Interactive Investor

Stockwatch: is it time to buy this share after a near 40% drop this year?

1st June 2022 11:40

Edmond Jackson from interactive investor

Our companies analyst Edmond Jackson examines the discount retailer.

The FTSE 100 shares in B&M European Value Retail (LSE:BME) are currently just about holding 390p after a sustained drop from a 635p high last January – quite similar to, if less dramatic than falls in other retailers including food, amid fears over margin compression.

B&M describes itself as “a variety goods retailer”, which can come across cynically as a Poundland-type operation that had better not lapse into another Woolworths. Yet these stores retain appeal to consumers who like a curiosity mix of regular offers.

The B&M stores account for 83% of group revenue, while Heron Foods is just 9% and although the story from France sounds good – margin recovery over 9% has helped operating profit nearly treble to £32 million – it is 8% of revenue.

Much therefore depends on predicting UK consumer behaviour in the “value” retail space, and its competition.

Has the drop extended too far as growth investors bail?

After floating in 2014, the stock traded in a 200p to 350p range; then a drop 250p in March 2020 set up a strong bull run, significantly because the B&M stores offer consumer goods alongside essential food items, hence were allowed open during Covid lockdowns.

This rescued a plunge in net profit to £90 million in the year to 27 March 2020, achieving a record £428 million in 2021.

You could say I missed B&M’s rally but it seemed potentially fleeting; driven by the special circumstances of Covid and enough people sat at home, punting on momentum stocks. Mean-reversion was inevitable.  

Profits are currently expected to ease by mid-single-digit percentages, this year and next, such that a circa 38p earnings per share (EPS) consensus for 2023 implies a price/earnings (PE) multiple just over 10x.

If projections for DPS around 22p with nearly 2x earnings cover are realistic – indeed, the table shows very strong free cash flow capability – then the yield is 5.6% which looks like support.

It compares for example with Tesco (LSE:TSCO) on a 12x forward PE and 4.2% yield, around 260p; although Sainsbury (J) (LSE:SBRY) is similar to B&M, at 230p just over 10x for its PE and yielding 5.4%.

Fair pricing is itself uncertain in the near term

The latest prelims’ narrative cites “cautious optimism” amid difficulty to project key variables. Product cost prices are rising and there is further normalisation in customer behaviour as the pandemic eases.

Lower-cost food and consumer goods should however appeal to lower-income households given they are most-affected by soaring costs of living; and the stores may attract new shoppers seeking keener prices.

A key uncertainty is what aspect of product offering involves discretionary spending. B&M’s general merchandise has enjoyed several years’ strong growth in sales and margin.

“Some extent of mark-downs is expected to return and there may be an adverse impact from category mix as customers shift spending away from more discretionary higher margin merchandise in favour of food and basic goods.”

This appears why, despite respectable figures in last Monday’s annual results, the stock closed down 15% at 390p.

Flat annual profit but EPS but up 23% on a two-year view

In a classic shift of the shareholder base, from growth to income investors, dividends come more into focus.

B&M’s fundamentally strong cash generation explains a 25p special dividend last January, despite the ordinary dividend easing 5% to 16.5p. Also, a manifest policy of maintaining over 2.5x earnings cover implies scope to reduce this given capital expenditure needs are modest.

There is nearly £1 billion debt plus £1.3 billion lease liabilities – B&M is not an operation like Morrisons, with a substantial asset base – which generated £88 million net finance costs relative to £610 operating profit.

It is therefore interesting to speculate on the board re-rating the ordinary dividend per share, potentially higher than around 22p expected.

The special payout already meant 30p was paid out, timing-wise, up to March 2022, reducing earnings cover to 1.4x – arguably appropriate.  

Management proclaims highly attractive long-term growth prospects

At least 950 B&M UK stores in total are targeted, versus 701 currently, also expansion of Heron Foods, meanwhile in France “the pace of organic growth is expected to step up from the 2024 year onwards”.

The last financial year saw 34 new UK store openings and 14 closures or re-locations. Aldi and Lidl similarly reckon on further scope for UK expansion of value-retailing; but when might capacity be reached?

If the going is so good, you also wonder why an Arora family investment vehicle – representing Simon as CEO, Bobby as group trading director and Robin as a senior manager – sold 40 million shares at 585p last January, reducing their stake from 11% to 7%.

It unsettled investors, as if the effective B&M founders had cashed in to the maximum extent institutions would swallow, after the stock reached an all-time high.

Simon and Bobby Arora acquired B&M as a 21-store chain in December 2004, and in the last month or so Simon has declared intent to retire – being replaced in due course by the current CFO. While he does have a strong retail track record and margin control is now in focus, it begs an old question whether a number-cruncher has marketing flair. 

B&M European Value Retail SA
Year-end 26 March

  2016 2017 2018 2019 2020 2021 2022
Turnover (£ million) 2,035 2,431 3,030 3,273 3,813 4,801 4,673
Operating margin (%) 8.6 8.4 7.9 9.7 8.7 12.8 13.1
Operating profit (£m) 174 205 240 319 333 613 610
Net profit (£m) 125 143 186 194 90.0 428 422
EPS - reported (p) 12.4 14.3 18.6 19.8 20.4 42.7 42.1
EPS - normalised (p) 13.2 14.8 19.1 19.8 17.7 43.1 41.6
Operating cashflow/share (p) 14.3 17.9 19.8 37.5 54.9 82.5 49.1
Capital expenditure/share (p) 5.7 5.2 11.5 10.6 12.4 8.8 8.5
Free cashflow/share (p) 8.6 12.7 8.3 26.9 42.4 73.7 40.6
Dividends per share (p) 4.8 5.5 7.2 7.6 8.1 17.3 30.0
Covered by earnings (x) 2.6 2.6 2.6 2.6 2.5 2.5 1.4
Return on total capital (%) 12.8 13.8 14.8 12.0 12.8 23.3 17.6
Cash (£m) 91.1 156 90.8 86.2 428 218 173
Net debt (£m) 349 396 530 1,814 1,640 1,814 2,093
Net assets (£m) 802 800 912 992 867 733 746
Net assets per share (p) 80.2 80.0 91.1 99.2 86.7 73.2 74.5

Source: historic company REFS and company accounts

An historic UK food price advantage may be eroding

On 10 May with the stock around 460p, analysts at Jeffries argued “B&M does not offer either the haven of its grocery peers or the cyclical gearing of UK discretionary peers”.

Its estimate of a B&M UK food basket over 41 items suggested value has declined from over 17% to 9.5% over three years. Expanding this to 109 items, however, brought a 15% price advantage in its favour. Combining the two results implied price leadership near 14% but this falls below 10% versus the keenest rivals.

Jeffries also questioned whether B&M can retain very favourable branded buying terms as it scales up; and citing the stock as its least-favourite name in UK big cap retail, cut its target from 520p to 460p.

While such a target range may be justified by fundamentals, a dilemma is the chart showing anywhere from 350p to 450p as possible for mean-reversion.

Each time the stock has dropped just lately, around 450p it was said a gap had to be filled at 400p – which it was – then the talk shifted to 350p. Frankly, it is all chart-based sentiment, but technical analysis does often appeal when fundamentals look dicey.

Short sellers currently look astute

Also helping explain stock-fall extending to 40% is three institutions a total 4.1% short of B&M and where Marshall Wace – I noted lately as a warning sign over WPP (LSE:WPP) as it increased its short – edged up 0.1% to 1.0% of the total issued equity.

That represents £39 million bet on further downside by one trader, and £160 million by all three. They likely need to hedge multi-billion-pound equivalent, equity portfolios though.

Citadel did start to trim its short as of 27 May.

A very tricky call

Where a low for the stock exists, is not predictable – just like the economy and consumer behaviour.

You might consider a small position, with a view to averaging in – to lock in a 5%+ yield. Short closing potentially offers upside, quite when though. Conservative investors should avoid, but if you appreciate the risks and how this idea may be premature: Buy.

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

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