When JD Sports Fashion (JD.) acquired Blacks Leisure from the administrators in 2012, shareholders knew there were some painful losses to come as the flagging outdoor apparel business was overhauled. Now, though, that onerous restructuring process is largely complete and the balance sheet remains strong, which suggests this could be a good opportunity to snap up JD Sports while the shares remain incredibly lowly rated based on a key contrarian valuation metric - the enterprise-value-to-sales ratio (EV/S).
- Extremely cheap on key contrarian value indicator
- Core business growing and Blacks set to recover
- Attractive dividend yield
- Net cash
- Fashion category struggling
- Weak consumer demand
The EV/S ratio, which is used as a primary way to identify value by investment gurus such as Ken Fisher and James O'Shaughnessy, is considered a powerful indicator of contrarian value because it can highlight companies where sales are strong but share prices are weak due to the earnings-obsessed market putting an undue focus on a temporary slip in profitability. JD Sports looks like a prime example of such a contrarian value play. Its EV (market cap, minus cash, plus debt) represents a meagre 0.25 times last year's turnover. Based on this metric, it is the fourth lowest valued out of 21 FTSE All-Share consumer-discretionary retail stocks. Its rating compares with a median sector average of 0.85 times sales and 1.3 times for the only other UK-listed sports retailer, Sports Direct.
The key reason for the negative sentiment is that, following the Blacks acquisition, operating margins have tumbled to 4.9 per cent. However the five-year average margin stands at 7.6 per cent, which is actually above the 7.4 per cent boasted by Sports Direct, based on S&P CapitalIQ data. Most importantly, we believe JD's margins are now set to rebound, powering a revival in profits over the coming years, which should also produce a substantial re-rating of the shares. There's a decent dividend to enjoy while waiting for the recovery story to unfold, too, which looks very secure based on forecast cover of 3.7 times this year and a hearty net cash position.
In acquiring Blacks, JD Sports inherited a badly managed business which has required a great deal of time and investment to get back on track. It faced a number of obstacles: an excessively large store portfolio paying high rents, a bulky central cost base and a limited and unbalanced stock position. As a result, Blacks took a sizeable bite out of JD Sports' full-year earnings. Group operating profit before exceptional items slid 20 per cent to £61.3m, mainly due to an eye-watering £14.9m full-year loss at Blacks.
| JD SPORTS FASHION (JD.) | ||||
|---|---|---|---|---|
| ORD PRICE: | 747p | MARKET VALUE: | £364m | |
| TOUCH: | 745-748p | 12-MONTH HIGH/LOW: | 845p | 600p |
| DIVIDEND YIELD: | 3.7% | PE RATIO: | 7 | |
| NET ASSET VALUE: | 488p* | NET CASH: | £45.6m | |
| Year to 2 Feb | Turnover (£bn) | Pre-tax profit (£m) | Earnings per share (p) | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 0.77 | 61.4 | 88.2 | 18.0 |
| 2011 | 0.88 | 78.6 | 115 | 23.0 |
| 2012 | 1.06 | 67.4 | 96.3 | 25.3 |
| 2013 | 1.26 | 55.1 | 79.7 | 26.3 |
| 2014* | 1.27 | 68.3 | 101 | 27.4 |
| % change | +1 | +24 | +27 | +4 |
Normal market size:300 Matched bargain trading Beta: 0.54 *Includes intangible assets of £96m, or 197p a share **Investec forecasts | ||||
Now, though, a new management team has been installed, stocks are being better managed, store investment has begun and a cost reduction programme is under way. Losses are expected to fall back substantially as the business benefits from these actions. So, while the initial results were more disappointing than anticipated, the group now has a firm foothold in a growing UK outdoor lifestyle market and is set to turn Blacks, which generated £121m of sales last year, into a core retail operation.
The group has also faced challenges with its sports fashion business, which slipped from a £3.3m profit to a £2m loss in the recently completed financial year. But the division only accounts for 13 per cent of sales and it is now undergoing a makeover, and a new management team and acquisitions over the past two years should drive stronger long-term growth. What's more, the core sports business, which accounts for just over two-thirds of sales, is performing well. Sales here rose 10 per cent last year to £854m, with like-for-like growth of 2.5 per cent, leading to a 5 per cent rise in operating profit to £78m.
