Fool's Eye View

[ November 1, 2000 ]

More Matalanamania!

By Maynard Paton (TMFMayn)

Carburton Street, London -- After previously writing a rather downbeat appraisal of the company's annual results, it's perhaps an unfortunate coincidence that, yet again, I'm assessing the fortunes of Matalan (LSE: MTN). And having had a quick look at today's interim results from Matalan, guess what? I'm still bearish! Growl...

You see, Matalan are the latest in a long line of that most dangerous of investments -- the fast-expanding specialist retailer. Every so often, a retailer will surface that has latched onto the latest High Street craze. At the moment, the current retailing scene is all about value-for-money. Capitalising on this trend is Matalan, the country's leading discounter of clothes and "homeware". The company is frantically opening new stores to cash in on the consumer's liking for cheap goods sold from out-of-the-way warehouses.

Beware the specialist retailer

There are two points that lead to Matalan investment danger.

Firstly, investors' expectations get carried away. It's easy to see why as estimating future profits is relatively straightforward. Just extrapolate Matalan's store rollout plan over the next few years, project a sales per store figure (remember to factor in further demand for Matalan's offerings as they become more popular!) and then derive profits using a suitable margin. With such earnings growth "visibility", investors readily accept very high price to earnings (P/E) ratios.

But the big unknown in such profit forecasting is Matalan's competition. Here's Warren Buffett:

"Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive... This shooting star performance is far more common in retailing than it is in manufacturing or service businesses. In part, this is because a retailer must stay smart day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail."

Of course, the ever-present competition is liable to throw the earlier profit projections out of the window. In a nutshell, there is nothing that Matalan can do that can't be replicated by another discounter or by one of the major supermarkets. Bereft of their own success, copycat retailers are sure to join the discounting bandwagon.

Of course, when Matalan's growth slows due to the inevitable competition and the shares remain on an optimistic rating, investment disaster looms...

Shopping for growth

But today's interim numbers show that the Matalan formula has still been thriving. Sales in the six months ended August 2000 surged 48% to £256m, aided by a 13% increase in retail floor space. However, the bulk of the revenue improvement was through a stunning 33% like-for-like sales growth performance. Overall, pre-tax profits soared 72% to £35m over the half-year.

Also, there seems no slowdown in Matalan's expansion plans. The group announced today that it expects a 41% increase in its floor space over the full-year. Longer term, Matalan have stated that its store estate could more than triple.

However, there are one or two signs that Matalanamania could be slowing. Firstly, the all-important like-for-like sales growth figure is currently running at 15.6%, a sharp drop against the 33% reported through the half-year. And secondly, Matalan are only "maintaining" gross margins at present. In the past, investors have previously been accustomed to gross margin improvements underpinning substantial historic profit growth.

Matalan shares, having jumped 32.5p to 682.5p this morning, now stand on forward P/E of 46. And with the directors having sold £250m of shares earlier in the year, I can't but help repeat my conclusion from six months ago:

"A very high rating, directors offloading their shares and the inevitable boom-and-bust of retailing concepts all indicate that Matalan shareholders should be heading for the checkout very quickly."

Where Next?

• Will Matalanamania ever recede? Express your thoughts on the Matalan discussion board.
• The first signs of Matalanamania
• Paulypilot, Lorben and WainscottBoy convey their doubts over Matalan's valuation.