Budget battles

Budget battles

If you want to take your kids camping, bypass Batemans Bay and head straight to Amazon. A decent Coleman canvas sleeping bag will set you back about $118 including shipping – a 30 per cent discount to what the same one sells for at BCF: Boating, Camping, Fishing.

No wonder retailers are feeling the heat from online shopping. But, until recently, there was one clear exception – Super Retail Group, owner of BCF, Super Cheap Auto, Rebel Sport and a host of other brands.

A well-implemented acquisition strategy has helped the company triple sales to more than $2 billion since 2007 and management now plans to increase the 600-store network to more than 800 over the next five years.

Bullet-proof: Tough economic times won't hurt The Reject Shop - in fact they may even help it.

Bullet-proof: Tough economic times won't hurt The Reject Shop - in fact they may even help it.

Intelligent Investor Share Advisor recently made the case that The Reject Shop’s accelerated store rollout would increase value for shareholders over the long term but was causing the stock to be undervalued right now.

With Super Retail’s share price down 36 per cent this calendar year but a similar rollout planned, is this a similar opportunity or just another value trap? Let’s compare the two to find out.

By 2017, 60 per cent of all retail sales are expected to involve the internet for either research or purchase. Retailers already operate on slim margins so it won’t take much in the way of lost sales to destroy profitability.

Super Retail, though, is more exposed than The Reject Shop. Small, expensive items such as car accessories and camping gear face more online competition than low-cost items like decorations and toiletries. The Reject Shop’s average customer spends just $10 a visit, which is why it doesn’t have an online store.

Super Retail’s expansion is also more costly. A typical Reject Shop costs about $90,000 to fit out while a new but far larger BCF costs nearly half-a-million. With more flexibility to try new locations and less downside if stores are unproductive, The Reject Shop wins out here, too.

What about cash flow, a key factor to be watched in any retail expansion? Super Retail's inventory turnover has been remarkably steady at 2.5 times but days payable outstanding has increased from 37 to 81 over the past few years. Potential investors should watch this figure closely. There may be an innocent explanation or it could be a harbinger of trouble.

The Reject Shop is also likely to be more resilient during an economic downturn. In fact, as people become more price conscious it may even benefit. If a recession hits and you’re out of a job, passing on the $400 Waeco portable cooler while reaching for the $2 Reject Shop shampoo just makes more sense.

What about management? Super Retail’s management has a great track record but, with competition increasing and no protection from a downturn, its five-year target of greater than 4 per cent same-store-sales growth and an EBIT margin of 11 per cent look unrealistic. The company’s EBIT margin peaked a couple of years ago at 9.3 per cent and lagging same-store-sales were a major contributor to the company’s recent profit downgrades.

Price ≠ Value

Of course, we could set aside all of the risks in Super Retail if the price at which it trades compensated for them. Unfortunately, it doesn’t. On a price-earnings ratio of 15 The Reject Shop delivers twice the revenue per share, 7 per cent higher net profit, significantly more tangible equity and zero debt.

Super Retail, on a similar PER of 16, offers a slightly higher dividend yield of 4.6 per cent compared with The Reject Shop’s 3.9 per cent, but not much more reassurance than that.  

An aggressive store rollout into a market facing strong headwinds with little in the way of a sustainable competitive advantage is rarely a recipe for success. Super Retail would be hard hit by recession and the price offers no compensation for that possibility. It’s best to AVOID.

The Reject Shop faces many challenges too but the difference is in its price, which offers a greater margin of safety. On a conservative price-earnings multiple of 15, The Reject Shop would be worth about $500 million, or $17 a share, in 2019, making today’s price of just over $9 a steal.

The alternative is for the company to abandon its growth strategy and concentrate on same-store sales growth. That would reduce opening costs and immediately boost profits in 2015. So this is the pitch: if The Reject Shop curtails its store openings, it’s cheap. If it doesn’t, it’s even cheaper. BUY.

Nathan Bell is a director of Intelligent Investor Share Advisor (AFSL 282288). To unlock all of Share Advisor’s stock research and buy recommendations, take out a 15-day free membership.