Top 7 UK retail stocks bucking the downtrend

Top UK retail stocks to buy and trade

Brokers are bullish on JD Sports but it is not the only stock bucking the downturn in the retail sector. Below is a selection of UK retail stocks that have been assigned a Buy rating by brokers as per the Reuters poll dated 10 June 2019:

1. JD Sports
2. Dixons Carphone
3. N Brown Group
4. WH Smith
5. AB Foods
6. ASOS
7. Boohoo

Reuters Broker Recommendations

JD Sports

JD Sports has been a stalwart of retail in recent years. As others grapple with falling sales and higher costs, downsize their bloated store networks, and battle for custom through aggressive discounting, the athleisure firm continues to deliver consistent growth without the need to slap sales tags on its products.

Revenue soared 49% in the recently-ended financial year to the start of February, contributing to a three-fold increase over the last five years. Its gross margin and profitability at the bottom line deteriorated last year but JD still managed to report a 15% rise in pre-tax profit, which has also more than trebled since the 2015 financial year.

The company, which focuses on selling premium clothing and boasts strong relationships with the likes of Nike and Adidas, generates 45% of its revenue from the UK – the most mature part of its portfolio – but it has plenty of growth potential overseas. JD has said it believes the existing store network in the UK and Ireland is the right size because it is still delivering growth in revenue and profit against a tough backdrop. Meanwhile, it continues to open new stores in Europe, Asia and the US, with the latter being boosted by its recent $400 million acquisition of Finish Line. Europe accounts for 29% of revenue while the US generates 21%, but the company has said its push into the US represents the biggest opportunity. Although, it has said the US market is complex because operating in different states is like operating in different countries, stating what works in the likes of California may not work in another state.

The fundamentals behind JD are strong, with the core UK and Ireland portfolio still generating growth and the company pursuing rapid growth abroad. Its dividend is also a testament to that. JD has consistently raised its pay-out but has 'restrained' growth in order to invest more in the business. While some shareholders may prefer JD to return more when times are good it does demonstrate JD’s prudence and shows it has more flexibility, which should mean the dividend is safe even if business deteriorates.

JD Sports – Key figures (£, Mn)

Still, JD has been cautious going forward. The company has said it is ‘not immune to the widely reported challenges to physical retail in the UK with lower footfall on many high streets, malls and retail parks combined with cost challenges from increasing minimum wage rates and rises in business rates’, and warned Brexit poses a threat. It also declined to report figures for the initial months of the new financial year when it released its annual results because the movement of the Easter holiday would have distorted the figures.

Read about the impact of Brexit on UK businesses and how to trade it

Key upcoming dates to keep an eye on include JD’s annual general meeting (AGM) on 3 July, and the publication of its interim results on 10 September.

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Dixons Carphone

Dixons Carphone managed to keep the ship steady over the Christmas trading period. Over the 10 weeks to 5 January 2019, sales of electrical items in the UK and Ireland rose 2% on a like-for-like (LfL) basis but mobile LfL sales plunged 7% following a string of store closures. Its international arm – accounting for 40% of total sales - fared much better, with Scandinavia and Greece the main drivers behind LfL growth of 5%. The overall result was flat revenue growth on a reported basis and a 1% lift in LfL sales.

While electrical sales growth has been driven by demand for gaming gear, smart devices and televisions, its mobile arm has been hit as people wait longer to upgrade their handsets and increasingly purchase either just a phone or a SIM, rather than both as a bundle. It has said it has renegotiated its contracts with mobile service providers that should make the business more sustainable and ID Mobile – selling under the tagline ‘Cheap Mobile Phones and SIM Cards’ – has continued to grow with over 975,000 customers on its books.

It has reiterated its target to deliver annual pre-tax profit of £300 million when it reports full year results on 20 June, which is likely to be a catalyst for its share price.

The Christmas update was more positive than its interim results to 27 October 2018, when the company swung to a pre-tax loss of £440 million from a £54 million profit the year before thanks to booking large impairments against its mobile business. That was accompanied by a cut to the interim dividend to help bolster its finances.

The Dixons Carphone share price has fallen over 13% since it released its Christmas trading update in January, but sits at roughly the same level as when it released its interim results in December.

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N Brown Group

N Brown Group – the digital fashion retailer that owns brands like Simply Be, Jacamo and JD Williams – delivered better-than-expected annual results for the year to 2 March. The company reported a £57.5 million pre-tax loss for the year (swinging from a £16.2 million profit) after booking £146 million of exceptional charges related to legacy issues, including its decision to close its stores and sell purely online. However, profit rose 2.5% when those charges were omitted to £83.6 million despite revenue dipping 0.8%.

Revenue was down 5.6%, but this was partly offset by its credit business, with financial services revenue up 11%. Its gross loan book stood at over £682 million at the end of the financial year.

The company has had to spend big to get the business fit for the future and shareholders have paid the price, with the dividend halved following a rebasing in October last year. Although the company has put its legacy issues behind it and is better positioned than it was a year ago, N Brown’s outlook is not overly optimistic. It has said its gross margin is to move between 0 and -100 basis points but hopes to cushion this somewhat with a 2.5%-4.5% reduction in operating costs. Capital expenditure and depreciation and amortisation costs will all remain broadly flat year-on-year (YoY).

N Brown and its shareholders have had to take a hit to refresh the business but the jump in its share price following the release of its annual results shows investors are willing to take a short-term hit in search of long-term gains, and brokers think there is more headroom for investors to take advantage of. The next date that could be a catalyst for N Brown shares is on 20 June, when it will release a first quarter trading update.

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WH Smith

WH Smith has been slowly transitioning its focus from high street stores to travel outlets that serve commuters and holidaymakers. High street sales have been in decline for years and WH Smith has been focused on cutting costs to offset the effect on the bottom line, while expanding its travel shops and improving its margins thanks to the willingness of customers to pay over the odds for a last-minute phone charger, book or newspaper. This has slowly seen the travel business become a driver of profit in the business: the division accounted for 48% of trading profit in the six months to the end of February, up from 45% the year before. That profit was up 7% in the period compared to the 4% dip in profit from its high street shops.

Overall adjusted pre-tax profit dipped 1% in the period while reported profit plunged 21%, but the company sweetened shareholders by lifting its interim dividend by 8% to 17.2p, stating this reflected its confidence in the outcome for the full year. In the subsequent 11 weeks (to 18 May), total sales jumped 15% YoY while LfLs increased by 1%, suggesting things have improved since the first half (H1). Travel sales rose 26%, mostly boosted by the addition of US digital accessory retailer InMotion, with LfLs up 3%. High street sales were down 1% on both a reported and LfL basis, showing the company has managed to continue stemming the decline that shareholders have become used to.

Read about WH Smith acquiring InMotion for £155 million

WH Smith’s chief executive officer (CEO), Stephen Clarke, announced he will be stepping down in October 2019 following six years in charge. While external candidates are being considered it is thought the company would prefer an internal appointment. Shareholders will be keen to find out Clarke’s successor as he has been praised for the company’s resilient performance over recent years.

In May’s update shareholders seemed to focus on Clarke’s departure rather than the improvement in sales growth as shares fell. The company is due to release a pre-close trading update in August before its financial year closes at the end of that month.

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AB Foods

AB Foods (Primark) is a multi-faceted business. It grows and supplies a variety of products, including sugar and animal feed, and also has a division supplying goods such as Twining’s Tea and Ryvita to the grocery sector. However, over 63% of its adjusted operating profit comes from low-cost fashion brand Primark, which has managed to show that a bricks-and-mortar strategy can still deliver results in the digital age.

Although its sugar and agriculture businesses struggled in the six months to 2 March, Primark continued to perform well by delivering a 4% lift in revenue, with growth across all geographical regions. There was further encouragement that it delivered a 25% jump in adjusted operating profit thanks to a much higher margin, but two thirds of that was down to a weaker US dollar.

Although most retailers find themselves burdened with oversized store networks and with a lack of digital expertise Primark continues to defy the market. It still doesn’t offer an online service (although there are reports it has started to move on implementing an initial trial of a click-and-collect service soon) and continues to open new (and often large) stores, particularly in newer territories across Europe and the US.

While Primark has deservedly earnt applause, investors must remember that investing in AB Foods means investing in the entire business, including the less profitable parts. AB Foods saw overall adjusted pre-tax profit remain flat in H1 while reported pre-tax profit fell to £515 million from £603 million the year before despite the growth reported from Primark. The dividend was raised 3% to 12.05p.

AB Foods will report its annual results for the 2019 financial year on 11 November. It has maintained its guidance for overall adjusted earnings per share (EPS) to be in line with the 134.9p reported in the previous financial year.

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ASOS

ASOS was one of the original online firms to disrupt the fashion retail market, able to undercut rivals with lower costs. However, it has seen growth slow, margins come under pressure, and it has continued to invest heavily, all of which has started to weigh on the business. Overall revenue rose 14% in the six months to the end of February, but its gross margin tightened, and pre-tax profit plunged 87% to just £4 million from nearly £30 million the year before.

Revenue growth is still strong in both the UK and abroad, but margins have suffered because sales of its own label, higher-margin fashionwear has lagged that of lower-margin, third-party clothing. Meanwhile, increased capital spending saw it swing to a net debt position of £38 million from a net cash position the year before and it has said net debt will peak at around £50 million by the end of the current financial year before it returns to positive free cashflow in the 2020 financial year.

ASOS admitted its H1 performance was ‘disappointing’ and said the company was ‘capable of achieving more.’ The focus is on maintaining profitability going forward. It is still heavily investing in logistics and technology at a time when margins are tightening, and sales growth is slowing and, with no dividend paid yet, that could make ASOS less-attractive to investors. ASOS said its heavy investments did compromise its customer service but has insisted it was ‘temporary’, giving investors hope that things should improve relatively quickly.

Although ASOS has some challenges the 28% drop in its share price over the last six months has provided an opportunity, with brokers seeing upside potential on the stock. ASOS will release a trading statement on 23 July, with annual results due to be released on 16 October.

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Boohoo

Boohoo.com, often compared to its older rival ASOS, delivered a stunning performance over the year to the end of February. The online fashion retailer reported a 48% jump in revenue, a better gross margin and a 38% increase in pre-tax profit. Boohoo outperformed its rival ASOS in several areas.

The company sells its own label products and also has a string of low-cost ranges, including PrettyLittleThing and Nasty Gal (both of which have seen stellar growth thanks to the company’s social media strategy). Boohoo is also investing heavily in the business but is in a much better position to do so as it has net cash of £190 million - and that is building.

However, its guidance is to deliver annual sales growth of 25%, suggesting it expects growth to slow considerably in the near future. It is targeting adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) margin of ‘around 10%’ over the medium term (versus 9.9% in the last financial year), but many question the company’s ability to maintain margins as competition increases. Signs of slower growth have already started to appear, with new customers growing 9% over last year versus 22% the year before.

Boohoo shares have gained more than 25% over the last six months and the stock has risen over 5% since releasing its annual results, but brokers are still bullish on the stock’s prospects.

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