Mothercare: baby or bathwater?

We’re now well into earnings season. I love earnings season. Some stocks go up. Some go down. For those who turn up having done the work, there is plenty of opportunity up for grabs. It’s also a time to find new stories and learn about new businesses. Stocks come and stocks go, and they can float in and out of your watchlist as the years go by. One thing that is important to acknowledge is that stocks, unlike leopards, can change their spots. Board shuffles, corporate restructurings, and equity financings all play a part in helping stocks to reinvent themselves. Stocks that I have believed would be a perennial pooch have become attractive. Sometimes, those companies slide into obscurity, before the quiet de-list and exit into nothing. But sometimes they do reinvent themselves and the market can take time to realise.

The market often looks forwards. When it comes to growth stocks, future years’ worth of expected earnings can be baked into the stock price. It’s rare that quality compounders ever trade on a value rating – perhaps only in times of distress as we saw last year. Games Workshop (GAW) dropped spectacularly but trebled from its lows. This is just one of many examples. But if you’re not going to buy quality when it’s going cheap – when are you?

However, the market can be slow to change. Remember, prices are only an indicator of sentiment and what someone else is prepared to pay. Were Games Workshop’s shares really worth only around a third of what they trade at today?

When it comes to turnaround stocks, the foundations of the strategy can start to bear fruit and the building blocks for growth can be well under way before the market catches on. This can often be a factor for a rerating. Spotting stocks that the market has overlooked has been a profitable strategy so far in my trading career.

We saw this with Tremor International (TRMR) earlier in this year – I highlighted the stock on Twitter when it traded below 200p. It reached highs of almost 700p a few weeks ago. Granted, the stock has benefited from repeatedly beating earnings expectations and delivering upgrades, but the big change has been that the market no longer hates the company and in general is willing to price the shares at a higher earnings multiple. Looking for stocks that can benefit from price/earnings ratio expansion can be a good trading strategy – so long as the fundamentals check out.

I have potentially found an opportunity that could be a similar trade. It warrants more research, but it’s a company that has been so disastrous you will likely turn your nose up at it. Mothercare (MTC) has been an avoid for most of the past decade. It’s a fatigued brand attached to a bloated and badly managed company. I’m not going to conduct a full autopsy into what happened as the chart tells us everything we need to know.

Looking at Chart 1, we can see the stock never convincingly broke above the 200-day exponential moving average (pink line). This indicator is a crucial one, as so many market participants regard this as the ultimate trending indicator. If the indicator is trending upwards we can view the stock as in an uptrend, and the opposite is true too. We can see that in Chart 1 ever since the autumn of 2015 the stock has never appeared to have been trending upwards. There were some attempted breakouts that I have highlighted with arrows, yet the stock either failed to break out or instead fell back while the pink line was trending downwards.

Traders should seriously ask themselves the appeal of a stock that is consistently trending downwards – often it’s better to wait for the trend to smoothen and even start trending upwards. It doesn’t matter whether you bought at 200p or 20p – if a stock falls 90 per cent then you have lost 90 per cent. It is worth looking at my debut article ‘Size matters’ (1 August 2019) to see the destruction a poorly timed buy and hold can have on an account.

However, there may be change afoot at Mothercare. The company has been able to refinance, securing a loan and also converted some of the loans to equity. There has also been a change of strategy, with a new capital-light structure with the goal of moving to a franchise-focused revenue model.

The company’s admission to Aim announcement last Friday contained an interesting quote from the chair: “Mothercare faces the future as a conservatively financed, cash generative and profitable business for the first time in many years.” Is he referring to the business how he sees it in the future? Or the business as it is right now – which is how I read it? If it is the latter, that would confirm the turnaround is now seeing progress. We are told there will be a trading update in late April, but for now the price looks to be settling nicely.

Looking down to Chart 2, I have marked arrows where the stock has dipped and volume has increased. That tells me that there is a keen buyer – or maybe multiple buyers – when the stock comes off. I’ve also drawn a line marking the recent high just under 15p as a resistance point. I am long the stock to keep me interested, but would add into this breakout.

We need more colour to see if the turnaround is really making progress – but I am happy to play this chart if we see the price move north.