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Published 30 July 2013 09:55, Updated 01 August 2013 00:45
Some smaller, lower-profile retail stocks are in, or nearing, value territory. The pick is Specialty Fashion Group, which owns Katies. Photo: David Tease
Are retail stocks overvalued? Several key retailers have rallied this year, despite surveys showing anaemic consumer and business confidence, and shoppers ignoring low interest rates.
It is hard to see confidence improving in the next few months. The lead-up to a federal election is never good for retail; business surveys suggest sluggish economic growth will continue for some time, and headlines about job losses could spook consumers.
Short sellers will have the retail sector in their sights in the coming profit season. Most retail stocks are trading beyond value territory, even after falls in May, and look ripe for profit-taking on the first whiff of earnings disappointment.
Retail bulls will argue the sector was grossly oversold late last year.
Hysteria about online retailing killing the traditional variety drove retailers such as JB Hi-Fi, Harvey Norman and Myer far too low. This year’s rally has been more about correcting market mispricing than fundamental change.
The other bull argument is that confidence will bounce after the federal election, and one party emerges with a clear victory. Another ace is falling interest rates. Odds are firming for an August rate cut and possibly another by year’s end after recent tame inflation data. Although rate cuts are in response to a weakening economy, cheap money should speed the property market’s recent recovery, boost prices, and make home owners feel wealthier and more confident. A better sharemarket and higher superannuation balances also add to the “wealth effect”, and coincide with interest costs as a percentage of disposable income falling and overall debt being paid down.
However, I favour the bearish view of consumers needing more time to get high debt to comfortable levels, and perceptions of rising job insecurity dampening retail spending growth. This suggests more retail stocks struggling in coming months.
Value investors must watch and wait for better value. My favourite retailers, Flight Centre, Super Retail Group, JB Hi-Fi and ARB Corporation, have run too far this year and are due for a pause. But some smaller, lower-profile retail stocks are in, or nearing, value territory. The pick is Specialty Fashion Group, owner of the Millers, Katies, Crossroads, Autograph, City Chic and La Senza chains.
Specialty Fashion hit a 52-week low of 47¢ before rallying this year to 87¢ after a stronger than expected interim profit result. Revenue rose 1.3 per cent to $311.1 million on the same half a year earlier; net profit soared from $6.1 million to $17.9 million, and basic earnings per share almost tripled to 9.3¢. Higher gross margins and excellent cost control impressed.
Always look for companies that can grow in good and bad cycles through astute management, and have untapped value. In Specialty’s case, it has a database of 7 million customers, which it must mine for online sales, and use to drive customers into stores.
As with all small-cap stocks, Specialty is a higher-risk idea suiting experienced investors. It has solid momentum in a weak retail sector and strong leverage to any lift in consumer confidence and retail spending.
And it is one of the few retail stocks still offering value at current prices, after an overdone sell-off in May from the 52-week high of $1.24.
Its nearest listed peer, Noni B, has been pummelled after another profit downgrade. The owner of 219 Noni B and Liz Jordan stores is frustrating: it has a well-known brand and store network but a poor return on equity and volatile earnings. Aggressive discounting in budget women’s fashion is another concern. Even so, Noni B is nearing value territory. A share price below 50¢, from 62¢ now, might tempt value investors but better opportunities exist in higher-quality retailers.
Joyce Corporation has also frustrated investors, trading sideways after falls during the 2008 global financial crisis. Joyce owns and franchises the Bedshed chain; has an investment property in Sydney. In February it invested in KWB Group, which sells and installs customised kitchens and wardrobes. In a July shareholder letter, Joyce said like-for-like sales were up on the previous year and in line with expectations.
The market has ignored Joyce’s net assets per share of 78¢ at December 31, 2012, which compares with a 40¢ share price. The 41,000-square-metre property in Sydney’s inner east has a book value of 42¢ a share.
Joyce said it could be worth 48¢ a share at current valuations.
A nearby $400 million development due to start in 2014 could lift the value of Joyce’s property again.
I’m not sure why the market is applying such a big discount to Joyce.
The Sydney property has good valuation prospects and the underperforming Bedshed chain will improve as some company stores in regional areas are closed. Joyce should sell its property sooner rather than later, return cash to shareholders, or reinvest it in higher-growth retail assets.
Mixing franchising and property makes the thinly traded Joyce a difficult stock for investors seeking pure retail exposure. But it also creates an opportunity for speculators who are comfortable with micro-cap stocks, and can see the rising value of the property, which, on Joyce’s stated NTA, is worth more than the company’s $11 million capitalisation alone, meaning the market is not valuing the Bedshed business or investment in KWB Group.
Like Noni-B, Joyce might be worth more under private equity ownership, via takeover.