No Such Thing As Too Much Bling

Australia | Mar 25 2021

This story features LOVISA HOLDINGS LIMITED. For more info SHARE ANALYSIS: LOV

With a better than expected first half and prospects of an even better second half, the only way from here is up for Lovisa Holdings

-Lovisa continues to benefit from a cash-laden bored consumer 
-The company's first half was better than expected driven by cost management
-Going ahead, the aggressive expansion policy may slowdown
-Lovisa may be your early global store rollout story

By Angelique Thakur

Barring a few bumps along the way, things may be looking up for Lovisa Holdings ((LOV)) if the company's first-half results and trends are anything to go by.

The worst might be behind the fast-fashion retailer, is the unanimous consensus opinion of brokers including Morgan Stanley, Citi and Canaccord Genuity.

Of course, that does not imply it will be smooth sailing, especially since the company is smack in the middle of some very hard negotiations with landlords in the US and Europe. 

A beneficiary of spare cash and boredom

Lovisa has emerged as a prominent if unexpected beneficiary of resurgent discretionary demand post the havoc covid wrecked last year.

The upbeat demand, miles ahead of the rest of the world according to Canaccord Genuity, is driven by a combination of spare cash and a willingness to spend on the part of bored domestic consumers itching to indulge in some retail therapy.

Both Macquarie and Citi consider the stock well placed to benefit from a reopening post-covid. That the recovery does not really depend on the border reopening but on normalising activity levels domestically contributes heavily to Macquarie’s investment thesis.

Filling the fast fashion void

Born in 2010 out of an idea to provide trendy fashion jewellery at “ready to wear” prices, Lovisa has grown to be one of Australia’s biggest fast-fashion accessories retailers. The company has made a name for itself in the “buy now, wear now and move on” category and targets fashion-conscious females aged 25-45.  

The ASX200 component fashion accessories retailer expanded into South Africa in 2011 and by 2012 had more than 100 stores across five countries. In 2013, Lovisa debuted in Dubai and continued to expand through the Middle East till 2015 when it forayed into the UK and then subsequently into the US and France. Today Lovisa has more than 400 stores across 15 countries.

While the brand has made significant progress into offshore territories, Australia remains the retailer’s largest market exposure.

The brand has a voracious appetite for growth, following an aggressive expansion strategy, adding yet another new feather to its well-accessorised cap late last year when it added 90 plus stores to its kitty from the beleaguered European distributor Beeline.

The entire deal is expected to complete between March-May this year. What’s remarkable about the deal is Lovisa ended up paying a mind-blowing sum of sixty euros for Beeline! In fact, Lovisa is effectively being paid to acquire the Beeline stores in Europe, highlight both Canaccord Genuity and Citi.

Of course, it’s not all peaches and cream since Lovisa will be taking over substantial lease liabilities. And this is what makes Citi skeptical of achievable sales per store.

Citi seems to think the underperformance of the Beeline stores probably has to do with factors like store locations which for obvious reasons are difficult to change for Lovisa.

Another potential thorn is international travel, which remains on life support while increasing the probability of facing integration risks, especially with key personnel unable to travel.

Added to this are doubts regarding jewellery demand in the Beeline regions and thus, Citi retains a healthy dose of scepticism and wants to see some action before turning more hopeful.

Macquarie is a tad more positive, pointing out the cash inflow of EUR11m on handover will go quite a long way in de-risking the transaction.

The first half result

While definitely better than expected, Lovisa missed the mark on revenue back in its February release, posting flat growth in A&NZ. Revenues in Asia, Africa and Europe remained covid-afflicted and shrank over last year. The US was the only exception where same store sales grew by 23.5%.

The company saw a strong performance from stores in the Southern hemisphere, somewhat offset by a subdued northern hemisphere with 42 stores in the UK and 23 in France remaining shut during the first half.

So, then what explains the better-than-expected result?

Three words: Better cost control.

Mostly led by the reduction in employee expenses which saw Lovisa standing down hundreds of jobs during the pandemic, a necessary if highly unpleasant step in the company’s bid to survive during one of the most unprecedented crises of our times.

Thanks to this, Lovisa was able to exit the first half with a strong cash balance of $42.5m despite the US being the only region to note a rise in same-store sales.

Overall, the company did better than Canaccord Genuity, Citi, Macquarie and Morgan Stanley had dared to hope. In fact, the company was able to achieve Morgan Stanley’s operating income forecast for the entire financial year in the first half.

But what really got Citi excited was Lovisa reinstating its dividends with an interim dividend of 20c which went a long way in reinstating confidence in the company’s prospects.

All in all, the first half result makes Canaccord Genuity more confident about an eventual recovery in Lovisa’s offshore markets.

Not that there are no pitfalls to having global exposure, as Lovisa has realised. Back in 2018, the company was hit by weak consumer sentiments in the UK owing to Brexit fears and more recently in mid-2020 when it was forced to exit Spain owing to covid.

The exit has Citi worried since this highlights the possibility that Lovisa’s model may not work in all markets as was thought previously by the broker.

And there are fears of things slowing down in the US amidst covid cases which may be a little inconvenient especially since US contributed more than 20% in same-store sales in the first half.  

A notable feature of the first half result was the huge bump in online sales, rising 335%. While partly the result of a small starting base, the growth nevertheless suggests people continued to engage with the brand on other channels during store closures, in Citi’s view.

Citi also suggests the rising online sales may just be the leverage Lovisa is looking for in its negotiating with the landlords.

What lies ahead:

Things are definitely looking a lot better for Lovisa into the second half, with sales up 12% in the first seven weeks.

Going by strong discretionary spending tends in Australia alone, Citi expects like for like sales to go up 40% in the second half.

And there could be a lot more in store especially if the fashion retailer manages to clinch better rent negotiation terms.

Even though the company has been following an aggressive offshore expansion policy, going from 0 to 435 stores across 15 countries, the pace may slow down going ahead, warn Jarden, Citi and Canaccord Genuity, hit by covid and an inability to be on the same page with the landlords.

Thus, undoubtedly, negotiations with landlords is expected to remain a notable feature of the second half in the US and the UK.

Citi believes Lovisa may also be limited by maturing markets like A&NZ and South Africa. Macquarie remains positive and dismisses the slowdown as just a temporary blip.

The company is experimenting with offering products between $100-$200 as against its previous cap of $50, something Canaccord Genuity finds interesting and is observing keenly.

Lovisa’s cash in hand provides a sort of safety net with Citi forecasting a cash conversion of 105% in the second half .

Bell Potter in particular believes the company should have no issue whatsoever in continuing to successfully navigate through the covid quagmire and has an optimistic view on long term prospects.

So, should you buy Lovisa?

In Canaccord Genuity’s view, the only way is up from here and this might be a good time to buy more of the stock. As a result, Canaccord Genuity has upgraded its rating to Buy.

Bell Potter retains its positive view and holds on to its Buy rating.

Citi is more reserved, noting the stock is already trading at a “demanding FY22 P/E” and retains its Neutral rating.

Jarden also prefers to play it safe for now what with the execution risk surrounding the integration and the relatively lagging online penetration. The broker prefers to stick to Underweight.

Morgan Stanley suggests the company offers investors an early global store rollout story. Impressed by Lovisa’s resilience and quality management, Morgan Stanley upgraded to an Overweight rating in February.

The FNArena broker database, which includes none of Canaccord, Bell Potter or Jarden, shows three Buy or equivaleent ratings and one Hold, with a consensus target of $15.44, suggesting 9.3% upside from yesterday's closing price. Targets range from Citi's (Hold) $13.30 to Morgans' (Add) $17.95.

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