We recently revisited Premier Investments (ASX:PMV) after the Company issued a very strong trading update to the ASX on 12 January 2021. The trading update reflected a solid sales performance in the context of COVID‐19-related disruptions, particularly in international markets. Underlying EBIT is estimated to have grown by ~40%, reflecting continued strength in online and gross margin expansion.
The weakness in the share price since the trading update reflects expectations that underlying EBIT growth in 2H21 and FY22 slows from 1H21 levels. The factors driving strong sales in 1H21 are going to be difficult to sustain beyond FY21 and the cost benefits that supported underlying EBIT in 1H21 are non-recurring. Given PMV’s strong track record of delivering results ahead of expectations, is the market over-estimating the expected decline in earnings for FY21?
About Premier Investments
Premier Investments owns global retail brands Smiggle and Peter Alexander as well as a portfolio of apparel brands in Australia & NZ. Smiggle and Peter Alexander are the highest-margin and highest-growth brands and currently account for 45% of group sales.
- Smiggle is a retailer selling bags & accessories, pencil cases, food & drink, stationery, toys and school supplies. Smiggle has a network of 347 stores (including concessions) in major developed countries/regions, including Australia & NZ, UK & Ireland and Asia (Singapore, Hong Kong & Malaysia). A key aspect of the Company’s strategy with regards to the Smiggle brand is to expand into Europe and increase both the portion of online sales (currently ~20% of overall group sales) and store networks.
- Peter Alexander is a retailer selling sleepwear (men, women & children), homeware and beauty products.
- The Company also operates five core apparel brands in Australia & NZ. In order of FY20 sales contribution, these comprise Just Jeans, Jay Jays, Portmans, Dotti and Jacqui E.
Key Fundamental Drivers
1. Expansion in Gross Profit Margin May be Sustained into the Medium Term
In the most recent trading update, gross profit margin was not disclosed, but was well ahead of the prior corresponding period in % and $ terms, reflecting industry-wide reductions in promotions as inventory levels were low. In addition, a lighter inventory position and possible reductions in sourcing costs as a result of a stronger A$ have supported gross profit margin expansion in 1H21.
Given the potential for promotional activity to escalate under more a “normal” retail environment, it is unlikely that that the gross profit margin expansion is sustainable in the medium term. Having said that, gross profit margin expansion could be sustained in the event of a stronger sales outlook for Smiggle, as well as an increased portion of higher-margin online sales.
2. A Focussing on Store Profitability Supports EBIT Margin
PMV’s focus on store profitability has been a factor in reducing rent to sales, and more broadly rent to store sales, up to 1H20, which in turn has moderated overall rental growth. This factor, as well as ongoing channel mix to online and the wholesale strategy for Smiggle, are expected to drive EBIT margin expansion compared to pre COVID-19 impacted levels.
The key factors underpinning an expected decline in rent/sales and rent/store sales include:
i. Lower rents achieved as per the 1H21 trading update, as well as the extent to which PMV is positioned to optimise store profitability via rent, ensure that store rent/sales is expected to remain low.
ii. The mix shift to online will continue to drive overall rent to sales lower. Further, there is scope to increase online sales/close further stores in the event that rents become uneconomical.
3. Smiggle Targets Not Achieved – But Strategic Merit Remains
A key driver of PMV’s growth profile (pre-COVID) was Smiggle’s offshore expansion. COVID-19 resulted in significant disruption and slowed the roll-out. More recently, Smiggle has been the most impacted by COVID-19 due to: (i) School children not being at school as a result of school closures, (ii) Exposure to markets where the negative impact of COVID-19 has been more significant than ANZ, and iii) Online is a lower share of sales vs other brands.
Despite PMV not achieving its targets for Smiggle, the Company’s focus towards high EBIT margin channels with much lower capital requirements (i.e. wholesale and online) supports strong sales growth and EBIT margin expansion and results in a higher return on capital employed over the medium term.
4. Strong Balance Sheet
PMV has historically enjoyed a net cash or low net debt position, with its net cash position having become much larger in FY20 and 1H21. In addition to the net cash position, the balance sheet shows investment in associate of $257m, which relates to the Company’s 27.8% interest in ASX-listed Company Breville Group (ASX: BRG), which at the time of writing was worth ~$1b.
The typically strong balance sheet and cash generation funds the store rollout program, online investments
and geographic expansion, which has occurred concurrently with a strategy to re-distribute capital back to shareholders.
While PMV have not typically pursued Merger & Acquisition (M&A) opportunities, these could become available given the uncertainty around some international brands in light of COVID-19.
At present, the shares are trading in line with the average multiple over the last six years and not demanding in the context of: i) EPS growth of ~11% over FY20-23 on a CAGR basis and ii) A net cash balance sheet position and strong cash generation which supports the expansion/online strategy and provides potential for capital management.
While there are avenues in place for PMV to generate stronger earnings growth in FY22, the market is likely taking a wait-and-see approach, especially with the Company’s 1H21 results release due later this month.
PMV’s share price fell away at the end of January but the range appears to be tightening up now, which is a good sign. This means that we are very close to seeing a buying opportunity, as long as we see a break from the range. At the moment, that appears to be happening so if we can continue to see PMV stay above the diagonal blue lines, then that would be a trigger to buy the stock. We would look to have our stops just under support near $21.
Michael Gable is managing director of Fairmont Equities.
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