Don’t discount B&M

B&M sells a mix of groceries and homewares in over 700 stores in out-of-town retail parks across the UK. Its footprint has ballooned since brothers Simon and Bobby Arora bought the 21 original stores in north-west England in 2004, later complementing these with the acquisitions of Heron Foods in 2017, and French bargain store Babou in 2018. 

Stellar performance

On balance, the pandemic turbocharged the group’s fortunes. Its classification as an “essential retailer” allowed it to stay open throughout lockdowns in the UK, where it makes 85 per cent of its sales as B&M. Despite Covid-induced delays to its expansion plans, adjusted Ebitda rocketed 83 per cent to £626mn in the year to March 2021.

Margins also rose by four full percentage points to 13 per cent, thanks to higher sales density in its stores and a product mix skewed towards higher-margin homewares, which account for roughly a quarter of total sales, according to broker RBC Capital Markets. Profitability narrowed slightly to 12.4 per cent in the half year to September 2021, after the group once again factored in business rates, but margins are still well up on 2019.

Performing under pressure

Fast forward to 2022, and a new tailwind is blowing. Historically, the firm has put in its best performance when broad consumer confidence is weakening (see chart). Prior to the pandemic, B&M achieved its fastest UK like-for-like sales growth of 27 per cent in the first quarter of 2010, as austerity measures set in after the global financial crisis.

This was at a time when most retailers’ profits were evaporating. Discount supermarkets Aldi and Lidl had fired the starting gun on a price war which led UK retailers’ store-based profit margins to more than halve between 2009 and 2017, going from 8.8 per cent to 4.1 per cent, according to analysis from Alvarez & Marsal and Retail Economics. The discounters won, raising their market share from below 5 per cent in 2009 to 16 per cent today and reinforcing the value of businesses catering to bargain hunters.

Bargains are already back in vogue. Market researcher Kantar shows Aldi and Lidl grew their sales by 3.3 per cent each in the three months to 20 February, despite overall UK supermarket sales falling 3.7 per cent during the same period. Mirroring this, analysts at RBC expect consumers to “become more price conscious and seek greater value for money”, resulting in higher customer numbers for B&M, but also potentially a weaker product mix with stronger sales of lower-margin groceries.

B&M's January trading update reflected shoppers' enthusiasm for bargains. The retailer posted its “best-ever Christmas”, suggesting it may have retained many of the new customers it gained during the pandemic. Management celebrated by announcing an extra week’s bonus pay for staff and lifted adjusted Ebitda guidance for the year to March to between £605mn and £625m, well above consensus estimates of £578mn.

Despite the upgrade, B&M's shares have faltered in 2022, and currently rest 14 per cent below their 12-month high over concerns around inflation and the sustainability of recent growth rates. January’s sale of a 4 per cent chunk of shares by SSA Investments – the vehicle owned by chief executive Simon Arora and his brothers – added to the unease.

Measuring success

One of the reasons investors have underpriced B&M is by underestimating its longer-term growth story. Given the recent trajectory, that’s not entirely surprising. After hitting like-for-like sales growth of 24 per cent in FY2021, UK stores saw a 5 per cent drop in the 26 weeks to 25 September. The market is clearly unsure about prospects from here.

However, measuring like for likes only tells half the story of the B&M business model. Taking into account extra revenue streams from the 14 new stores it opened in the six months to November, half-year sales were up by 1.2 per cent. That may not seem very inspiring, but remember that this is against a year in which competition was heavily restricted by lockdown rules. From another perspective, B&M has held onto much of its new ground.

Management has made continued strides towards a long-term target of 950 stores in the UK, which has given B&M “one of the strongest ROIC [return on invested capital] profiles in European retail”, according to broker Berenberg. These stores are not just adding vanity sales, but are profitable from launch thanks to a capital-light approach.

The latest additions are already making a “higher store contribution margin than the company average”, according to management. And the pace isn’t set to drop, although a temporary eviction moratorium could push a few of the 45 new stores that were expected to open this financial year into FY23.

Virtual expansion

Like other discount retailers such as Primark, B&M has so far chosen to forego online sales and keep costs down. This is set to change after the bargain chain hired a digital head in March 2021, with plans for a limited launch of home deliveries for items that are difficult to transport by car in spring 2022.

At this small scale, an online launch should not add much in terms of cost, and would likely be incremental to earnings, helping to increase the discounter’s market share from a low base of around 1 per cent. Attracting customers should be simple given the brand’s large presence on Instagram, which at 1.4mn followers is higher than any of its competitors and double that of the closest rival Aldi. 

Bargaining power

Meanwhile, B&M is in better shape than most retailers when it comes to the rising costs of materials and freight. Operating costs as a proportion of sales have fallen 76 basis points over the past two years, thanks to contractually-fixed costs for the year and better sales density. 

The group also rents space in cheaper retail parks rather than in city centres, and sources most of its products directly from Chinese suppliers with whom it has long-standing relationships. The latter point, while leaving it exposed to global supply chains, helps it to preserve competitive discounts of around 15 per cent to standard prices, according to broker Liberum. Meanwhile, the sales mix of general merchandise and groceries generates higher profit margins than traditional or discount supermarkets.

“The beauty of our model is that our customers don’t expect us to stock anything,” said chief executive Simon Arora on an analyst call in November. “They’re very happy to have any bargain you like, we don’t have to have any particular bargain.”

In other words, B&M has the flexibility to only stock its most profitable items. The retailer constantly refreshes its stocks, with 100 new products added in an average week. 

This rapid churn also keeps customers coming back for the latest deals, buying more than they need “while stocks last”. What’s more, an unpredictable jumble-sale quality to its stores leads shoppers to invariably buy more than they had planned to.

One issue for the group is its heavy debt load, which could impact its growth plans in the event of a revenue hit. Including lease liabilities, net debt stood at £1.814bn in September, but refinancing of its current bank facilities and high-yield bonds last year pushed back maturity profiles to 2025. With interest expenses covered seven times by operating profits, there’s little need for concern, although after three special dividends since the start of the pandemic, distributions could scale back from here.

While it is unrealistic to expect sales and profits to keep growing at their pandemic-fuelled heights, we believe B&M is that rare retailer that is well positioned to weather an inflationary environment. The discounter’s attractive balance of value and growth is not reflected in its own discounted price of 14 times forward earnings – below the shares’ five-year average and in line with a less differentiated peer group.