Not all retailers have been thumped by the recession. But among those that have there exists some excellent profit opportunities.
Who in their right mind would buy retail stocks in this recession?
Well, in my last article I suggested doing just that. Some might consider that 'brave'. Given the good run that retail stocks have had in the last few weeks (with a number rising by more than 50%) some may consider that doubly brave.
However, the recent recovery in prices still represents only a fraction of the loss of value in the recent past.
Investing in stocks just because the price has fallen is no kind of strategy at all (what goes down does not always go up!) but looking at cyclical stocks it can pay to look whether they are likely to re-attain their former glory.
The table below shows the current market capitalisation, a five-year earnings history and two years of forecasts for a number of retailers one might expect to be cyclical.
Market capitalisation and annual earnings in £ million for selected retailers
| Company | Market Cap | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 |
|---|
| ASOS (LSE: ASC) | 254 | 0.7 | 0.9 | 1.4 | 2.4 | 5.1 | 9.9 | 13.7 |
| Blacks Leisure (LSE: BLSA) | 17 | 9.9 | 13.8 | 14.5 | -12.6 | -6.1 | -6.0 | -3.0 |
| DSG International (LSE: DSG) | 620 | 283.3 | 246.0 | 211.7 | 2.4 | -259.7 | 23.2 | 14.7 |
| French Connection (LSE: FCCN) | 55 | 26.4 | 23.0 | 9.7 | 0.1 | 1.4 | -16.6 | -7.2 |
| Game Group (LSE: GMG) | 619 | 10.6 | 20.0 | 2.7 | 21.1 | 47.2 | 85.6 | 73.3 |
| Moss Bros (LSE: MOSB) | 13 | 1.0 | 7.2 | 4.2 | 3.2 | -1.4 | -0.5 | -0.4 |
| Next (LSE: NXT) | 2,763 | 250.1 | 305.4 | 331.5 | 331.5 | 353.9 | 302.3 | 258.5 |
| Smith WH (LSE: SMWH) | 612 | -126.0 | 22.0 | 32.0 | 60.0 | 59.0 | 59.2 | 63.1 |
So far from being a single homogenous picture there are three fairly discrete groups here:
The Growth Stories
ASOS ("As Seen On Screen") the online fashion retailer and Game Group show a good record of earnings growth which is forecast to be largely sustained through the recession. However, one pays for this growth -- ASOS trades on a multiple of 19 times 2010 forecast earnings -- too rich for my liking, although you might be tempted if you believe the growth has further to run. Game group on the other hand is on a more modest multiple of 10 times and looks worthy of further consideration.
Steady as she goes
Earnings for Next & WH Smith look pretty robust through the period (if one ignores the 2004 hiccup for Smiths). Whilst they are clearly not immune to the recession they do not look as cyclical as one might expect and current year PERs of 8 & 10 respectively don't look expensive for such robust performance.
The Faded Stars
The earnings profile for the remainder look far more risky and the share prices have been punished accordingly. It is here though that fortunes may be made, or lost. The key question is whether any of these companies can return to or near their former glory. The table below shows their P/E ratios based on both the average earnings over the seven years and the best two years from the seven.
| Company | Average Earnings Ratio | Best 2 Years Ratio |
|---|
| Blacks Leisure | 11 | 1 |
| DSG International | 8 | 2 |
| French Connection | 10 | 2 |
| Moss Bros | 7 | 2 |
The average ratings only look moderately cheap, but just look at those peak earning ratios, a return to or near previous levels of profit would produce multi-bagging returns. But are these business models permanently broken or is there any prospect of such a recovery?
If there were easy answers to those questions, the prices wouldn't be where they are now, but here are some quick starters for further research:
One thing that becomes clear is that for many retailers things started to get tough before the current recession really kicked in, with earnings sliding in 2007.
Each of these businesses has instigated some degree of restructuring to improve both their retail presence and to improve their cost structure and all are reporting some degree of success from these approaches.
Nevertheless the forecasts for the next two years make grim reading, reflecting more than anything the state of the economy, so we are looking out to 2011 already for any signs of improvement.
That may seem a long way out, but don't forget that the market is a forward-looking beast and improvements in share will likely lead any improvements in financial results.
There's a certain act of faith involved in investing in any of the businesses, but IF they prove to be survivors and IF than can return to near previous levels of profitability the rewards for the brave will be significant.
This is just a handful of the possible candidates for further research and retail still represents a risky venture in the current market, so my approach would be to take positions in a number of well researched possibilities. There may well be some failures amongst them, but with the right selection these should be more than compensated by one or two who go on to prosper over the next few years.
More from Tony Boden:
Tony has a beneficial interest in DSG International.
