A bargain retailer available at a bargain share price

Step forward B&M European Value Retail (BME), the listed winner from Wilko’s demise, which this month confirmed that it would acquire 51 Wilko stores for up to £13mn. This prompted some bullish reviews from analysts. Liberum argued that the move could add at least 5 per cent to B&M’s annualised cash profits, while Shore Capital upgraded its rating to a buy and pushed up revenue forecasts for 2025 and 2026 by 3 per cent and 6 per cent, respectively. 

The operating model

The company, which doesn't trade online, has three divisions across the B&M and Heron Foods brands. B&M UK (around 80 per cent of revenue with more than 700 stores) and B&M France (around 10 per cent of revenue with more than 100 stores) sell a wide range of branded products, from electrical goods to pet accessories. Heron Foods (the other 10 per cent of revenue) has more than 300 stores and focuses on frozen, chilled and ambient foods. The City consensus is for cash profit growth in each of the three divisions in the coming years. 

Store numbers continue to grow, and given new and replacement stores are normally larger than existing sites, this is driving a higher sales contribution. The Wilko news also accelerates expansion plans. Management said earlier this year that it was aiming to revert to a strategy to opening 40 new stores a year and viewed a target of 950 B&M UK stores as “conservative”. This now looks like an understatement given the boost to the pipeline. 

But rolling out new stores is only one part of the growth plan. The company estimates that every 1 per cent increase in like-for-like (LFL) sales from the existing estate has the same impact as opening seven new stores. LFL sales at B&M UK came in at 9.2 per cent in the first quarter of this year, a positive sign for the growth trajectory. 

New stores and organic growth are backed up by a pricing strategy which continues to bear fruit at a time when discretionary spending remains squeezed. In the 13 weeks to 24 June, revenue rose by 14 per cent year on year to over £1.3bn, with both grocery and general merchandise delivering solid results.

According to the Office for National Statistics, UK retail sales volumes rose by 0.4 per cent in August, suggesting shoppers continue to pay more for fewer items. B&M's focus on keeping prices down – what chief executive Alex Russo called an “unchanged strategy to relentlessly focus on price” – means that its prices are over 15 per cent cheaper than its competitors', according to Liberum. This is proving an enticing proposition for consumers in the current economic climate. 

B&M can also flex its pricing model when needed. Analysts at RBC Capital Markets noted earlier this month that "in periods of inflation, B&M puts prices up when it needs to, but to a lesser degree than its competition”. The brokerage estimates that this is likely to mean a strong competitive position in the event of further deflation in the coming months.

Similarities can be seen between B&M's trading model and those of Aldi and Lidl, which have been taking grocery market share as shoppers trade down. B&M's management argues that its branded approach is "highly complementary" to the grocers' own label focus and pointed to strong trading at locations which have both B&M and German discounter stores. 

But B&M’s success hasn’t just come from shoppers’ response to the cost-of-living crisis, as its sales and profit growth since its 2014 listing attests. Now, the group has "normalised to a new, sustainable and higher level of underlying sales and margin" comparedwith pre-pandemic levels, says management. The adjusted cash profit margin of 11.5 per cent for 2023 was 2.5 percentage points up on 2020, while the gross margin of 32.7 per cent sits above a 2019 baseline, despite inflationary headwinds. 

Debt and dividends

B&M's approach to stock management acts as a key support to strong cash flow generation. A drive to keep stock turnaround at a low level and a disciplined approach to markdowns is reflected in the financials: in the year to March, inventories fell by £99mn, allowing the group to announce a special dividend payment. Annual inventory turnover has returned to over four times, further demonstrating tight stock control. 

The balance sheet is perhaps more of a concern. As of March, net debt stood at £2.01bn, equal to just under three times shareholder equity. Of this figure, around £1.3bn is made up of lease liabilities, with the bulk of long-term financing comprises a £400mn bond that matures in 2025 and a £250mn bond maturing in 2028. 

However, set against cash profits, leverage looks much more manageable. Borrowings have consistently been below 1.5 times over the past few years – well under the company’s ceiling of 2.25 times – while a refinancing of the company's facilities in March has left £450mn available under a term loan and revolving credit facility should management require it.

A decent balance of gearing and cash generation also supports B&M’s attractive capital return policy. The company targets a dividend payout ratio of 30 to 40 per cent of net income, which resulted in the return of 30 per cent of B&M’s market capitalisation in the three years to 2023, once special dividends were factored in. Given strong trading and cash generation – the company delivered £866mn of cash generated from operations in the latest year – the outlook for distributions looks sound. The potential for share buybacks cannot be ruled out, either.

A discounted rating

The shares are available at a rating of 15 times forward consensus earnings, in line with the five-year average. An enterprise value to cash profit ratio of 8, meanwhile, represents a discount to the wider retail sector, which seems undemanding given the growth opportunity and track record (a compound annual growth rate of 11 per cent over the past five years compares favourably with retail peers such as Next (NXT) and Pets at Home (PETS)). A vast market opportunity (the company has only a 2 per cent share in the UK and less than that in France) means there is considerable scope for B&M to keep on growing for the coming years.

When half-year results arrive on 9 November, investors can expect further strategic guidance from what remains a relatively new management team. Russo, who took over a year ago alongside new chief financial officer Mike Schmidt, capped a period of investor nerves following the retirement of founder and longstanding chief executive Simon Arora. The evidence so far, based on current trading and strategy, suggests that Russo and Schmidt have a firm grip on the business.