Security price: $1.34
FY1 value: $1.71
Industry: Retail
FY17 forecast distribution: 6.8 cents per share
RCG Group is a vertically integrated shoe retailer and one of the few compelling growth stories in a sector characterised by flat consumer spending, poor like-for-like sales growth, and a systemic lack of innovation. Many local players are struggling to combat the encroachment of online retailers, whose offerings are simultaneously less expensive and more expansive. A few years ago, RCG would have fallen into the same category. Its portfolio of brands, though solid, lacked any remarkable momentum and accordingly, RCG struggled to distinguish itself from the pack of small cap retailers.
Then in 2015, RCG announced the acquisition of NZ-based Accent Group, which gave the combined group a portfolio of attractive, growing shoe brands under a structure that could grow them efficiently. Earnings tripled, store count near-doubled and RCG quickly established itself as one of the most dynamic retailers in Australia.
Following this, most investors expected RCG to spend the next two to three years integrating and augmenting its new brands. Though it has done so, in July 2016 it unexpectedly announced the acquisition of Hype DC, a retailer of premium, exclusive and limited edition sneakers curated from global brands like Nike and Adidas. We view this acquisition as largely rounding out RCG’s product offering, with a range that stands to target most demographics within its categories. Though integrating the new businesses will be challenging, RCG’s management is one of the strongest in the industry, giving us confidence that they can mould the portfolio as it stands into a cohesive offering capable of leading in the domestic shoe market. To do this, it will need to execute its store roll out effectively, which we believe will see store count approach 500 over the next three years.
We are also attracted to the shoe market itself as it is more defensible than other apparel categories. It is not seasonal in the same way clothes are and it has proven resistant to online disruption. That being said, shoes, like any discretionary product, are subject to consumer-driven cyclicality. It is RCG’s job to understand trends in consumer demand and spending across multiple demographics, in order to weather or even exploit this cyclicality. We believe it will continue to do just that, as it expands its footprint in some of Australia’s fastest-growing shoe brands.
For those concerned about Amazon’s entry into the local market, the industry structure for athletic/leisure shoes is much less conducive to online disruption. First, the path to market is tighter and more concentrated, with RCG, Rebel Sports and FootLocker all having significant market share. Second, margins received by shoe giants such as Nike and Adidas are higher under the current structure than they would be through Amazon, disincentivising a change. That being said, longer term migration to online channels is inevitable, and RCG is focusing heavily on developing leading e-commerce channels for its own brands, in order to create what it hopes will become one of Australia’s leading multi-channel retail offerings.
Currently trading well below our forward valuation of $1.72 and offering a fully franked 5% yield, RCG may be an attractive opportunity for income-focused and value investors alike.
Originally published in The Australian, Tuesday 29th November 2016.