After a spectacular rally by the high street retailers recently, analyst Edmond Jackson gives his view on the sector and picks out one company of particular interest.
Charts have perked up across the retail sector in the first week of 2023, looking increasingly as if a bottom was established last October and a recovery is gaining momentum.
Sentiment is helped by better-than-expected results from Next (LSE:NXT), Greggs (LSE:GRG) and B&M European Value Retail (LSE:BME), which sports a classic “inverted head and shoulders” reversal pattern – implying a rally to at least 500p, if chart theory can be trusted.
A turnaround in retail stocks is similar to financials stocks, the likes of Lloyds Banking Group (LSE:LLOY), Legal & General Group (LSE:LGEN) and Jupiter Fund Management (LSE:JUP) firming up. There is potentially wider relevance because retail and financials often lead the market.
Such a start to 2023 affirms the notion that equities became over-pessimistic last October when the UK’s “car-crash” mini-budget coincided with fears in the US that its central bank would ruthlessly raise and maintain interest rates at a level which restores 2% inflation. That we might not see too serious a recession, equities might be modestly priced in advance of an earnings recovery in 2024.
Such logic implies a greater risk of being in cash, where retailers show what you miss when there are surprises on the upside.
I would beware a tendency for crowd sentiment to change, just because it does. The macro context remains, and it will be some time before we see the effects of rising interest rates. Yesterday in the US, equities faltered after a strong jobs report cited companies adding far more positions than expected in December. While this bodes well for consumer spending hence economic demand, it implies that US rates will stay higher for longer to curb inflation there.
A positive start to Christmas updates affirms visible footfall
In the city of Lincoln, East Midlands – where I was out and about over Christmas and New Year – there appeared no change in people’s enthusiasm to shop over the festivities.
Once sales had started, a car park serving the likes of Currys (LSE:CURY), Halfords Group (LSE:HFD), ScS Group (LSE:SCS) and Pets at Home Group (LSE:PETS), was gridlocked with cars struggling to move. Elsewhere in the city centre, hobbyists were back inside a Warhammer shop, and its owner Games Workshop Group (LSE:GAW) should provide a December trading update with interim results next Tuesday.
While Halfords Group (LSE:HFD) appeared a relative disappointment – the fewest customers inside a large store – who is going to buy car and bike parts after Christmas? Halfords nowadays derives around half its profits from vehicle servicing.
“Value” retail seems tricky to judge: Poundland stores were consistently busy, helped by strong positioning along a busy high street and being smaller inside than B&M Home.
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While B&M appeared to be doing well, so was Home Bargains, which has a similar format and a long history since founding in Liverpool in 1976. With 539 stores across the UK, it provides direct competition for B&M’s 700 or so.
Although it was tricky to deduce revenue from visible footfall, I left Lincoln feeling there was ample evidence to counter pessimism on spending – affirmed by this week’s updates.
Yet UK macro data claims retail footfall fell by a quarter in the last week of December, on the week before (how rather unsurprising) and was 20% down on the same week in 2019.
I would take more notice of the Centre for Retail Research saying that 17,145 shops closed in 2022 – up nearly 50% on 2021 – as this could be useful restructuring to benefit those left.
Certainly, a dilemma for holding retail sector equities is that conflicting signals are likely to persist.
Does B&M warrant an upgrade to ‘buy’?
Last November, I re-examined B&M, concluding with a “hold” stance at 370p after profit/earnings estimates had fallen 16% for the March 2023 year and consensus reckoned on a nominally flat 2024. Considering inflation, that implied a decline in underlying value.
Short-selling data showed three hedge funds over the 0.5% disclosure level - significant bets against a circa £4 billion company. Meanwhile, there was no director buying.
Yet the stock edged up to 411p by year-end, then rose strongly this week before yesterday’s update continued its rise by 2% over 450p.
Despite a recently bullish chart pattern, I think this stock had to mean-revert down after Covid drove a boom in eating from home and buying items to enhance domestic life. Yes, B&M should continue to prosper as a value-operator, but the retail sector’s fundamentals limit chances for a further re-rating.
The months ahead will be an interesting test of a supposedly key “reversal” indicator.
I originally made a “buy” case at 390p last June, but the stock turned volatile and I suspect sentiment may remain mixed. For example, at end-December, one hedge fund raised its short position 0.08% to 0.9% of the issued share capital, although two others reduced theirs below the 0.5% disclosure threshold. Perhaps this short covering helped the stock’s rise.
B&M’s fourth-quarter 2022 update implies the consumer environment would need to turn dire to justify shorting this stock, but does a “buy” case stack up?
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Year-on-year group revenue rose 12%, with a 10% advance in the UK and France up 25%. New store openings are not distinguished, but I recall an intent to open three outlets in France in the second half of 2022 taking the estate to 111 stores, thus strong organic growth.
“Very good performance” is cited in grocery and general merchandise, and the smaller Heron Foods business is up 23%. Yet Poundland had said last June that UK consumers were cutting back even on essentials. It would appear that B&M has benefited like Aldi from people seeking keenest prices, hence stock and cost management will remain critical.
Net profit for the March 2023 year is guided into a £560-£580 million range against consensus for £557 million, but recalling November, it had been downgraded anyway.
A 20p special dividend is also declared, if lower than 25p in respect of the March 2022 year and the 45p paid in 2021 when free cash flow neared £74 million, helped by Covid lockdowns. B&M began special pay-outs in respect of 2019 at 15p a share.
Mind how note six in this trading update – in relation to the special dividend – cites a 15% Luxembourg withholding tax due to B&M’s domicile.
B&M European Value Retail SA
Year-end 26 March
|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|
|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
B&M’s share price has risen nearly 2% to 452p in consideration of the latest update. Such a price represents a 7.5% yield if adding a 17p special pay-out (net of the extra tax) to the circa 17p ordinary dividend expected for the March 2023 (also 2024) financial year. Otherwise, it’s a 3.7% yield based on the ordinary dividend.
The price/earnings ratio is 12.5x the consensus for March 2023 earnings per share (EPS) of 36p, but which expects March 2024 EPS of 34p based on a 7% reduction in net profit to £340 million. This would cover the ordinary dividend around twice, perhaps reason not to rely on further special payouts.
Holders could yet stay lucky for income, and I think B&M’s retail positioning implies it should remain a relatively strong performer in tough times.
Yet calling retail stocks is capricious when we are yet to see the full effects of cost-of-living increases. Britons notoriously splurge over Christmas, which may confuse the medium-term trend.
I therefore regard B&M as fairly priced, if lacking sufficient “growth at fair price” to deserve up-grading. Initially positive signals from retailers are reassuring but I remain cautious about UK consumer spending. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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