Interactive Investor

Stockwatch: this might be a useful defensive share in tough times

6th June 2023 11:46

Edmond Jackson from interactive investor

A strong balance sheet and track record of success convinces analyst Edmond Jackson to upgrade this FTSE 100 company to ‘buy’ after a recent share price drop.

Despite what some might see as “antics”, retail entrepreneur Mike Ashley is certainly resolved. 

Last December, he took out a leveraged upside bet on sporting goods and fashion retailer Frasers Group (LSE:FRAS) by way of selling put options (the right to sell shares at a specified price) over 800,000 shares with an 800p strike price, expiring this September. His anticipated upside has yet to materialise, however, with Frasers currently trading just below 700p in markets cautious at prospects for consumer discretionary spending.  

Towards the end of last month, he managed the situation by part-exercising some of these options, and also making a spread bet equivalent to 100,000 shares at 718p, worth £717,645. 

While it can be hard to unravel his mercurial actions, Ashley’s move is interesting after the stock dropped below its 2023 trading range of 720-800p amid concerns at weak numbers from Foot Locker Inc (NYSE:FL) last month. JD Sports Fashion (LSE:JD.) was also hit from around 170p to below 150p. 

His trading happened shortly before the closed period on dealings begins later this month – it was 20 June last year followed by a trading update a month later, then annual results in September. It seems a drawn-out process for a FTSE 100-listed group with a 24 April financial year end, but such are the idiosyncrasies of Mike Ashley-controlled companies – he owns nearly 71% of Frasers. 

They also include appointing his son-in-law as CEO from May 2022, where common sense suggests they should both have a decent sense of underlying trading. 

Might sporting kit be defensive in tough economic times? 

While 58% of group revenue derives from Sports Direct stores and online business, the troubled House of Fraser department stores were acquired for £90 million in 2018 – then a string of fashion-related acquisitions such as Missguided, I Saw It First, Gieves & Hawkes, and more recently Topgrade Sportswear from JD Sports Fashion last March.  

I had premonitions over House of Fraser lest gremlins emerged, but it appears to have affirmed Ashley’s capability as a scavenger of retail assets. I have for decades watched this strategy get results in industries such as oil & gas. 

Frasers’ approach does appear timely: to buy more retailers in Britain and Europe as tougher times force smaller companies – especially those that previously chased sales – to seek financial support. This assumes integration benefits and the group not becoming over-complex to manage.

Interim results to 23 October showed revenue as 20% premium lifestyle, 19% international and 3% wholesale/licensing. UK sports retail was 58%. The gross margin eased from 44.7% to 42.0% like-for-like.  

At the operating profit level, (and based on the last annual figures) sports retail constituted 56%, premium lifestyle 6% and international 36% - helping justify European expansion. 

A key reason Frasers catches my attention is the longstanding adage about how people prioritise appearance and fitness in hard times. Perhaps this was affirmed by Sports Direct’s relatively strong performance a decade or so ago, in the wake of the 2009 recession and ongoing eurozone debt crisis.

Market researchers also note a modern trend towards spending on experiences rather than things, in a 21st century realisation that we all own too much “stuff”.  

Obviously, much also depends on whether affluent professionals and the like continue to spend on fashion if discretionary spending dips. 

In the US, Dick's Sporting Goods Inc (NYSE:DKS) stock had fallen 17% since April on fears for discretionary spending, then posted an earnings beat and its stock has firmed from a recent low around $122 to $128.  

Perhaps “athleisure” clothing and footwear has become rather crowded, hence more sensitive to reduced discretionary spending. 

Sports Direct can have a Marmite reputation – for example some people dislike its 28 days returns policy involving a credit note rather than cash refund; and sports-gear retail is undoubtedly competitive. Yet when I resumed tennis a year ago, having not played since a small boy, it was possible to get well-kitted out at low cost from Sports Direct.

Stock rating may over-discount fears for consumer outlook 

If Frasers meets consensus for £354 million net profit in its latest financial year, generating earnings per share (EPS) of 75.4p, then the stock currently at 695p implies a modest price/earnings (PE) multiple of 9.3. Admittedly, that is in line with the expectation for around 8% EPS growth this current financial year to 81.5p.  

Yet these appear conservative numbers relative to the 8 December interim statement guiding for annual pre-tax profit in a £450 million to £500 million range. Yes, this was six months ago, but there has been no change indicated via the regulatory news service and companies are not meant to tweak expectations without declaring.  

Despite strong cash flow backing as you would expect of a retailer (see table below), there is however no dividend record given the strategy to re-invest in acquisitions. That could be justified by Frasers’ return on equity jumping to 18% in the last financial year, although previously it has been in volatile single figures. 

By comparison, JD Sports Fashion trades on 11.9 times the consensus EPS expectation for its year to 28 January 2024, easing to 10.7 times in 2025. There is a circa 0.5% yield albeit that’s no real prop should the narrative turn adverse. 

It’s unclear whether it’s a sign of strain or just capable reaction to tougher times, but at the start of this month it was reported Frasers would lay off up to 200 employees as part of streamlining the business after acquisitions over recent years. 

Frasers Group - financial summary
Year-end 24 April

Turnover (£ million)2,9043,2453,3603,7023,9573,5074,691
Operating margin (%)
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-
Return on total capital (%)
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

Strong balance sheet to withstand a recession and make acquisitions 

At 23 October 2022, the group had £814 million bank debt, all long-term, plus £660 million lease liabilities - in context of £315 million cash and £1,382 million net assets. Intangibles constituted a modest £152 million and there was no goodwill. The interim net interest charge was just £11.4 million relative to £283 million operating profit.  

A potential risk is the young CEO splurging money on deals, but I fully expect he is using Ashley as a sounding board on all strategic matters. 

An investment case therefore exists along a rationale that this stock is priced cautiously for the perceived “Mike Ashley maverick factor” (even now, post Sports Direct plc) plus uncertainty as to discretionary spending. Yet the business has strategic elements well-suited to potentially challenging years ahead. 

Bear in mind, I am a slightly stale bull, having made a “buy” case a year ago similarly at 700p, on the basis that Sports Direct could benefit from people trading down in tougher times. There was a longstanding culture of Ashley running a tight ship which he would likely pass on to the new CEO. 

The stock did test 950p last July then fell by year-end as interest rate concerns weighed on consumer stocks. 

There are no disclosed short positions in Frasers, albeit scant liquidity for shorting given Ashley plus Phoenix Asset Management and the employee benefit trust own 82% of the equity. I should point out that aside from Phoenix firmly holding its 7.6% stake, seven other institutional shareholders over the 1% level have reduced their positions – this was the case last December when I moderated my stance to “hold” at 815p.  

Given a long period without an update, strictly you should wait for the next piece of news. On a long-term view, however, I upgrade to Buy.

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

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