Many big name retailers have fallen out of favour with stock market investors. Some of these appear to offer good value, but there are risks in this sector. Growth prospects are uncertain, and it’s not yet clear how high street retailers will adapt to the relentless growth of online sales.
In this article I’ll look at Debenhams (LSE: DEB), J Sainsbury (LSE: SBRY) and Associated British Foods (LSE: ABF), which owns Primark. Do these big UK retailers offer good value in today’s market?
Cheap for a reason?
Shares in department store Debenhams currently trade on just 9.4 times 2016 forecast earnings, and offer a prospective yield of 4.8%. That ought to be an attractive valuation.
The risk is that Debenhams’ 2015 earnings of 7.6p per share were lower than at any time since 2010. Under outgoing chief executive Michael Sharp, the group’s profit margins have fallen and sales growth has been limited. One problem may be the increased competition from online retailers.
A second risk is that companies that offer credit to customers, like Debenhams, may be too dependent on the interest income from customers who don’t make full repayments each month. This income could fall if regulators force stores to reduce their high APR interest rates.
However, Debenhams’ shares do look cheap. The firm is also due to get a new chief executive later this year. I suspect this stock could be a value buy at current prices.
This deal could be disruptive
Until recently, I rated Sainsbury as the best of the UK supermarkets for investors. Now I’m not sure. The firm’s £1.4bn offer for Argos-owner Home Retail Group has created a cloud of uncertainty about the outlook for Sainsbury.
Although Home Retail’s high cash balance means the deal is less expensive than it might seem, I think that investors need to question the logic behind acquiring Argos. Will this deal really generate sales growth, or will it just lead to a dilution of Sainsbury’s successful formula? Supermarkets have a mixed track record when it comes to selling non-food goods.
Sainsbury’s shares currently trade on 12.5 times forecast earnings and offer a 3.8% dividend yield. Although this should be attractive, I’d argue that the shares are only a buy at the moment if you believe that the Argos deal will add value to Sainsbury’s business.
Should you sell ABF?
Although sales at Primark are expected to have risen by 7.5% over the last year, I have concerns about the growth outlook for the chain’s owner, Associated British Foods.
ABF shares currently trade on 32 times 2016 forecast earnings and offer a potential dividend yield of only 1.1%. In my view, a high level of growth is required to justify this valuation. I’m not sure ABF can deliver the goods.
In its latest update, ABF said that a “marginal decline in adjusted earnings per share” is expected for the six months ending 27 February. Analysts’ forecasts suggest that full-year earnings will be just 2% higher than last year.
Although earnings are expected to jump by 17% in 2016/17, my view is that this is already reflected in the share price. Any disappointment could trigger a big sell-off. I believe there are much better buys elsewhere in the retail sector.