Finding retailers that are less affected by Amazon and the boom in online retailing is becoming a prerequisite for investing in the sector. Many small and micro-cap retailers are not sufficiently capitalised to invest in competitive online sales platforms.
Do not underestimate the threat of Amazon to Australian retailing. Several commentators have argued that the company’s effect in this market has been vastly overstated. And that its launch in Australia last year, after so much hype, was underwhelming.
That view is true to some extent. The Amazon-inspired carnage on retail stock valuations got out of hand when retailers less exposed to the online sales threat were caught in the crossfire. Amazon wasn’t quite the retail Armageddon some had predicted – at least for now.
Don’t be fooled by Amazon’s relatively modest launch. A soft launch was always likely as the company worked out its product categories and systems in this market. The e-commerce giant has time on its side: it could lose money in this market for 10 years to gain share, and barely raise a sweat, such is the size of its balance sheet.
It’s a matter of time until more retailers feel pain – possibly company-killing pain – from growth in online sales.
Having a reasonable defence against growth in online retailing has never been more important. That’s not to say smaller retailers cannot benefit from their own online sales. But investors need to know the company will not be blown apart as consumers shop more online.
This is one reason I have favoured retailers such as Nick Scali, Bapcor and Greencross. I cannot see people buying luxury furniture online in large numbers. It’s a product you need to see, feel, smell, touch and buy instore, given the price tag.
The same is true of car-parts provider Bapcor. Most of its business relies on servicing car mechanics through the Bapcor delivery network. Some of its retail business might be affected, but I can’t see car owners rushing to buy parts online to save a few dollars.
Greencross is another example. Pet owners, me included, like taking their animals to Petbarn for different products and services. It’s a bit like going to Bunnings on Saturday morning for some people. Sure, some pet products might be bought online to save money, but I don’t see this as a category ripe for online sales disruption – at least the kind that crushes company valuations.
Fast-fashion jewellery provider Lovisa Holdings also has good online defences. I noticed a queue of teenage girls outside its store at a large Melbourne shopping centre recently. Presumably, this is a market that wants its cheap, disposable jewellery now – particularly if it matches something worn by a celebrity and is promoted on social media.
I cannot imagine too many young consumers are prepared to wait days for a cheap piece of jewellery to save a few dollars, or sacrifice the experience of buying it in-store. Visiting a Lovisa store with a group of friends to check up on latest jewellery seems part of the experience.
In the US, online sales of fast-fashion jewellery are estimated to be less than 5 per cent of that market.
Long-term readers of The Bull know I have favoured Lovisa for several years. I identified the company for this publication in September 2015 when it traded around $3.40, only to watch it hit $2 in early 2016 after a nasty earnings downgrade.
Thankfully, the faith was rewarded and Lovisa soared to $7.90 earlier this year and now trades at $7.57. A strong trading update this month sparked the rally.
Lovisa said Earnings Before Interest and Tax (EBIT) in the first half of FY18 would be $34.5-$35 million – about 10 per cent above some broker estimates. As many retailers continue to downgrade earnings, Lovisa has emerged as a rare retail gem going the other way.
My thesis for Lovisa remains intact. First, it has an attractive product concept as growth in “disposable” jewellery and fashion items increases. Right or wrong, we’ll see younger consumers buying goods and using them only a few times before disposal.
Second, Lovisa has excellent overseas growth prospects and capacity for a faster store rollout. The ability to grow overseas is another prerequisite for investing in retail (and a reason why I like Premier Investments, owner of the Smiggle stationery chain that is expanding overseas). Small retailers solely exposed to a patchy Australian economy are hard work.
Third, as mentioned earlier, Lovisa is less affected by growth in online sales than other retailers. It’s not immune from that threat, but arguably deserves a valuation premium compared to its peer retailers facing the online-sales blowtorch from Amazon and others.
Valuation is a key issue with Lovisa. After soaring from a 52-week low of $3.24 to $7.57, investors could be tempted to take profits. Some profit taking for early investors might be justified, but I see Lovisa’s rally continuing, albeit at a slower pace, in the next few years.
Macquarie Group’s revised 12-month share-price target of $8.60 looks fair. The potential for further earnings upgrades from Lovisa as more stores are opened should support a higher valuation.
Still, the big gains have probably been made for now and it would not surprise to see the well-run company give back some of its recent share-price gains as profit takers move in.
That could be an opportunity for patient value investors to buy at lower prices and gain exposure to one of the few small Australian retailers with an expanding global footprint and less exposure to the online threat.
Chart 1: Lovisa Holdings Source: The Bull
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article you should consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/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 January 10, 2018.