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OPINION

A smart performance

A smart performance
May 25, 2016
A smart performance

This performance was even more impressive considering Moss Bros was up against tough comparatives from the same period last year when underlying sales rose 7.4 per cent. And it's not as if the top-line growth is being achieved at the cost of margin as the company has delivered a hefty 4.3 percentage point improvement in its retail gross margin implying a run rate around 60 per cent, a marked acceleration on the 3 percentage point improvement seen in the second half of the last financial year. This was mainly achieved by not running a mid-season sale, a decision which chief executive Brian Blick believes reflects the "strength of our core offer." He has a point as it's not as if the general retail backdrop has been benign, far from it in fact. So the fact that Moss Bros has been able to not only buck the retail trend, but generate solid revenue growth is a clear indication of its growing appeal to customers.

Indeed, the launch of sub-brands Moss London, Moss 1851 and Moss Esquire have all strengthened the company's brand offering and are underpinning the level of full price sales and boosting gross margins. Online initiatives are helping improve channels to market, too: digital sales increased by almost 10 per cent year-on-year in the latest 15-week trading period and now account for 10.7 per cent of total sales. A 'click & collect' service for store purchases and hire sales is clearly helping drive online sales as site traffic, conversion and retention rates are all improving.

The accelerated store roll-out programme is also driving sales momentum as these upgraded outlets generally post underlying sales growth of 10 per cent in the first year, and around 5 to 6 per cent in the second. Having updated 21 stores in the 12 months to end January 2016, Moss Bros is spending a further £3.3m on sprucing up 20 units this year of which three stores reopened in the last 15 weeks. I understand that the refurbished outlets have a cash pay-back period on investment of three years. They deliver decent like-for-like sales outperformance, too, hence the continued growth being seen in Moss Bros' underlying sales figures. Around 85 of the 124-strong estate is currently trading in the new format and this will rise to over 100 stores by January.

It's comforting to see that hire sales are back on track and the order book is favourable going into the all important wedding and summer season. The company has added more lounge suits and contemporary products to the range and has introduced branded product from Ted Baker too. It's clearly appealing to potential customers.

 

Potential headwinds

Of course, the forthcoming EU Referendum is a potential fly in the ointment as this could have a destabilising effect on retail sales across the sector if a Brexit vote leads to financial instability, something the prime minister and chancellor were at pains to point out earlier this week. However, I am still of the opinion that the majority of voters will vote to stay in the EU, as are investors who are betting on the outcome. Indeed, over £14.4m has been wagered on the outcome on Betfair and the current odds now only point to a 20 per cent chance of the UK voting to leave the EU. Perhaps, the government's scare tactics are working.

Another potential headwind for retail spending on the high street is the Euro 2016 football championships in France which kick off on Friday 10 June and run for a month. However, analysts have already factored in a slower end to the first half for Moss Bros given the potential for disruption to sales from soccer mad customers glued to their television screens. As a result although analyst John Stevenson at brokerage Peel Hunt believes that Moss Bross will deliver a 22 per cent hike in pre-tax profits to £3.4m in the six months to end July 2016, he has left his full-year pre-tax profit unchanged at £6.8m, implying 15 per cent growth for the year as a whole.

This forecast could prove conservative as it only implies 10 per cent profit growth year-on-year in the second half even though the company can expect a decent sales uplift from the 21 stores spruced up last financial year and from those that are being refurbished at the moment. My view is that if the positive sales trends continue, and the UK population decide to stay in the EU, then there could be significant scope for upgrades as the year progresses as the operating leverage of the business kicks in.

 

Valuing the business

I would also point out that Moss Bros has a cash-rich balance sheet with net funds of £17.3m, or 17.4p a share, which you have to account for when assessing the valuation. So although a cash adjusted forward PE ratio of 17 for the current financial year, falling to 15 times in the 2017/18 financial year may seem fair value, you also have to factor in that this is a very cash-generative business. In fact, cash profits of £13.3m forecast for the current year are almost double pre-tax profits estimates of £6.8m, reflecting non-cash depreciation and amortisation charges of £6.5m. In other words, the enterprise value (market capitalisation of £107m less net funds of £17.4m) to cash profit ratio is only 6.7 times, a rating that in my view is not stretched. This is my preferred way of valuing the business given the cash-rich balance sheet and chunky non-cash charges that subdued the pre-tax profit line.

Furthermore, it's the cash generative nature of the business that will enable the board to pay out a dividend of 5.8p this year even though it will not be covered by EPS estimates of 5.3p. More important is that cash profits cover the cash cost of the payout 2.3 times over. Indeed, it was the highly cash-generative business model that attracted me to the company in the first place, as was the potential to recycle cash flows back into the business, when I first spotted a great buying opportunity at 38p ('Dressed for success', 20 February 2012). I have no reason to alter my positive stance either, having last recommended buying the shares at 100p ahead of yesterday's trading update ('A chic performance', 6 April 2016).

Underpinned by a 5.4 per cent prospective dividend yield, and rated on less than seven times cash profits to enterprise value, I continue to rate Moss Bros shares a buy on a bid-offer spread of 104p to 107p and maintain a target price range of 120p to 130p. Interestingly, a close at 110p or above would indicate a major break-out and increase the likelihood of a move to my fair value target range. Buy.