The athleisure king JD Sports shows how partnering with heavyweight brands can turbocharge a retailer’s expansion. Frasers, the owner of Sports Direct, is applying a similar game plan to a market beyond trainers and tracksuits.
Frasers, part of the FTSE 100, posted a 4 per cent rise in organic revenue over the six months to the end of October and adjusted pre-tax profits were up 39 per cent to £267 million. Guidance for adjusted pre-tax profit this year has been kept at £450 million to £500 million.
Not surprisingly, for a business rapidly changing shape, that profit figure included several parts that could be regarded exceptional: £91 million from store disposals and just over a £26 million benefit from the sale of the US retail businesses, albeit partly offset by lower impairments on the value of its properties and intangible assets.
Investors focused more closely on how the underlying business might fare amid the economic downturn, sending the shares to the top of the FTSE 100 loser board yesterday.
Sales at the sports retail business, which accounts for more than half total group revenue, fell just over 3 per cent. Revenue for the premium segment might have risen 22 per cent but a big part of that was a result of opening more Flannels stores, the luxury chain that Frasers took full control of in 2017.
Then there is cost inflation. 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 US retail businesses. But it is also the consequence of a lower proportion of full-price sales, the higher cost of goods and wage inflation. Cost inflation isn’t getting any worse for the group, but it remains elevated at a time when the risk of sales slipping is also greater.
Recent weakness belies a sharp re-rating of the shares over the past three years. Few retailers are in expansion mode and sales have boomed since stores reopened after lockdown. Acquisitions this year include fast-fashion retailer I Saw It First and Missguided, bought out of administration, and the Savile Row tailor, Gieves & Hawkes, after the company’s Chinese owner was placed into liquidation. Further distress will produce more potential takeover candidates; Frasers has the balance sheet and cash generation ability to fund more deals.
Michael Murray — who took over as Frasers chief this year from his father-in-law, Mike Ashley, the founder of Sports Direct — is pursuing an “elevation” strategy. That means upgrading stores and moving further into the premium retail sector via acquisitions such as Flannels and House of Fraser.
The rationale is twofold. One, a more upmarket image helps convince more brands to stock their produce in stores such as Sports Direct and Frasers. Bagging partners such as Nike helps sales in existing stores, and could also provide a springier launchpad to expand in continental Europe. Two, if retailers are going to convince shoppers it is worth schlepping into town, rather than buying online, stores need to offer a more pleasant experience.
Investors might query the cost. Just 100 of Frasers’ almost 1,600-strong store estate is freehold, the rest is leased. But the average lease length is just two years and terms are becoming more favourable to the occupiers. About half of Frasers’ estate now has turnover-based rental agreements. Lease liabilities fell by about £25 million to £660 million.
Is Frasers’ firmer footing already reflected in the share price? A forward price/earnings ratio of 11 is a sizeable discount to Frasers’ long-running average multiple, but we are in a recession. Compared with other retailers in expansion mode, such as JD Sports and Next, Frasers looks less cheap.
Meeting profit guidance for the full year, when consumers have been through a winter of higher energy bills, would be a more impressive test for the retailer to pass.
ADVICE Hold
WHY Resilient sales and further potential expansion are already reflected in a richer share price
Fidelity Special Value
Picking stocks with beaten-up valuations in the hope that the market will eventually see their worth is an approach that has rarely paid off at any point since the last great financial crisis in 2008.
A rapid rise in inflation and a steady increase in interest rates have given value investing the edge over investing for growth, which might give investment trusts such as Fidelity Special Values a better chance of outperforming. The trust, part of the FTSE 250, invests predominantly in small and mid-cap companies whose earnings potential it thinks is underappreciated. Potential catalysts could include expansion into a new market or a change in the competitive backdrop. Backing cheap stocks is also seen as a means of limiting downside risk.
There is a big caveat. Many of the trust’s stocks are closely tied to the fluctuating fortunes of the UK economy. Amid the post-pandemic rebound of late 2020 and early last year, the trust markedly outperformed the FTSE all-share index, the yardstick it tries to beat. However, being more exposed than the index to financial services and industrial companies has held back performance.
The trust recorded a 3.7 per cent slide in the value of its assets over the past year compared with a 2.8 per cent fall in the benchmark. Being underweight in energy majors such as Shell and BP, which have recorded sharp rises in their share prices this year, hasn’t helped. Like most investment trusts, Special Values trades at a discount of almost 7 per cent to the value of its assets.
The trust is still ahead of the benchmark on a five-year basis, recording a 20 per cent increase versus the 12.7 per cent delivered by the index. The key potential catalyst for returns in the near term? A faster easing in inflation, which could improve sentiment towards banks and insurers, support services companies and consumer goods companies to which Special Values is most exposed. Until there is greater visibility around the pace of recovery, it is hard to be bullish.
ADVICE Hold
WHY A slowdown in inflation could help the trust’s value recover over the next year
