The point is that if a company is outperforming the expectations you had when you first appraised the investment case, then it is only reasonable to adjust your expectations higher. This subject matter is highly relevant right now because I have had a chance to reappraise the investment case of general retailer Moss Bros (MOSB: 71p), a company I have been following since I initiated coverage when the share price was 39.5p early last year ('Dressed for success', 20 February 2012).
I subsequently reiterated that advice last autumn when the price was 48.5p ('Small-cap wonders', 1 October 2012), rated the shares a trading buy in January when I lifted my original target price of 60p to 80p ('Jumping the gun', 1 January 2013) and again in June this year when the price was 57p ('Trading plays', 6 June 2013). I last updated the holding at the start of last month ahead of Moss Bros's half-year results when the shares were trading at 64p ('Dressed to impress', 2 September 2013).
At the time I thought a target of 80p was still reasonable. But having drilled through the half-year numbers I feel this is now too conservative, both from an operational perspective and also from a technical one, too.
Accelerating sales trends
Before the company went into a closed period for its half year to end-July, it issued a trading statement for the 18 weeks to 1 June 2013 which revealed a 2 per cent rise in like-for-like retail sales, including e-commerce, and an improvement in underlying cash gross profit. That represented a very decent recovery in trading after cold, unseasonable weather until mid-April proved a drag on performance. Overall, like-for-like sales in the 26-week period increased by 1.7 per cent, but the key take for me was that the trend is now accelerating and in the eight weeks to end of September like-for-like sales were up 4.9 per cent. This is ahead of the run rate in second half sales forecasts for analyst John Stevenson at broking house Peel Hunt, reflecting a positive response to the retailer's autumn/winter ranges.
Moreover, there are enough positive drivers to suggest that the sales momentum can be maintained between now and the financial year-end of 31 January. For example, following the launch of a new retail website in January, e-commerce sales have ramped up sharply and were 164 per cent ahead year on year in the six months to end-July, with the growth accelerating during June and July. Tablet sales are clearly having an immediate impact in driving growth and already account for 8 per cent of internet sales, even though a mobile enabled site was only launched in May. Internet sales now account for 4.5 per cent of all retail sales and, with conversion rates around 50 per cent, this segment is becoming an increasingly important sales channel. The company is also exploiting the web opportunities overseas by launching a number of country specific, local currency websites to target international customers in a more focused way. Websites in Australia, Sweden and Denmark are scheduled to come on stream before Christmas and management is eyeing the US market next year.
In addition, a transactional website for Moss Bros' suit-hire business launches next month and the full catalogue is expected to be online in the next six weeks, which can only enhance future digital sales. It's worth pointing out that Moss Bros is also using the web to maximise the margin it earns on clearance stock which is no bad thing.
Boosting returns from high-street estate
Importantly, Moss Bros is making headway with its store refits. A further four stores were refurbished in the first half as part of an ongoing programme, bringing the total number of stores trading with the new format to 24, comprising 18 refitted stores and six new stores out of a total portfolio of 133 sites. Another 10 stores are planned to be refurbished by the end of January. According to analysts, the new format stores are delivering sales uplifts of more than 8 per cent in year one, and more than 4 per cent in year two, which means that the cost of the investment is fully recouped within three years.
That's a very interesting point to note once you consider that Moss Bros was sitting on a cash pile of £29.7m, or 30p a share at the end of July. Or put it another way, if the store refurbishment programme continues to be self funding from cashflow, and the pay-back period on invested capital remains relatively short at three years or less, then there is obvious scope for the board to return a chunk of that cash pile back to shareholders.
That particular line of thinking gains more credence once you consider that Moss Bros is capitalising on its strong negotiating position when store leases expire. Management can afford to play hard-ball with landlords over the terms of renewal, or walk away from the stores in order to take advantage of opportunities elsewhere and relocate to new space with better footfall. In the last financial year, I understand that management negotiated an average reduction on the rent bill of about 17 per cent on stores with expired leases and demanded break clauses at five or even two years on these new leases. And given the store leases are the biggest cost Moss Bros incurs, then savings on th rent roll can either be used to refurbish more stores, or be recycled back to shareholders through dividends.
Conservative profit forecasts
So, with the combination of accelerating growth emerging from new sales channels, a lower cost base, upside from store refits and soft comparatives to beat, then the business case is well underpinned. In fact, analyst John Stevenson at Peel Hunt notes that "although full year retail margins are forecast to be flat, strong progress in the first half suggests potential for outperformance". In other words, if Moss Bros maintains the positive sales momentum for the remainder of this financial year, there is a very good chance the company will beat current earnings estimates.
For the financial year to January 2014, Peel Hunt currently expects revenues to rise from £104.6m to £106.6m, pre-tax profits to increase from £2.7m to £3.1m and adjusted EPS to rise from 1.9p to 2.3p. Having raised the dividend from 0.4p to 0.9p last year, Peel Hunt expects the board to raise the full-year payout again to 1.1p in the current year. The company has already raised the interim payout by 50 per cent to 0.3p, so Peel Hunt's estimates could prove conservative. Analyst John Cummins at brokerage WH Ireland is forecasting a full-year dividend of 1.2p, rising to 1.8p in the 12 months to January 2015. On that basis, the prospective yield is 1.6 per cent rising to 2.5 per cent.
Furthermore, with margins improving and further cost reductions expected as store leases expire and are renewed on far more favourable terms, Peel Hunt expects pre-tax profits to ramp ahead to £3.9m on revenues of £110m in the 12 months to January 2015. This largely reflects an improvement in the operating margin from 2.7 per cent to 3.3 per cent, which looks quite conservative to me. Analyst John Cummins at brokerage WH Ireland is more bullish, predicting sales of £116m, pre-tax profits of £4.3m and EPS of 3.1p next year. On this basis, the PE ratio net of cash drops to 13. For a recovery situation, and for a company which Peel Hunt believes has potential to generate annual revenues of £140m and operating profit margins of 8 to 10 per cent, this is not an expensive earnings multiple.
Positive share price set-up
Interestingly, after a minor pull-back post the half-year results at the end of last month, the company's share price found support around 67p which coincided with the August highs in the current phase of this bull run. In my opinion, there is now a very strong chance that the share price will take out last month's six-year high around 75p. The 14-day RSI has unwound and at a reading of 60 is not overbought. Moreover, the price action is consistent with the step formation in the chart witnessed since June. If the 75p resistance level is breached, I see little reason from a technical perspective why the share price can't run up to the next major band of resistance at 90p, dating back to the first quarter of 2006.
So, ahead of what is expected to be an upbeat pre-close trading statement in the first half of December, I rate Moss Bros's shares a decent trading buy on a bid offer spread of 70.5p to 71p. I have upgraded my fair value target price from 80p to a range between 85p to 90p, equating to a rating of 18 times January 2015 earnings estimates net of cash and pre-likely earnings upgrades. If achieved, this offers us between 20 per cent and 27 per cent further upside.
■ Finally, as a pre-Christmas offer exclusive to Investors Chronicle readers, all telephone orders placed with YPDBooks for my new book Stock Picking for Profit will receive complimentary postage and packaging. This offer is strictly for a limited period, is subject to stock availability and applies to only telephone orders placed until Friday, 15 November 2013.
Please note the book is only being sold through YPDBooks and no other source. Full details of the content of the book is available online at www.ypdbooks.com. If you would like to take advantage of this offer, please contact YPDBooks on 01904 431 213 and quote reference 'ICOFFER'. The book is priced at £14.99. Internet orders will continue to incur the normal postage and packaging cost of £2.75. I have also published an article outlining the content of the book: 'Secrets to successful stock picking'. The book also includes a dedicated chapter on how I select my annual Bargain Shares Portfolio with case study analysis.
MORE FROM SIMON THOMPSON ONLINE....
I have published four other articles this week on the following seven companies:
■ Trifast ('A timely bolt on purchase', 21 Oct 2013)
■ Noble Investments ('Bargain shares update', 21 Oct 2013)
■ Stanley Gibbons ('Bargain shares update', 21 Oct 2013)
■ Cairn Energy ('Bargain shares update', 21 Oct 2013)
■ Eros ('Time for some price action' 22 October 2013)
■ PV Crystalox Solar ('Time for some price action' 22 October 2013)
■ BP Marsh & Partners ('BP Marsh cashed up to invest, 23 October 2013)
