Accelerating sales trends
That's because sales trends are now accelerating which not only underpins full year profit expectations for the financial year to end January 2014, but offers potential that Moss Bros could actually exceed analyst estimates.
To understand why, it's best to break down the performance in the key trading periods. In the first six months of the financial year to end-July, the company's like-for-like sales increased by 1.7 per cent, but since the half-year end they have surged 5.3 per cent in the past 19 weeks. Moreover, in the first eight weeks of the second half to end-September underlying sales were up 4.9 per cent, which implies in the past 11 weeks since that previous trading update the run rate has picked up to somewhere around 5.6 per cent. Namely, sales momentum is clearly building.
Furthermore, there are enough positive drivers in the latest update to suggest that the sales momentum can be maintained between now and the financial year-end of 31 January, and beyond. For example, following the launch of a new retail website in January, e-commerce sales have ramped up sharply and are now 194 per cent ahead year on year in the first 45 weeks of the financial year. The segment now accounts for 6.4 per cent of the company's sales, up from 4.5 per cent at the time of the last update 11 weeks ago. With conversion rates around 50 per cent, this part of the business is becoming an increasingly important sales channel. For instance, tablet sales already account for 8 per cent of internet sales, even though a mobile enabled site was only launched seven months ago.
Moss Bros is not just a UK growth story either as the management team, led by chief executive Brian Blick, have been exploiting web opportunities overseas by launching country specific, local currency websites to target international customers in a more focused way. Websites in Eire, Sweden and Denmark have gone live since the summer and early next year Moss Bros will launch one in Australia. In addition, I understand that a new transactional website for Moss Bros' suit-hire business went live in beta testing last month and around 10 per cent of customers are being directed to the new service. It's worth pointing out that Moss Bros is also using the web to maximise the margin it earns on clearance stock which can only enhance margins by targeting a wider customer group, lower stock levels, improve stock turn and reduce the amount of working capital tied up in stock.
Refurbishment programme gathers pace
The other major key take for me in this month's trading update is that Moss Bros is continuing to make strong headway with its store refits. Following the upgrade of four stores in the first half, a further nine have been refurbished in the second half as part of an ongoing programme, bringing the total number trading with the new format to 38 stores. This comprises 28 refitted stores and 10 new stores out of a total estate across 133 sites. Another 20 store refurbishments are planned for the financial year to end January 2015. In turn, these refits underpin around 50 per cent of the like-for-like sales expectations of analyst John Stevenson at brokerage Peel Hunt.
Importantly, the return on sales generated from the new format stores have been accelerating and are now 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 being easily recouped within three years and is being entirely self funded through operating cashflow. And with business on the up, Moss Bros is in an even stronger strong position with landlords when store leases expire. The average reduction on the rent bill negotiated by the company was around 17 per cent on stores with expired leases last year, and the company has been playing hardball on the lease terms with break clauses inserted in these new leases at five or even two years.
These savings are not just significant in terms of Moss Bros' cost base, but can be redeployed to either refurbish even more stores, or be recycled back to shareholders through dividends and maintain a very progressive dividend policy. For instance, Mr Stevenson currently expects Moss Bros to declare a dividend of 1.1p a share in the financial year to end January 2014, up from 0.9p a share the prior year, rising to 1.3p and 1.9p, respectively in the following two financial years to end January 2015 and 2016. This implies prospective yields of 1.8 per cent and 2.7 per cent, respectively. These estimates are not out of kilter with other broking houses either as analyst John Cummins at broking house WH Ireland is forecasting a full-year dividend of 1.2p, rising to 1.8p in the 12 months to January 2015.
It's equally telling that despite spending significant sums of store refits, Moss Bros has actually increased its cash pile since the start of the year by around £300,000 to £26m. Net funds are the equivalent of 26p a share. That's a very interesting point to note because if the store refurbishment programme continues to be self funding from cashflow, as is clearly the case now, and the pay-back period on invested capital improves further as sales uplifts accelerate on the new refitted stores, then there is clear scope for the board to return some of that cash pile back to shareholders. The current cash pile accounts for 38 per cent of the company’s market value of £71m, so even if only a half was returned to shareholders this would represent a significant cash return.
Profit forecasts well underpinned
For the financial year to January 2014, Peel Hunt 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. But with margins improving and more cost savings expected as store leases expire and are renewed on favourable terms, Peel Hunt predicts pre-tax profits to jump 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. Analyst John Cummins at brokerage WH Ireland is even more bullish, predicting sales of £116m, pre-tax profits of £4.3m and EPS of 3.1p next year.
This means that once you strip out the aforementioned chunky cash pile, Moss Bros is trading on a PE ratio of less than 15. For a recovery situation, and one that 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 given the scope for margin expansion.
Target price
There is obvious price resistance at around 75.5p, a glass ceiling which the share price has failed to break through on three occasions in the past three months. However, I am still of the opinion that the post Christmas trading update in a month's time will prove to be the catalyst to take out that six-year high. Following the latest failed attempt, and the very modest drift in the share price, the 14-day RSI is now around 40, which is not overbought and offers scope for the rally to start again from modestly oversold levels. Moreover, if the 75.5p 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 mid-January, I rate Moss Bros's shares a trading buy on a bid offer spread of 70p to 71p. My fair value target price range of between 85p to 90p equates to a rating of 18 times January 2015 earnings estimates net of cash before likely earnings upgrades.
Finally, due to unprecedented demand, my new book, Stock Picking for Profit, has sold out and is being reprinted for delivery the week commencing Monday, 6 January 2014. As a special promotion to IC readers, the first 100 pre-orders for the book placed online with YPD Books and quoting offer code ICOFFER will receive complimentary postage and packaging. The book can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213. The book is only being sold through YPDBooks and no other source. It is priced at £14.99, plus £2.75 postage and packaging. Telephone orders will continue to incur the £2.75 charge.
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