Security price: $5.40
Industry: Retail
Forecast distribution: 32c per share fully franked
Discount retailer, The Reject Shop, has become ubiquitous around Australia. It operates in major cities, but its bright red and yellow shop fronts are also increasingly noticeable in many smaller towns and regional centres.
Like its wares, The Reject Shop’s shares are on discount, with the company suffering from poor retail conditions. But that is offering income investors the upside of a turnaround play with a solid yield.
The Reject Shop operates more than 300 discount variety stores. As mentioned, the retail environment has been tough particularly due to falling consumer confidence.
The company has also been rolling out an aggressive expansion strategy to exploit the closure of competitor, Retail Adventures. In 2014 alone 45 new stores were opened, taking the total over the past two years to 87.
Pursuing this expansion strategy in the midst of a poor trading environment saw a 25 per cent fall in The Reject Shop’s net profit last financial year.
The soft trading conditions continued into the first quarter of the new financial year, which along with higher spending on stores and discounting, led to a profit warning ahead of its first-half results, due this week. (assuming this is running Tuesday Feb, 17)
But the good news is that The Reject Shop has already reported that after that weak first quarter, sales and overall profitability stabilised and there were “signs of continuing improvement in the early weeks of January”.
New managing director, Ross Sudano, is expected to outline a plan of attack when announcing the first-half results.
The Reject Shop is currently in a transition phase. We expect key metrics will normalise over the next year or two and the company to achieve much sounder results.
The expanded store base should also contribute to significant sales growth and improved profit margins due to greater scale, better buying power and positive fixed cost leverage off its embedded infrastructure.
The Reject Shop has net cash of $11.8 million which underpins its financial strength. The company is forecast to pay a dividend of 32c per share fully franked this financial year (a slight drop from 2014’s 34c), giving a solid dividend yield of 5.9 per cent. That is forecast to increase to 42c in 2016, a strong yield of 7.7 per cent.
At $5.40, the Reject Shop is trading well below our current valuation of $8.08, and its future value (based on forecast results) of $8.46.
A quick turnaround for The Reject Shop’s fortunes is unlikely soon. Some investors may want to be patient and wait to see further evidence of a turnaround, particularly at its first-half results.
But The Reject Shop is a high quality company with strong historical performance. At current prices it offers the possibility of intrinsic value growth and dividend income, so the stock should at least be on income investors’ watch lists.