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B&M knows a good deal

The discount chain is proving defensive against a structurally changing retail market
November 8, 2018

News of a recent acquisition in France has reignited our interest in discounter B&M European Value Retail (BME). Meanwhile, progress at B&M's German business, Jawoll, provides reason to hope a stall in the group's earnings-upgrade cycle may prove to be only a short hiatus. The overseas progress combined with an aggressive, high return, new store roll-out programme in the UK, not to mention the group’s focus on some of the few bright spots in bricks-and-mortar retail, means we think now could prove a good time to buy.

IC TIP: Buy at 426p
Tip style
Growth
Risk rating
High
Timescale
Medium Term
Bull points

Babou acquisition
International expansion
Defensive position in retail market
Good internal cash flow

Bear points

Integration risk
Competitive market

In May, B&M faced some difficulties as comparative figures grew tougher to beat following a good run in 2017. And colder weather in the spring, combined with a foreign exchange headwind also put a dampener on sales during the final month of its last financial year. Meanwhile, the German business has been undergoing a period of overhaul and stock clearance in order to align it more closely with the wider group. The impact can be seen in the tempering of the earnings-upgrade cycle that powered the shares upwards until early 2018 (see graph).

 

 

There are now grounds to hope for a return to the good old days. A first-quarter statement issued in July revealed a “strong start to the new financial year”, reporting group revenue up 21 per cent. The German business also registered a solid sales improvement of 7 per cent, driven largely by strong demand in the gardening category and management changes, while profits are expected in Germany this year. 

The recently announced deal to buy Babou offers a further catalyst for the shares. The deal valued the French retailer at 3.7 times its cash profits (Ebitda) based on an implied enterprise value (EV) of €91.2m (£79.7m). The price paid should mean an immediate earnings boost for B&M, but the potentially bigger gains should come from revamping Badou's operations and using it, combined with the reinvigorated Jawoll, as a springboard for overseas growth. 

For now, the UK represents the lion share of the business, accounting for over nine-tenths of last year's sales. In a struggling domestic retail sector, B&M makes an interesting proposition. It has a focus on value and convenience, which are arguably the only areas offering growth potential on the UK's battered high streets. These areas also face little competition from the internet as online stores find it hard to replicate the offering and retail experience. B&M has also focused on strategic acquisitions to enhance its position, such as the Heron Foods deal, which enhanced what was already a thriving grocery channel by adding more frozen and chilled foods to the range.

In the UK, the group is aiming for 50 new openings this year, while the roll-out of a new warehouse management system and a new 1m sq ft Southern distribution centre should help the supply chain keep up with store expansion. Despite the rate of openings, returns remain impressive with broker Liberum estimating the return on invested capital (ROIC) over the last four years at 18.5 per cent – over twice the estimated cost of capital – thanks to "a combination of asset efficiency and robust margins". That said, once leases are factored in, last year's return on capital employed (ROCE) looks closer to 12.5 per cent.

One possible disappointment for shareholders is that following the Babou deal, the 10p special dividend some brokers previously forecast this year may well not be paid (we've stripped this out of the numbers in the accompanying table). However, we think the use of capital to fund the acquisition has the potential to produce far better returns for shareholders than a higher payout.

B&M EUROPEAN VALUE RETAIL (BME) 
ORD PRICE:426pMARKET VALUE:£4.3bn
TOUCH:425.7-426p12-MONTH HIGH:436pLOW: 360p
FORWARD DIVIDEND YIELD:2.3%FORWARD PE RATIO:18
NET ASSET VALUE:92p*NET DEBT:57%
Year to 31 MarTurnover (£bn)Pre-tax profit (£m)**Earnings per share (p)**Dividend per share (p)
20162.0416113.014.8
20172.4319014.95.8
20182.9822217.87.2
2019**3.3726321.48.7
2020**3.6929824.29.9
% change+10+13+13+14
Normal market size:3,000   
Beta:0.63   
*Includes intangible assets of £1.1bn, or 105p a share
**Liberum forecasts, adjusted PTP and EPS