Stockwatch: A retail play with the right answers?

by Edmond Jackson from interactive investor |

This retailer has faced testing times, but is it now ready to justify comparisons with Boohoo.com?

With UK equities exposed to prolonged Brexit uncertainty and questions over the international business cycle, achieving capital growth means exploring more radical options - so long as it doesn't lead to bearing yet more risk.

Small cap turnarounds are one such area, albeit inherently tricky given smaller companies' sensitivity to economic change. We've only just seen how womenswear retailer Bonmarche (LSE:BON) in the FTSE Fledgling index has gone from bad to worse with marketing shortcomings in a tough retail environment.

Yet very useful share price recoveries can happen in oversold situations where, after a spell of bad news, the companies proceed to report reasonably consistent trading.

They can also result from institutions bailing out at a share price low, largely to get any bad company name off their books rather than have to justify to trustees why they continue to hold it.  A dilemma is figuring out which rallies are inherently speculative, or have substance.

I was intrigued by AIM-listed LED lighting specialist Luceco (LSE:LUCE) which floated at the end of 2016 but a year later began a plunge from 270p which did not bottom out until a low 30p range at the end of last year.

Its products appear to have a decent reputation but its finance side didn't manage fluctuations in currencies and copper prices, and a tougher retail environment didn’t help. With hindsight, a classic example of a flotation that was over-priced.

In principle you'd wait for solid evidence of improvement but in practice new speculators may take a gamble: Luceco's stock has more than doubled to 80p and capitalising the group at around £125 million. The price held firm after 2018 results, the specifics of which you could quibble over but suggest a relatively more stable situation.

QUIZ versus Boohoo.com

Currently there's another example for speculators to consider. AIM-listed QUIZ (LSE:QUIZ) floated at 161p a share in July 2017 and promptly soared to test 200p, capitalising the business at £245 million.

With operations in fast fashion-wear for 16-35 year-old women, comparisons were inevitably drawn with Boohoo Group (LSE:BOO) which had achieved a £2.5 billion value on AIM. Yet QUIZ saw profit taking and its price slumped in the second half of 2018 and into 2019, with a series of profit warnings, to a low around 15p.

It rallied from 17p to 24p last Thursday and Friday however, after an update in respect of the year to March 31 showed a total 12% revenue growth with online sales up 34% to £41 million, international up 8% to £23 million and UK stores/concessions up 4% to £66.9 million.

Not as dynamic as AIM-listed Boohoo.com at a similar stage in development, QUIZ's revenues are about five times its market cap versus Boohoo's market cap about 4 times sales!  

A discrepancy can be justified if one retailer has much better marketing, but these valuations are extreme.

Day traders clipped the rally bringing the price back to 20p last Friday afternoon but the stock started the week firmly, at around 21p. Near £30 million, QUIZ is borderline for the kind of stock I comment on, although trading volumes show decent liquidity for a small cap and in principle at least, the company’s financial base implies.

Net tangible assets around 30p per share

The September 30, 2018 cash position was £11.9 million after net flotation proceeds of £10.6 million, with £15.5 million property plant and equipment supporting net tangible assets around 30p a share. The most recent update has not cited the cash position, although that's not unusual unless a company is perceived at risk for cash.

What leases are involved in the stores portfolio are very short-term, so unlike Debenhams (LSE:DEB) the company is not constrained to rid of relatively poor performers.  

Obviously NTAV lends some comfort but unless some activist investor is forcing a break-out and return of cash to shareholders, assets are only of interest in terms of what they are capable of earning; and if a clothing retailer is not on the ball its cash will dissipate.

Possibility of a P/E rating around 7 times or lower

The March update has affirmed operating profit expectations of about £4.5 million, and while forecasts aren't cited by Company REFS the market's sense appears to be for normalised EPS of 3.3p in respect of the latest financial year, possibly about 3p for the current year to March 2020.

A chief reason for an implied price/earnings (P/E) multiple of 7 or lower is that Debenhams constitutes 23% of annual revenue (just under half the "stores and concessions" element) where store closures look set to make a high single-digit impact on QUIZ's overall revenues and a risk continues of bad debts from Debenhams' operating companies.

Any focus on P/E can be misconstrued though, in the mercurial world of clothing retail. The example of Bonmarche showed how trends can shift quite dramatically versus even conservative expectations. Similar to Bonmarche, QUIZ said in March it had to apply higher than expected discounts to clear excess stock.

This is where Boohoo enjoys a strong reputation for being attuned to demand e.g. via social media, responding swiftly yet in a controlled manner - a class marketing act certainly deserving an extent of its share price premium. 

QUIZ - financial summary        
year ended 31 Mar 2015 2016 2017 2018
         
Turnover (£ million) 61.3 69.3 89.8 116
IFRS3 pre-tax profit (£m) 4.9 5.7 8.1 8.6
Normalised pre-tax profit (£m) 4.9 5.7 8.1 8.6
Operating margin (%) 8.0 8.2 9.1 7.4
IFRS3 earnings/share (p) 3.0 4.0 5.0 5.0
Normalised earnings/share (p) 3.0 4.0 5.0 6.2
Earnings per share growth (%)   33.7 24.7 23.1
Price/earnings multiple (x)       3.0
Annual average historic P/E (x)     35.6 24.4
Cash flow/share (p) 3.7 4.5 2.6 5.9
Dividend/share (p)       0.8
Covered by earnings (x)       7.8
Net tangible assets per share (p)     27.3 29.7

Source: Company REFS

Respectable operating margins of 7-9%

In fairness to QUIZ it has achieved a margin similar to Boohoo.com and substantially ahead of Bonmarche's 3-4% in its last two financial years. A near-term dilemma however is the stock clearance amid the sales shortfall in the company's final quarter of its 2019 financial year means a gross margin hit, so eyes will be on whether QUIZ can recover this.

Attention is likely next to be on a "thorough review of all aspects of the business" due with the June 11 prelims, "with a view to mitigating the effects of slower than anticipated growth during the year."

If confidence can grow that the business is at least stabilised then the stock will climb higher, but there's no room for more marketing mishaps.

You'll be aware I drew attention to Bonmarche despite warning of balance sheet issues such as swollen trade creditors, as if a stressed company was delaying on suppliers.

So judge for yourself whether I’m making a similar error of intrigue with a fallen star in the clothing trade; whether the two key owner-managers floated this business chiefly to cash in £92 million and still retain 25.6% of the company, amid euphoria over Boohoo.com.

They should have at least had the kind of lean operation now promised, when they floated. But if they have talent to cope with the current retail environment, the stock can multiply from 21p. Speculative Buy.

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

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