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EMMA POWELL | TEMPUS

Frasers Group is taking stakes and having a gamble

The Times

Muddled concepts never go down well with investors. Mike Ashley’s Frasers Group risks turning off shareholders with its patchwork approach to mergers and acquisitions.

This month’s spree has included a 21 per cent stake in AO World, the electricals retailer, a 9 per cent piece of its rival Currys and a 5 per cent holding in the fashion giant Boohoo. Distressed share prices are a common trait, a consequence of dire trading after a pandemic boom in online shopping. AO World, Frasers’ biggest recent splurge, lost £11.6 million over the first half of the year.

True, this isn’t uncharted territory for Frasers, which owns Sports Direct, House of Fraser, Flannels and Jack Wills. Its “strategic position” in Hugo Boss led to Frasers stocking its products in some of its outlets, part of the FTSE 100 group’s “elevation strategy”, upgrading stores and moving further into the premium retail sector.

Stakes in Currys and AO World make less sense. Does a shareholder wanting to speculate on the growing spend on athleisure also want exposure to far more volatile demand for big-ticket items such as fridges and televisions?

For now, it is not overstretched. Net debt stood at £499 million at the end of October, which equated to about 0.9 times earnings before interest, taxes and other charges for the last financial year. It had £315 million in cash alone on the balance sheet at that point, excluding undrawn debt facilities.

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Like the rest of the retail sector, Frasers has been marked down amid a weaker consumer spending appetite and inflationary pressures that have compressed margins. The gross margin fell to 42 per cent, from 44.7 per cent the year before. Some of that reflects the purchase of the lower-margin Studio Retail and the sale of the American retail businesses. However, it is also the consequence of a lower proportion of full-price sales, the higher cost of goods and wage inflation.

A forward price-earnings ratio is about half the long-running average and close to the record lows plumbed in March 2020. That is also a discount to its rival, JD Sports, whose shares change hands for just under eleven times earnings. Sure, JD Sports has also faced challenges, warning of a slowdown in the US market — but the proposition for investors is tight enough. It is also swimming in cash, £1.5 billion of it, which it can use to fund its ambitious stateside expansion.

Sales are hardly flying. In the first half of the financial year, the bulk of sales growth was driven by acquisitions. Sales for the UK sports retail division, responsible for more than half of the group’s revenue and profit, declined by 3.1 per cent on an organic basis.

An increase of a fifth in inventory levels to almost £1.5 billion at the end of October might also unnerve some investors, even if its provision has been kept level at £218 million. Some of that will reflect an element of cost of goods inflation but the jump in the value of stock on the balance sheet exceeds annual consumer price rises.

Frasers, now led by Michael Murray, who took over as chief last year from his father-in-law, Mike Ashley, is not without a narrative for shareholders to latch on to. A more upmarket image helps convince more brands to stock their produce in stores. Bagging partners such as Nike could also provide a springier launchpad to expand in Europe.

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Geographical expansion and securing more partnerships with global brands to push forward the core business is most likely to catalyse a re-rating in the shares. Scattergun deals in some of London’s most troubled retailers are an unnecessary distraction.

In both value and capital allocation terms, JD Sports looks the more interesting bet.

ADVICE Hold
WHY Taking stakes in a range of troubled retailers might be unhelpful for the share price

Lok’n Store
Stubborn inflation poses a fresh challenge for commercial landlords hoping that peak interest rates are in clear sight. The boss of Lok’n Store thinks the bottom has already been hit for its self-storage assets.

Andrew Jacobs reckons the underlying value of its portfolio at the end of July won’t be any worse than January, when the company’s adjusted net asset value declined almost 6 per cent over a six-month period to 915p a share. Analysts at the house broker Peel Hunt are more bullish, forecasting a net tangible asset value of 958p a share at the end of July, which partly reflects the opening of two new self-storage sites. Investors remain more cautious, pricing the shares at a 10 per cent discount to the value of the company’s assets at the end of January.

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The Aim-traded company has more than just higher interest rates to contemplate. Home movers typically account for about a fifth of revenue, which naturally leaves it exposed to the downturn in the housing market.

Thus far there has been no big slide in demand. Revenue over the second half of the financial year is expected to come in at about 10.5 per cent higher year over year, split roughly evenly between occupancy gains and higher rates per square foot. True, that is lower than the growth rates clocked up last year, but it is still in line with historic norms.

Developments in the pipeline are largely freehold and in prime locations. Building new assets naturally brings with it more risk than opening stores on a managed basis, a capital-light approach where Lok collects a management fee for running the site. Then again, there are potentially greater NAV gains to be had from the former.

Lok has roughly £40 million in cash on its balance sheet, enough to fund the four committed schemes, and a debt facility of about £100 million, which would finance the remaining six sites in the pipeline.

Once opened, new stores are typically marked up from the development cost, which could make the gap between the NAV and the shares look even more incongruous.

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ADVICE Buy
WHY Solid demand indicates the shares’ discount could be too harsh

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