The disappearance of various shops from high streets and retail parks can be viewed as an opportunity or a reason to steer clear of the retail sector. B&M European Value Retail is a disruptor with the potential to generate a lot of money from this shake-up, but there are plenty of “what ifs”. Fierce competition and shifting consumer preferences make picking long-term winners extremely difficult.
B&M has carved out a niche selling branded foods and various other goods, such as homewares, garden furniture and toys, at lower prices than its competition. The discount chain, which also owns Heron Foods and has stores in France, charges about 15 per cent less than the Big Four supermarkets for the same branded products and still manages to generate an operating profit margin of just under 11 per cent.
The secret to its success includes keeping costs to a minimum and inventory levels tight, selling a narrower range of products, buying directly from manufacturers and leveraging its close relationship with them.
In the 13 weeks to December 23, B&M proved again that the cost of living crisis is playing into its hands. Against tough comparatives, the FTSE 100 constituent reported rising revenues, including on a like-for-like basis in its core British market, and confirmed that it was on track to achieve 9 per cent adjusted cash profit growth in the year ahead.
The company aims to capitalise on the popularity of its stores by opening many more of them. This could end up being very profitable for shareholders as B&M is renowned for quickly turning a profit on new shops. And, despite already expanding substantially, the company has only a 2 per cent market share in the UK.
Peel Hunt, the broker, reckons the discounter could increase its presence by 25 per cent within the next three years and it expects pre-tax profit to climb by 49 per cent in that time. A result anything close to that should cause the share price and dividend payments of this highly cash-generative business to rise.
Investors, it appears, have not fully bought into B&M’s growth and income appeal. The shares trade at 14 times forecast earnings, a 5 per cent discount to the five-year average. One of the biggest fears weighing on sentiment is that discounters will lose customers once economic conditions improve and people have extra money in their pockets. That opinion is shared by several analysts, but it seems a bit short-sighted, particularly when considering the enduring popularity of the likes of Aldi, Lidl, Primark and Walmart.
Rampant inflation is boosting traffic and is making greater numbers of people realise that these shops are more attractive than they maybe once thought. When conditions normalise and personal finances improve, it is debatable that new customers will go back to spending more for the same or similar items. Efforts to improve the interiors of stores also should help to increase loyalty, attract more shoppers and ensure the company is able to continue growing organically.
The downfall of many British retailers can be linked to failing to evolve and general poor management. Up until this point, B&M cannot be accused of either, although that could soon change.
One of the biggest potential pitfalls is B&M’s lack of an online presence. Amazon’s ascent is proof that consumers find shopping on the internet convenient. Ignoring this may boost profitability in the short term, but eventually it could come back to haunt the company.
Other threats include the discount market becoming oversaturated with competition and the big supermarkets fighting back. Retail is notoriously competitive, moats are narrow and, as we’ve seen so often in the past, fortunes can change quickly.
These risks take some of the shine off B&M’s growth prospects and may be hard for buy-and-hold investors to digest.
Advice: Hold
Why: B&M has decent growth prospects but sector-wide risks put a damper on them
Grafton
It’s not a great time to be selling building materials and DIY products. High inflation and interest rates have limited the number of new homes getting built and older ones getting refurbished.
Grafton, which owns Selco Builders Warehouse, Leyland, Chadwicks, Woodies and several other brands well known to builders and DIYers, seems to be doing a good job weathering this tricky trading backdrop. The Dublin-based group reported that average daily like-for-like sales had fallen by 2.9 per cent in the final two months of last year and by 1.1 per cent overall and that its adjusted operating profit was set to be slightly higher than anticipated. This reaffirmed two things: Grafton is good at setting expectations; and it is better placed to handle hardship than most of its peers.
When times are tough, the FTSE 250 group’s strong balance sheet and international reach come in really handy. Sixty per cent of revenues are generated outside the UK, where housing markets are known to be particularly volatile and a fall in discretionary spending on homes has been profound. In the Republic of Ireland and the Netherlands, two other key markets, demand is proving to be more resilient.
Investors are pinning their hopes on falling inflation soon leading to interest rate cuts, bigger disposable incomes and a full-blown recovery in the building materials sector. They need to be patient. The company cautiously refrained from saying anything about 2024 in its latest update to markets and analysts reckon it could take a few years for volumes and margins to return to normal levels.
Grafton’s attractive dividend, continuation of its share buyback programme and plans to target more acquisitions in Europe ought to boost returns in the meantime. The problem is that investors, buoyed by signs of economic recovery and eager to call the bottom, have already been piling in. In the past six months the shares have risen by 15 per cent. They now trade on a forward earnings multiple of 12.5 times, which seems about right for this stage in the economic cycle.
Verdict: Hold
Why: The shares are fairly valued
