat with the likes of Boohoo (LSE:BOO) or the privately owned Shein online retailer, I discussed a week ago, it is palpable how JD faces a relatively more congested market.

The boom in sports shoes and the like has been around since Nike (NYSE:NKE) introduced its waffle shoe in the 1970s, whereas fast-moving online fashion is a new concept where elite operators dominate. 

Acquisitions also suggest development needs a kicker than relying on organic growth, to sustain a stock rating.

Two years after JD acquired the troubled AIM-listed Footasylum for £90 million in May 2020, it is in a stubborn with the CMA – which insists the combination is leading to “a substantial lessening of competition”. 

Instead of being possessed by organic growth, JD appears obsessed with this stand-off; it will continue to make a case strongly before the CMA releases its final report in October.

I am more concerned why management is not too busy with organic growth, to indulge this stand-off, although I accept it would be a loss of face if JD becomes a forced seller of Footasylum. 

Regulation is a tricky job but officials have to counter capitalism’s tendency to oligopoly and monopoly. Not surprisingly, managers may take a different view on a fair outcome.

The CMA has argued that JD’s being Footasylum’s strongest competitor means higher prices, fewer discounts, less choice of products and less investment in customer service. The two sides also dispute the effects of online marketing by Nike and Adidas. 

So far however, it has not affected JD’s stock – which is currently at an all-time high of £10.40, up 23% on a pre-Covid high of 840p in February 2020, itself an advance on a 330p to 490p consolidation over 2017 to 2018.

Showing how a highly-rated stock can be sensitive in a market slide, JD dropped sub-500p in April 2020.  

This re-rating does appear justified by a seemingly permanent shift in the demand curve for informal wear, even if this reduces somewhat when lockdowns ease globally. 

Forward PE of 26x reducing to 22.5x, pre-exceptional items 

Interim results to 31 July are due 14 September meanwhile the full- year consensus forecast is for circa £400 million net profit to 30 January 2022.

This corresponds with JD’s last trading statement at its 1 July AGM which guided for £550 million pre-tax profit, and considering a 29% corporation tax rate incurred last year. 

Mind, it is “pre-exceptional items” hence potential for the headline number to be lower amid Covid costs for example. The gap between reported and normalised earnings per share (EPS) was 39% last year but was 34% anyway for the January 2020 year i.e. pre-Covid. That is not surprising for acquisitive groups.  

Assuming JD also meets consensus for £470 million net profit in 2023, it implies 24% normalised earnings growth this year and 16% next. That implies a forward PE around 26x reducing to 22.5x which some would say is not over-extended as a growth rating.  

Yet the AGM update noted a second round of US fiscal stimulus – paid directly to individuals – as boosting consumer demand. To what extent will it temper the revenue re-rating as stimulus tails off? The US represented 29% of group sales in the January 2021 year. 

Also, some stores remained temporarily closed in Asia Pacific and “we must recognise the risk of further temporary store closures across our global estate and the potential repayment of government support to payroll costs in the current year”. 

Stock looks fully valued for current circumstances 

The table shows operating margins on a decreasing trend before Covid, from an un-startling 10.1% in the January 2017 year to 6.2% last year. This however counters regulatory concern that JD enjoys excess market power hence freedom to price.

The recent years’ range of margins is still modest for a stock enjoying PE’s over 20x. Also, returns on capital employed and equity (see table) were in a 30% range up to 2018 but were sliding pre-Covid. 

The stock's price/earnings-to-growth – or PEG – ratio is 1.6 rising to 2.5, where strictly speaking value exists below 1.0 although in bull markets plenty of growth companies may trade at a premium.

Holding JD is therefore partly a question as to how long the pro-equities financial environment lasts. 

Last January’s net debt of £1.1 billion looks heavy relative to £1.2 billion net assets though is at least down from near £1.6 billion year-on-year, helped by a very strong cash flow profile versus modest capital expenditure needs.

The net interest charge was covered 6.3x by operating profit. Year-end cash more than doubled to £964 million. 

JD is not therefore financially stretched, were trading to defy hopes and moderate. You are unlikely to get hit, holding it, barring a market slump. The chief issue for me is a less attractive risk/reward profile around current prices.  

Holders may take some comfort that JD’s international reach and brand value means, if say a major US retailer moves to buy it while takeovers continue apace, then a premium for control would still be likely. 

JD Sports Fashion - financial summary
Year end 30 Jan

  2016 2017 2018 2019 2020 2021
Turnover (£ million) 1,822 2,379 3,161 4,718 6,111 6,167
Operating margin (%) 7.3 10.1 9.4 7.3 7.0 6.2
Operating profit (£m) 133 240 296 346 427 385
Net profit (£m) 97.6 179 232 262 246 224
EPS - reported (p) 10.0 18.4 23.8 26.9 25.3 23.0
EPS - normalised (p) 13.0 19.1 25.0 29.7 33.8 32.0
Price/earnings ratio (x)           32.5
Return on equity (%) 28.8 38.3 35.1 29.4 22.1 18.3
Return on total capital (%) 30.1 37.2 31.3 26.5 13.7 10.7
Operating cashflow/share (p) 23.2 28.7 34.8 38.8 87.7 109
Capital expenditure/share (p) 8.6 9.0 19.2 19.6 18.2 13.6
Free cashflow/share (p) 14.6 19.7 15.6 19.2 69.5 95.6
Dividend/share (p) 1.5 1.6 1.6 1.7 0.3 1.4
Cash (£m) 216 248 348 251 466 964
Net debt (£m) -209 -214 -310 -125 1,563 1,134
Net assets (£m) 382 552 770 1,009 1,219 1,239
Net assets per share (p) 39.3 56.7 79.2 104 125 127

Source: historic company REFS and company accounts

Puts more emphasis on interim results refreshing a growth story 

I make these points ahead of interim results which will need to impress, versus the CMA fiasco. Otherwise, how can the stock attract new buyers? 

Peter Gowgill, executive chairman, did buy £480,843 worth of equity last July at nearly 862p a share – adding 50,000 shares to hold over 3.9 million overall.

But it appeared quite a PR sop following controversy over his being paid a £4.3 million bonus last year despite JD benefiting from millions of pounds in government Covid support.

Despite a salary reduction his total pay tested £5 million and the board’s chair of its remuneration committee chair was sacked at the AGM.   

JD is therefore a mixed prospect for fresh money, on current evidence I would avoid. Holders need to assess the interim results which may yet show underlying momentum intact; however, there is no room for disappointment. Hold. 

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

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