5min read
PREVIOUS ARTICLE Investor Signposts: Week Begin... NEXT ARTICLE The best online brokers in Aus...

Few sectors are more hit or miss than retail. For every great retailer (think JB Hi-Fi), another destroys capital (think Myer Holdings). Identifying strong product concepts and management, rather than focusing mostly on top-down trends, is key.
Nick Scali is an example. The furniture retailer, a long-time column favourite, has a one-year total return (including dividends) of 74 per cent. A five-year annualised return of 49 per cent makes it one of this market’s great small-cap stocks. 
Chart 1: Nick ScaliSource: The Bull 
Nick Scali has traits of an exceptional company. The Return on Equity (ROE) has averaged above 40 per cent since FY10 – a remarkable performance for any company, let alone one in the cyclical retail industry. High-growth tech stocks would be proud of that ROE.
The company shows that great returns are still possible in retail. The key is avoiding retail segments in decline (think discretionary clothing) and those exposed to intense foreign competition (department stores). Amazon’s expected assault on Australian retailing is a new threat for retailers that sell small, higher-margin items (JB Hi-Fi, Harvey Norman).
Also, beware small retailers that are entirely Australian-based. The best mid- and small-cap retailers usually have a rapidly expanding international footprint. Premier Investments, another favourite, is an example with its booming Smiggles chain. 
Disposable jewellery retailer Lovisa Holdings is another preferred retailer. I first wrote about the company for The Bull in September 2015 at $3.37 a share and suggested it would look more interesting “closer to $3”.  The stock plunged to $1.92 in May 2016 after a shock earnings downgrade. The market over-reacted to the news.
Lovisa hit $4.12 earlier this year and eased to $3.80. The stock shot higher this month after a positive trading update and appears to have significant momentum. Some brokers have 12-month price targets above $5 as Lovisa rapidly expands overseas.
Chart 1: Lovisa HoldingsSource: The Bull
To recap, I rate Lovisa’s product concept of disposable fashion jewellery aimed at teenagers and young adults. Granted, women’s fashion jewellery is not my strength, but there is plenty of evidence of growth in disposable clothing, jewellery and other fashion items.
Social media is a huge driver of disposable fashion. Rather than make products on a seasonal basis, Lovisa responds to emerging fashion trends and what’s hot on social media. If a celebrity wears a certain type of jewellery, it’s a good bet the retailer has a cheap version soon after.
Lovisa’s products roughly range from below $10 to $50. Young girls who buy cheap jewellery, often worn only a few times, tend to make more store visits and repeat purchases.
This market looks less affected by foreign retail competition in Australia, which focuses mostly on mid-priced clothing. Discount department stores are probably the biggest threat, but they do not offer the same product range, in-store experience or speed to market as Lovisa.
The long-term trend of “tweens” (girls aged 8-14) spending more on fashion is compelling. That’s the case with my tween daughter who has suddenly discovered fashion. And who has a father who finds it hard to say no (at least compared to her mother)! 
Clearly, underlying trends are in Lovisa’s favour. That’s not to say it is a boom segment or immune to challenging retail conditions. But disposable jewellery looks a more appealing concept than cheap clothing, where profits margins are contracting.
My Lovisa hypothesis was reinforced last week when the company upgraded its FY17 guidance on underlying earnings to $38.5 million to $39.5 million. The market consensus was for $35.5 million. How many other retailers are upgrading full-year earnings (relative the consensus forecasts) by 10 per cent?
Lovisa said same-store sales growth in the March quarter was 6.7 per cent and 10.9 per cent year-to-date. Strong inventory management and limited sale and price markdowns have helped it maintain margins. Unlike many retailers, Lovisa has had moderate discounting.
The company announced the acquisition of another 17 fashion accessory stores in South Africa, completing its store rollout there. The acquisition is not material to Lovisa’s FY17 results, but it looks a good deal (the payback period is short) and expands the international reach.
Larger upside is in the United Kingdom. Lovisa says the conclusion of the South Africa rollout allows the company to focus on other international markets, such as the UK. There are seven Lovisa stores in the UK with 13 stores expected to be trading by August. 
Macquarie Wealth Management has factored around 45 UK stores into its forecast for Lovisa and says there is capacity “to roll out much more than this … As such, we see potential for medium- to long-term upside as confidence in the UK opportunity grows”.
Macquarie’s $5.06 price target for Lovisa over 12 months suggests upside from the current price. Six broking firms that cover the retailer mostly have buy recommendations and the average share-price target is $4.61.
Always beware consensus price targets based on a handful of forecasts. But Lovisa’s FY17 Price Earnings (PE) multiple of about 14 times is not excessive for a retailer that is beating market expectations and has a growing offshore footprint.
International store rollouts, when they work, can support rapid earnings growth. Smiggles, targeting hundreds of stores in the UK and Asia, is the best local example. 
The well-run Lovisa is only getting started offshore in developed markets, but its product concept appears to be gaining traction – and that is half the battle in retailing.

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week’s newsletter

• Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at May 10, 2017.