Stockwatch: Genuine re-rating potential here

Amid the market sell-off, it's worth keeping alert for shares in well-established businesses, priced modestly for earnings and where the dividend yield lends a prop. Most likely such firms lack growth appeal and patience is needed for management actions to show results; hence, active investors have switched into more exciting plays and stop-loss selling accentuated the drop.

The chart for Mid 250-listed N Brown Group is a good example. Shares in this specialist clothing retailer soared from 240p to 530p in the quantitative easing-driven boom of 2013, only to plunge right back by end-2014, the table showing how profitability kept reducing and revenue flattened. In the last 12 months or so the stock has traded volatile-sideways in a range between 450p a year ago to 290p now, in search of a fair price for a business hopefully in transition.

The five-year table shows a sound if unexciting operation, making roughly £90 million pre-tax profit on £800 million revenue, with pretty strong cash flow and capital spending needs mostly a lot less. It's the profile of a classic mature business, and with a good record of payouts.

The balance sheet also offers respectable net tangible assets: over 140p (174.5p including intangibles) per share, relative to a current share price of 313p. As yet, the business lacks the kind of growth appeal stockmarket investors seek, but it's interesting how - in a beaten down market - a company may only need to affirm "progress on track" for its shares to rise smartly.

"Plus-size" retailer goes digital

N Brown's fashion range covers areas overlooked by other retailers. In particular, it offers larger sizes for women over 50. Demand here is unlikely to diminish any time soon, hence a genuine marketing opportunity in clothing. Moreover, such customers often prefer to order and try on garments at home, hence online sales offering scope to advance the business from catalogues. It amounts to plenty more than a niche.

October's interims to 29 August were mixed, with total revenue up 4.2% and underlying operating profit down 15.9%, albeit in line with expectations and with "the transformation strategy on track", as the business model alters from direct mail to digital-led.

Merchandising and systems have also been improved, and Brown's "power brands" such as JD Williams, Simply Be and Jacamo, were showing good performance, e.g. revenues up 20%. The bulk of store closures and redundancies were felt in this set of results, with statutory pre-tax profit down 54.6% to £19.4 million.

CEO's £70k stake

Retailers then endured another exceptionally mild autumn and start-to-winter, the likely reason for a near 30% drop in the shares from 390p in October to 280p just recently. However, on 21 December chief executive Angela Spindler bought 23,782 shares at 293p, nearly £70,000.

This was her first purchase since being appointed in July 2013, having previously been managing director of Debenhams since end-2007 and Asda's head of clothing before that.

The significance is clearer now N Brown has issued a trading statement for its third quarter to 2 January, citing like-for-like revenue up 4.1% with online sales up 13% to represent 66% of the total. The power brands have continued to perform encouragingly - double-digit growth - "and we are excited about the further potential of the online 50-plus fashion market". Admittedly, the stores' performance was flat, albeit only a "small" element of group sales.

Altogether, it doesn't mean a change to full-year expectations, but it's significant that the stock jumped about 13% in reaction to the news. This shows not only the market acknowledging N Brown's progress, but also how hard-beaten stocks can be sensitive to any positive news, especially where the dividend yield supports the risk/reward profile.

Even after its rise to about 313p, N Brown offers a yield of 4.5% covered 1.7 times by the consensus earnings estimate, management has affirmed.

Only recession can hinder progress

With the turnaround gaining traction, it would need a downturn in UK economic prospects to thwart N Brown gaining momentum: the chief risk being a Chinese upset spreading to impact both manufacturing and services.

Otherwise, it's hard to see a possible dent ahead to UK consumer spending; even if sterling falls amid weak manufacturing and trade statistics, the Bank of England is not going to raise interest rates in defence now the international situation is seen as high-risk. Slowdown would have an effect on N Brown, but its goods are modestly-priced essential items and the company has a strong market position. The dividend should be secure, hence supporting the stock.

The end-August balance sheet had £250 million longer-term debt and £30 million short-term, versus £40.2 million cash, with £3.8 million finance costs clipping 15.8% off operating profit. Gearing has increased from 41% to 49%, but the situation looks manageable.

The company has some £600 million tied up in trade receivables - amounts received for sale of goods - and a £38 million allowance for bad debts is estimated to apply. Aside from £8.9 million deferred tax, there aren't any contingent liabilities you have to consider with acquisitive groups.

Risk/reward improving

The latest update affirms forecasts of a return to earnings growth in 2016/17, hence scope to a target of 350p and better, according to updates. N Brown offers genuine upside potential as perception improves from an income share in a mature business trending sideways.

Entering the closed period ahead of prelims on 20 April means no further director purchases. It would be pleasing to see more in future given their modest stock ownership. But, altogether, the stock is "one to accumulate", with scope for capital growth backed by a useful yield.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.