Small Caps | Sep 03 2015
-Well placed for AUD impact
-Small footprint advantage
-Buy case based on offshore
By Eva Brocklehurst
Jewellery chain Lovisa Holdings ((LOV)) is undertaking due diligence on the northern hemisphere, in the hope of establishing an initial presence in the next 12 months. The company’s store roll-out, margin expansion and like-for-like sales were all robust over FY15 and brokers expect new markets will present further opportunities.
Lovisa may be experiencing a 17.8% increase in average buying currency in FY16 but, with a gross margin above 75% and average price of $9 per unit, Morgan Stanley suspects the company is better placed compared with other retailers when it comes to passing on the currency impact to consumers.
Still, the broker assumes the gross margin percentage will decrease by 100 basis points in FY16, to be offset by lower costs, as store growth is in low-cost countries and 20 underperforming Australian stores were closed over the year.
Morgan Stanley believes the brand is well positioned for international expansion with a small store footprint and low level of seasonality versus other specialty retail categories. The business model is highly scalable and suited to international expansion. Entering either the US or UK should provide significant expansion potential.
At present Lovisa operates profitably across six countries, while 11 of the top 20 stores globally by contribution are now offshore. Morgan Stanley expects a further decline in operating costs as a percentage of sales in FY16 as 20 stores begin contributing in South Africa, where rents and wages are substantially below Australia.
Further benefits should come from the Middle Eastern stores, where the group operates as a franchise and only the royalty revenue equal to 10% of sales is reflected in the accounts.
FY15 revenue beat prospectus but was slightly below Canaccord Genuity’s estimates, because of the lower promotional activity over Easter. The broker expects 20% revenue growth in FY16 and a gross profit margin of 75.6% but awaits more detail on the northern hemisphere plans before adjusting its outlook to incorporate either a US or UK market opportunity.
The company also expects to add an additional franchise partner in FY16, likely to be in Asia. Canaccord Genuity, not one of the eight monitored daily on FNArena’s database, retains a $3.55 target and Hold rating.
Morgans, too, bases its investment case on offshore expansion. FY16 looks to be the year of achievement and the broker envisages potential for substantial earnings and valuation upside. The broker observes like-for-like sales growth slowed substantially in the second half to just 4.2%, versus a first half result of 12.2%. This was attributed to soft April sales.
The company decided not to run its typical Easter promotion because its inventory position was clean. Management is also inclined to hold back on the April sale again in FY16.
This promotional discipline impressed Macquarie. This is why the company was able to meet prospectus margin forecasts despite a lower-than-forecast Australian dollar. Macquarie observes retailers regularly need to decide on the trade-off between like-for-like sales growth and gross margin, either discounting and selling more or holding firm on price and selling less at a higher margin. Macquarie will firm up its view as more detail on the expansion opportunity comes to light.
The South African acquisition contributed a $156,000 loss in FY16 and management continues to expect incremental earnings of $1.75m in FY16. Shares held by BB Capital and Shane Fallscheer were in escrow at the IPO last December, to be released immediately following the FY15 results. Of note, this escrowed stock is a significant share of total capital, being 48.7%.
FNArena’s database contains three Buy ratings. The consensus target is $3.85, suggesting 11.9% upside to the last share price. Targets range from $3.79 to $3.91.
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