The recent profit warning from JD Sports Fashion was especially painful. It raised questions about the relatively new management team’s ability to see challenges coming and suggested that the group was more vulnerable to economic turmoil than the market had believed. Being heavily dependent on Christmas and on weather conditions and being susceptible to competitors’ discounting were supposed to be other retailers’ problems.
This month’s wake-up call has left investors fearing the worst and adjusting their expectations. It’s tempting to view sell-offs induced by profit warnings as an attractive time to buy, but often they are not. When companies start delivering bad news, it’s usually followed by more of the same.
The present economic environment dispels hope of a quick turnaround. Many of the issues that forced JD Sports to downgrade its profit expectations aren’t going away any time soon. Interest rates are higher than normal and have been for a while. The longer this goes on, the more it weighs on disposable incomes, meaning that demand for the retailer’s expensive and arguably non-essential clothing and trainers could fall further.
When JD next updates the market, this tricky situation, compounded by the group’s high and increasing fixed-cost base, is likely to come up in conversation. Its bosses, after missing guidance, are now under serious pressure to not underestimate its challenges again.
Another valid concern is competition. For years, JD Sports was able to differentiate itself and to charge more than other shops because it stocks exclusives from popular sports brands such as Nike, Adidas and The North Face. Trading in the 22 weeks to December 30 made investors question the strength of that premium status. In that period, the retailer was forced to engage in price wars with other stores in the United States and Europe, the two regions in which it is expanding, in an effort to grow its market share and it missed out on sales because it refused to do the same in Britain.
All this understandably has weighed on sentiment. Over the past decade, investors valued the shares at just over 17 times forecast earnings. Today, they trade at only nine times.
A discount is warranted, given the unfavourable economic environment and question marks about JD’s quality credentials. However, a drop of nearly 50 per cent seems a bit excessive. The present rating prices-in a lot of bad news. It also seems to overlook the fact that the sports footwear and apparel specialist could receive a boost from this year’s Olympic Games and Euros football tournament, better exclusive product launches and easing inflation and that it is still a fundamentally good company.
JD Sports has an excellent track record and the potential to continue profiting from casual dressing and exercise becoming more popular. Organic sales keep growing, even during downturns, the group is swimming in cash and it plans to open at least 200 new JD stores in each of the next five years in underpenetrated markets, which could significantly boost earnings.
The growth potential is perhaps being overshadowed by two key fears: that expanding in the United States, where trainers sell more, will weigh on margins; and that one day the big brands JD Sports sells will decide to cut out the middleman.
Sudden shocks can cause investors to start fearing the worst and worry too much. In this case, some of their anxieties appear to be unwarranted. Sales of trainers generally are less cyclical than those of apparel and, when accounting for how many more of them can be packed into stores, are arguably just as profitable. Likewise, JD’s partnerships don’t appear to be under immediate threat. This business model has been beneficial to all parties for years, partly because the biggest buyers of sports fashion don’t want to dress head-to-toe in only one brand.
JD Sports perhaps no longer deserves to be valued as a quality growth stock. But it shouldn’t be considered a dog, either.
Advice Buy
Why The outlook is bleaker, but investors are being too bearish
Vertu Motors
Investors contemplating buying Vertu Motors after its profit warning in December might want to reconsider. A lot more bad news could be on the horizon and it has not yet been reflected in the share price.
The retailer trades under various brands, including Bristol Street Motors and Macklin Motors, and does all the stuff that car dealers generally do. It sells new and used vehicles and offers services and repairs on them.
Until recently, business was booming. Used cars selling for crazy money and a string of acquisitions led revenues to rocket. That, and speculation that Vertu could get taken over, like its peers, encouraged investors to jump on board and the shares to rally. Now the tables have turned. Supply shortages have gone away and the ugly side of car dealership companies is becoming apparent again.
The challenges are numerous. Prices are tumbling as the market is flooded with vehicles and the economic environment and general uncertainty make consumers hesitant or unable to buy them. And operating costs are rising, partly because of an increase in wages.
The prospect of squeezed revenues is particularly daunting for low-margin businesses with relatively high operational gearing. In the past, Vertu could simply say it is a case of riding out the economic downturn. This time it also has to contend with longer-term regulatory changes.
Consumers do not know which technology will be acceptable to drive in the future and are being priced out of greener options. That predicament may convince people to wait it out and hang on to old cars before making their next big purchase.
Vertu’s valuation dipped since the profit warning but arguably not enough to reflect all the challenges faced. In a period of deep uncertainty, the shares trade at just under eight times forecast earnings, which is close to the top of their historic range.
Perhaps the prospect of getting taken over is propping up the shares. The next wave of bad news could convince investors to put those thoughts aside and trigger a much more severe reaction.
Advice Avoid
Why Too much optimism is priced into the shares
