Today, I’m going to take a look at opportunities for investors in UK retail stocks. This sector has taken a battering, but I believe value opportunities are starting to emerge.
Kicking the tyres
The legendary US fund manager Peter Lynch advised investors to test out businesses before they invested. So when I found myself out and about with time to spare last weekend, I decided to do a bit of retail research.
The first retailer I visited was Sports Direct International (LSE: SPD). In the past I remember the firm’s stores as being messy and cheap looking. But I was pleasantly surprised this time. The quality of the stock and the store environment were both better than I remembered.
Indeed, the store I visited seemed very similar to a nearby branch of multi-bagger rival JD Sports Fashion.
It’s all about the big man
Sports Direct founder Mike Ashley has a habit of buying up other retailers. His current portfolio includes fashion retailer Flannels and House of Fraser. He’s also the largest shareholder in Debenhams and Game Digital.
In my view, investing in Sports Direct is effectively a bet on Ashley’s talents as a retail boss and investor.
This is highlighted by the firm’s latest accounts. Net cash from operating activities rose by 26% to £326m last year. Measured against underlying pre-tax profit of £152.9m, I think that’s a pretty strong performance.
However, the group also spent £292.1m on investments in other retailers. If we include spending on the group’s own stores and £155m of share buybacks, last year saw a cash outflow of about £200m. Net debt doubled to £397m.
Broker forecasts for the current year put Sports Direct on a forecast P/E of 16.7. This stock could look very cheap in a few years, if Ashley’s investments are successful.
I’m more confident than I was, but I still don’t feel able to call this.
Long-overdue changes
Elsewhere in the same town, I came across a branch of Marks and Spencer Group (LSE: MKS). When I visited a year ago, it was open. But it’s since been closed as part of chief executive’s Steve Rowe’s long overdue shakeup of the group’s store estate.
In his 2018 results presentation, Rowe admitted that M&S had more than 2m sq ft of unproductive store space. Amazingly, the group’s worst-performing stores have been in the same location for more than 75 years.
Rowe’s plans suggest that previous bosses have been in denial about the retailer’s costly store estate and inefficient supply chain. Major changes are also planned to food and clothing ranges. These have lost the reputation they once had for innovation and style.
I’d back this man
This complex turnaround programme is being overseen by M&S chairman Archie Norman, whose previous roles include running Asda and chairing ITV. Norman has an impressive record as a retail turnaround specialist. His time at ITV also suggests to me that he has a good understanding of digital marketing and the internet.
Marks & Spencer’s financial performance remains sound and the group continues to generate plenty of cash. At current levels, the shares trade on 11 times forecast earnings and offer a forward yield of 6.2%.
I understand the problems here and can see a solution. M&S is on my watch list, and I’m tempted to buy.