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This small-cap stock might be a falling knife worth catching after HALVING in price

With many high street retailers continuing to struggle thanks to reduced footfall and the onslaught of more nimble competitors, it’s become something of a rarity for a day of trading to pass without at least one of the former issuing a profit warning and making a gloomy prediction on the outlook for trading.

That said, today’s 50% fall in the share price of recently listed lifestyle retailer Footasylum (LSE: FOOT) will surely come as a surprise to even the most bearish market participants, particularly given the initially solid-looking numbers in today’s full-year results.

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Sales up 

Revenue at the small-cap jumped 33% to £195m over the financial year to 24 February with the company reporting “strong growth across all channels and product categories”. Interestingly, 30% of the latter came from online where sales soared 41%, no doubt helped by investment in the company’s main website alongside launches of sites and apps for Footasylum’s own brands Kings Will Dream and SEVEN.

All told, adjusted earnings before interest, tax, depreciation, and amortisation (EBITDA) rose 12% to £12.5m, although margins were lower due to money being ploughed back into the company. Last year saw the creation of a new in-house studio in Manchester alongside the opening of a second warehouse facility in Rochdale and 10 new stores. Staff costs also increased following the 21% jump in headcount over the reporting period to 2,270 employees. 

A profitable company posting decent numbers with a growing online presence. What’s not to like? 

So, why are the shares crashing?

A lot of today’s share price capitulation appears to be down to Footasylum’s outlook for next year. 

In addition to remarking that recent trading had not been immune to the general malaise experienced on the high street, CEO Clare Nesbitt stated that the Rochdale-based firm’s desire to open new stores in order to capitalise on its peak trading period in H2 will lead to higher costs that will restrict earnings growth. Indeed, pre-tax profit is now expected to be roughly 25% lower than that previously expected.

Is the market reaction overdone? I’m inclined to answer in the affirmative.

While I agree with broker Liberum that a reduction in profit guidance is “clearly disappointing” — even more so given that the company only came to the market last November — it surely doesn’t warrant a near halving of the company’s value in a single session. Relative to other retailers such as, say, Mothercare or Debenhams (the latter issued yet another profit warning this morning), Footasylum’s problems appear fairly minor. The company is clearly doing a lot of good things online and it’s not as if its image is staid or tired. Nor is the company ridiculously indebted. Indeed, a cash balance of £11.4m at the end of the last financial year means its balance sheet is in far better shape compared to peers.

Whether the stock will continue to fall or bounce back quickly is, of course, hard to say. Moreover, attempting to predict and capitalise on short-term market movements is counter to the Foolish philosophy of buying quality companies for the long term.

Nevertheless, like retail peer Superdry, Footasylum has now earned a place on my watchlist. A frothy looking valuation of 30 times forecast earnings before today was — in retrospect — clearly too high but today’s (over)reaction could see the shares become something of a bargain once the dust has settled.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.