I have been in a bit of a quandary lately about my shareholding in B&M European Value Retail (LSE: BME). On one hand, after falling 49% in a year, the company increasingly looks like a deep-value stock. And a 6.3% dividend yield is certainly tasty.
But I also see some reasons for concern that make me wonder whether B&M could end up being a value trap.
For now, that is what has held me back from buying more B&M shares even though on many valuation metrics the share price currently looks cheap. The price-to-earnings ratio is less than 8, for example.
Discount retail is a tough business
People often talk about the decline of the high street. It can be helpful to think about what shops used to be a visible force but are no longer around.
There are many, of course. Discounter Wilko collapsed into administration in 2023, though the brand has since resurfaced. Poundland is set to close dozens of shops after the company itself was recently sold for a pound.
Further back, a lot of what B&M sells now used to be on offer at Woolworths – another UK retailer that entered administration.
The maths are quite simple. Discount retailing is about “piling ‘em high and selling ‘em cheap“. In other words, it is a high-volume, low-profit-margin model.
Take B&M as an example. Last year its revenue was £5.6bn and its net profit was £319m. That means its net profit margin was below 6%. In fact that is pretty good for the sector: the equivalent figure for Tesco last year was just 2.3%. But a margin in the mid-single digits means that a company has limited room for error.
If it misjudges demand for certain products that can eat badly into profits. Meanwhile, extra costs like higher staff wages and National Insurance contributions are harder to absorb with thin profit margins than they would be at a more profitable business.
Unsettling medium-term outlook
The first quarter of the year saw B&M’s revenues grow 4.4% year on year. I see that as a solid performance and am hopeful that its keen pricing could help attract more shoppers in an increasingly tight economy.
But those numbers, released last week, did not impress the City. The share price sunk to an all-time low. That struck me as a possible buying opportunity, but for now I have decided not to add any more of the value stock to my current holding.
Why? One concern was weaker demand for the chain’s fast moving consumer goods products. It continues to work to get its offering right, but the concern here is that this might be the thin end of the edge. If B&M shoppers are cutting back on fizzy drinks and teabags now, could that be a sign of tightening purse strings that will hurt sales more widely in months to come?
A new boss at the chain has his work cut out. With a strong brand, large customer base, and extensive shop network, I think B&M still has the makings of a great business. In time, its current share price may turn out to be a steal.
But in the current uncertain economic environment, I will not be buying any more B&M shares in the absence of more reassuring, broad-based sales performance numbers.
