Stockwatch: Has this pariah stock turned a corner?

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Stockwatch: Has this pariah stock turned a corner?

Has Sports Direct (SPD) turned a corner, fundamentally and share price wise?

Media allegations about working practices at its warehouses were the principal trigger for a 2016 sell-off from about 550p. Then the Brexit vote exposed the company being without currency hedging, thus raising the dollar price of sports clothing and goods, it imports.

There's also been institutional shareholder frustration with founder Mike Ashley's tendency to treat the group as his fiefdom than a publicly accountable business.

But after trading sideways in a 250p to 275p range for a year, the stock has spiked over 400p in response to prelims for the year to 30 April 2017.

While profits were hit mainly by currency headwinds, group revenue rose 11.7% and "early indications show that trading in our new flagship stores is exceeding expectations."

This adds grist to Ashley's bold claim a year ago to become the "Selfridges" of sport.

He now asserts: "...on course, migrating to a new generation of stores to showcase the very best products from our third party brand partners." A near 40% jump in the stock might look excessive, but in long-term chart context is just bouncing out a trough.

Classic example of "reflexive" financial behaviour

George Soros' modus operandi has been to exploit situations where the internal dynamics of a company or currency impact on sentiment, which in turn influences fundamentals for better or worse, thus exacerbating trends until there's an "inflation point" and the process often reverses.

Sports Direct is a good example: when I drew attention around 200p in September 2011, earnings per share (EPS) were projected to grow over 20% in each of the next two years, but the price/earnings (PE) was a modest 10 times, given Ashley then owned 71.2% of the company and investors remained wary after a profits warning soon after it floated in 2007.

So there was what Soros calls "negative bias" in the stock, which hit an inflection point when a January 2012 trading update outpaced other retailers and the Euro football championships also Olympic Games beckoned.

Sports Direct shares soared, the table showing an annual average historic PE of 26.8 in 2014 - i.e. positive bias.

In February 2013 I drew attention to Ashley selling 25 million shares at 400p and, although he retained 385.4 million, said: "I would be cautious of recent growth rates continuing; that a master trader knows when to book profits."

Yet market enthusiasm pushed the stock over 900p and, indeed, underlying EPS advanced strongly to 2015.

But another inflection point was hit when the "pile 'em high, sell 'em cheap" retail formula (that worked well post the 2009 recession) became tired, and coincided with reports about tough working conditions.

The stock plunged in 2016, exacerbated by the Brexit vote. However, the chart trough from mid-2016 until just recently can be seen as a period of negative bias, hitting a latest inflation point as a new retailing formula starts to shine.

Is rebranding as Selfridges of sport, realistic?

This has been a four-year objective since September 2016, underpinned by a "360-degree" review in the last year - including working practices, employment, corporate governance and reporting.

I interpret this re-rating the business as "Sports Direct 2.0", with more high-quality branded goods, e.g. a strategic partnership with ASICS that installs their running shoes/clothing/staff into dedicated areas of the flagship stores; also an expanded range of kit towards achieving "The Home of Football".

Within the latest outlook statement, the average UK store is cited making £0.5 million operating profit with 11k sq ft sales area; the lowest-turnover flagship store achieving £1.0 million profit from 31k sq ft; and the highest-turnover flagship store £2.1 million profit from 35k sq ft.

That's encouraging if lacking the context of investment made to achieve this, also the actual extent of flagship stores within a 289 total, as of April 2017.

A section Freehold/Long Leasehold Property Purchases cites 23 acquisitions for £317 million in the last year, "a phased pipeline of stores over the coming years to transition to the new generation concept".

The aspiration is to acquire up to 30 properties over the next financial year with a combined expected investment value of £200 million to £300 million. On a three-year view, therefore, it offers material earnings leverage with asset-backing, if management gets the marketing mix right.

A qualification is whether UK consumer credit growth hits its own inflection point as inflation creeps up versus quite static wages, thus compromising demand for discretionary goods.

Yet this may be mitigated by the likes of football being ingrained in British identity, and the running boom benefiting from recreation as a means to health.

Recessions historically show more people concerned to improve their appearance. Thus, with adept marketing, Sports Direct can navigate a consumer slowdown; it largely depends how appealing the customer experience proves; an intangible that's hard to measure.

"Strategic challenges" in continental Europe

Despite international revenue up 38%, the results statement cited "strategic challenges" in continental Europe which aren't clarified in the operating review; just a reference to margin lost partly due to obsolescence of fast-moving stock.

As I've mentioned with all UK retailers, in particular those online such as Boohoo.com (BOO) and Gear4music (G4M), it's all very well their proclaiming bold continental expansion, but what will be the impact of Brexit?

Why should UK-owned retailers enjoy free access if manufactured exports are to involve tariffs? No management appears to say how they are preparing for what scenarios, while analysts pass over the issue completely. I may be over-cautious but it appears a tail-risk.

Sports Direct International - financial summary           Consensus estimates  
year ended 30 Apr 2013 2014 2015 2016 2017 2018 2019
               
Turnover (£ million) 2,186 2,706 2,833 2,904 3,245    
IFRS3 pre-tax profit (£m) 207 239 313 362 282    
Normalised pre-tax profit (£m) 211 234 308 307 92 131 170
Operating margin (%) 9.6 8.6 10.6 5.4 -1.1    
IFRS3 earnings/share (p) 24.4 29.2 39.0 45.5 38.3    
Normalised earnings/share (p) 25.1 28.4 38.2 36.5 6.7 16.5 20.4
Earnings per share growth (%) 51.6 13.2 34.5 -4.4 -81.7 148 23.6
Price/earnings multiple (x)         59.7 24.1 19.5
Annual average historic P/E (x) 22.2 26.8 20.5 9.9 30.5    
Cash flow/share (p) 19.0 27.6 39.5 10.8 32.9    
Capex/share (p) 8.8 11.8 13.4 27.5 70.5    
Net tangible assets per share (p) 67.6 94.6 152 197 188    
               
Source: Company REFS              

Marketing flair and property nous, shows through

If you've tuned into my comments on Sports Direct over time, you'll be aware I drew attention to it in one video as a stock that had caught my attention again on its way down.

This turned out premature with sterling/dollar weakness adding to media pressures, but my point remains: love or hate him, Mike Ashley is long-term highly capable at sports-kit retailing, backed by asset development.

Media controversy was more likely to fire him up to prove this business can perform, which wasn't going to happen soon, but "Sports Direct 2.0" is taking shape and the stockmarket senses it. It's why the post-results jump does not seem a spike and the price holds firm at 415p despite market jitters over Kim Jon Un threatening to lob missiles at Guam.

The rating would seem "up with events" currently in terms of a forward PE once again over 20 times, market value over 5 times net tangible assets and share buybacks pursued instead of payouts. But on a long-term view, if the marketing mix is right it will bring down ratings and brokers entertain 500p to 600p.

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.