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3 retailers that could deliver 30% gains in 2017

Photo: Dixons Carphone: Fair use

Today I’m on the hunt for value and growth opportunities in the beleaguered UK retail sector. This may seem an unlikely choice. After all, Next fell by 10% to a three-year low this morning, after the fashion group warned that 2017 will be “another challenging year”. But I believe there are attractive opportunities among UK retailers, if you look carefully.

A cash-rich budget brand

Footwear retailer Shoe Zone (LSE: SHOE) operates at the budget end of the market. This small cap is a familiar site on UK high streets, but also sells online.

The group’s strengths lie in sourcing footwear cheaply from contract manufacturers abroad and keeping costs low at home. This lean business model generates an operating profit margin of 6%, with strong free cash flow and no debt.

Consumer spending is expected to come under pressure next year, but Shoe Zone’s specialist focus on value should help to protect sales. Management also has a big stake in the business — founders Anthony and Charles Smith own 50% of the group’s shares.

Shoe Zone currently trades on a forecast P/E of 10, with a prospective dividend yield of 5.8%. Demand for this generous income could push the shares higher in 2017, if trading remains stable.

Big tech player looks cheap

Shares of electrical and tech retailer Dixons Carphone (LSE: DC) have fallen by 32% over the last year. However, earnings forecasts for the group have been much more solid, and are only 4% lower than they were a year ago.

Dixons’ like-for-like sales rose by 4% to £2,988m during the first half of the current financial year, while underlying pre-tax profit rose by 19% to £144m. Net debt is just £285m, giving the group a strong balance sheet.

This company’s large scale and combination of online and offline operations seem to make it competitive against big internet retailers. It’s also expanding fast in southern Europe.

With a forecast P/E of 11 and an expected dividend yield of 3.1%, I believe the shares are now starting to look too cheap. Medium-term investors could easily see a gain of up to 30% from current levels, in my view.

A deceptively safe buy?

Listed car dealership groups were big losers after last year’s Brexit vote, but there are some signs that this sell-off was too hasty.

Shares of AIM-listed Vertu Motors (LSE: VTU) are worth 27% less than they were at the start of June last year, but profit expectations are little changed from the start of 2016. Investors appear to be nervous about a slowdown in new car sales. But it’s worth remembering that new car sales don’t generate much profit for car dealers.

Companies such as Vertu make the majority of their profits from after-sales work and from used cars. For example, 72% of Vertu’s gross profit came from after-sales and used cars during the first half of last year.

New cars are usually serviced by the supplying dealer while they’re under warranty. This means that recent years’ strong sales should translate into a guaranteed stream of profitable after-sales work.

Vertu shares are currently trading on a forecast P/E of 7.2, with a prospective yield of 3.1%. If profits remain stable this year, I believe the shares could be re-rated onto a significantly higher valuation.

Is this today's top retail buy?

I'm not alone in seeing value in the retail sector. Our top analysts recently chose a well-known retailer to feature in A Top Growth Share From The Motley Fool. They believe that the company in question has the potential to triple in value over the next few years.

This company is a well-known high street name, but isn't mentioned in my article today. To find out the name of this potential high flyer, you'll have to download our free, no-obligation report. To get your copy, just click here now.

Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Vertu Motors. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.