Edmond Jackson's Stockwatch: JD Sports Fashion

Is British post-Olympics sporting enthusiasm more a sea change than a fad?

While the summer 2012 London Games were expected to provide a boost, it appears to be continuing - fuelling progress not only at sportswear market leader Sports Direct, but also JD Sports Fashion, a £500 million group which trades on a much lower rating due to losses in other areas of its business.

From its latest interim results for the 26 weeks to 3 August, JD's core sports business saw its operating profits soar 55% to £29.2 million before £1.8 million exceptional costs, on like-for-like sales up 7.5% in the UK and Ireland. They represent nearly 73% of group revenue, whereas fashion retail made a £6.9 million operating loss on £71.4 million revenue before £478,000 exceptionals. The loss for outdoors retail was higher, near £8.9 million on £43.1 million revenue, before £1.5 million exceptionals.

Fashion can be a gold-mine if management keeps hitting the spot - like at ASOS - but investors are justifiably wary of flighty performance.

Indeed the name "JD Sports Fashion" may be partly why the shares have traded on an average annual price/earnings multiple (P/E) of only six to seven times in recent years. The fashion side - Bank, Scotts and Tessuti - shows like-for-like revenue down by 2.2% although total revenue is up 8.8%, helped by the acquisition of Tessuti. It is a slight improvement since June, when 18 weeks' like-for-like performance fell by 5%, however the gross margin has slipped from 47.6% to 45.8% as excess old stock was cleared and there is a caution that turnaround for the Bank business "will inevitably take some time".

In outdoors retailing, investors have justifiably been cautious following the January 2012 acquisitions of Blacks and Millets from the administrators of Blacks Leisure Group. Management's original aim was to merge the two, then it was decided they have fundamentally different customers - so should be kept separate. The about-turn created a shortage of own-brand products, which hurt margins amid pricing pressure on branded items; however a restructuring and relocation to the North-west is now complete and management says the lower cost base is a platform for future profitability.

The drag from these two sides largely explains why JD's forward P/E is currently about 10 times whereas Sports Direct enjoys 21 times - with a well-honed operation as the sportswear market leader. Sports Direct is a long-term capital growth success story I have repeatedly drawn attention to from late 2011 and since advocating it as a stock for 2013 it has risen 90%, now on the verge of joining the FTSE 100 (UKX) index. Its progress looks set to continue, but JD intrigues me in a similar way Sports Direct did in the days when it was shunned.

Valuation largely depends whether 1 July broker forecasts, on which expectations are based for 13-14% earnings growth in each of the two financial years ahead, are fair. Conceivably the challenges facing fashion and outdoors may drag on, although there have been various management changes and the shares' rating hardly discounts recovery.

Risk could be on the upside if management can simply reduce losses while sports continues to do well, especially because the market is now besotted with Sports Direct and interest in JD is scant (i.e. sentiment has scope to turn).

The interim results reflect a turnaround in progress after the last financial year to 2 February 2013 saw pre-tax profit and exceptional items down 20.4% to £60.5 million, although the dividend rose 4% to 26.3p against adjusted basic earnings per share down 16.4% to 88.5p. Despite only a 2% revenue improvement to £556 million, the interims show like-for-like pre-tax profit up from £2.9 million to £6.1 million, albeit with basic earnings per share up only 3.5% to 4.45p. Net cash position has changed from nearly £1 million in debt to £20.6 million cash. At a current share price of about 1,025p the prospective yield is 2.75% - not insignificant, if not quite a prop.

Management looks to continental Europe as a "major strategic development" accounting for nearly 17% of group sales in the first half. France, Holland and Germany are being expanded, although not surprisingly Spain has proved difficult. Admittedly this introduces risk - both in terms of execution and while eurozone economies remain weak - but Sports Direct is doing the same, taking a long-term view.

The shares have not moved much since the results, probably due to a mixed outlook statement that cites sports' robust trading continuing but says Fashion "continues to be more difficult"; and while management maintains its "belief" the product offering in outdoors has improved significantly for the second half, "it is too early to comment on performance". December to January will be critical and the next update is due in November.

While this mixed picture does not yet imply a conviction buy, JD is interesting given the momentum in sports while it addresses its underperformers, and the shares' rating remains modest.

For more information see jdsports.co.uk.