Interactive Investor

Edmond Jackson's Stockwatch: High-risk JD Sports is worth watching

17th December 2013 00:00

Edmond Jackson from interactive investor

JD Sports Fashion's FTSE Small Cap shares have risen 40% to 1,434p since I drew attention three months ago to its modest rating of about 10 times forward earnings at 1,025p a share.

Currently 1,422p, the sports fashion and outdoors clothing retailer's 12-month forward price/earnings multiple of about 12 times remains cautious if earnings recovery follows as forecast; also if consumer spending can remain firm into 2014. However the stockmarket will want to see sustainability in the sports fascia's revenues which are the only leg for group profits, also turnaround at Blacks and Millets which were bought in January 2012 from the administrators of Blacks Leisure Group - and promptly reinforced their reputation as trouble spots.

Among reasons for JD's near-parabolic share-price chart since the late summer, breaking out of a consolidation for the last three years, is the surge in UK consumer spending that has surprised forecasters expecting years of 'austerity' behaviour. People have raided savings and record levels of consumer debt has been engaged as house prices soar, backed by the government's subsidised mortgage scheme. So the crux is whether economic recovery spreads to improve wages, otherwise spending is unsustainable and share rises like this may be exposed. It makes JD interesting as a litmus test of consumer behaviour, also for long/short trading.

JD Sports Fashion financial summary
Consensus estimate
Year ended 2 Feb2009201020112012201320142015
Turnover (£million)67177088410601259
FRS3 pre-tax profit (£m)38.261.478.667.455.1
Normalised pre-tax profit (£m)47.271.981.478.760.569.180.1
FRS3 earnings per share (pence)50.588.211596.379.7
Normalised earnings/share (p)69.810912111990.7102119
Normalised P/E multiple (times)    15.8714.112.1
Cash flow per share (p)11315615715872.7
Capex per share (p)56.956.579.197.899.1
Dividends per share (p)12182325.326.327.629
Covered by earnings (times)5.86.15.34.73.43.74.1
Net tangible assets per share (p)122183258242291
Source: Company REFS.

The situation also affirms rising UK money supply, especially physical cash and instant access bank deposits ('M1'), which rose by an annualised 11% last July and where such trends tend to lead the economy by six months or so.

Monetarist economics are not always dependable: latest indications are that the number of people entering shops in November slipped by 2.9% year-on-year. However JD's latest trading statement for August to November showed like-for-like sales growth "at very much the same level" of 5.8% for the 26 weeks to 3 August, noting that the full-year outcome remains "substantially dependent on the sales and margin performance through the Christmas period and particularly in the last two weeks of December... the board believes the group remains on course to deliver earnings at least in line with current expectations".

Quite where this leaves consumer spending, six months and more away, remains to be seen - so properly the market should pause to consider the evidence. But if the "risk-on" mood continues with speculators seeking recovery plays, sound figures from JD are likely to draw support.

A medium-term opportunity is how successful any turnaround of the January 2012 acquisition of Millets and Blacks stores for £20 million can prove. The last available 2012 accounts for Blacks Leisure showed a near £2 million pre-tax loss on £195 million revenue albeit 4.6p cashflow per share; so if JD can get a grip then its re-rating is logical in anticipating a financial boost.

In principle the hiking and camping products offered by Millets suit popular low-cost activities; and kit supplied by Blacks for more enterprising sports such as skiing, can beat rivals on cost. Yet Blacks Leisure plc was a problem business and JD's 2012/13 prelims showed these outdoor brands had "an exceptionally difficult year" resulting in a pre-exceptionals operating loss of £14.9 million. This, together with ownership of fashion fascias, when consumer spending was expected to remain pressured in 2013, explains why JD shares were modestly rated. Their re-rating is partly recognition of reducing risk as the turnaround evolves.

Issues at Blacks/Millets were blamed on previous mismanagement and a new team "will give us the foundation of a business which is capable of delivering sustained operating profits in the medium term" (April 2013 prelims). But a change of plan to retain the Millets/Blacks split meant a shortage of product hence margin pressure and only a small reduction in this acquisition's operating loss to £8.9 million in JD's first half year although management was "working hard to bring in the right product". Notably the latest update says: "We are pleased with very recent progress in the outdoor fascias."

The five-year table shows how group profits fell in the 2012/13 years despite annual revenue growth near 20%; and even the normalised profit recovery forecast to £80.1 million would be shy of £81.4 million achieved in 2010/11. So if management can exact a worthwhile margin on the additional sales then it ought to be possible to target pre-tax profit of about £100 million; another reason why the re-rating is logical.

A managing director, ex-LSE:ASC:ASOS and Arcadia, has been brought in to initiate a turnaround of the fashion fascias, which lost £6.9 million in the first half (up from £5.3 million like-for-like), which raises hopes albeit evidence is key.

84% of last year's revenue was UK-derived, otherwise continental Europe, so the short to medium-term crux is whether recovery in UK consumer spending proves sustainable. Management has cited pleasing progress with its store openings in Europe, which quite depend on recovery or deflation getting the upper hand.

JD is therefore quite a high-risk investment with just a 2% yield in support, although net debt of £1.0 million at 28 July 2012 was transformed to net cash of £20.7 million at 2 August 2013, helped by tight inventory control. The situation remains worth following for its trading potential and feedback on consumer behaviour.

For more information see jdplc.com.

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