Plus Size Profits
Isn’t it great when what you’re looking for falls into your lap? Granted, it’s not quite the woman of your dreams turning up at your house and asking for directions, or a Euromillions lottery win making me a very rich man, but N Brown does tick all the boxes for my slowly shaping-up portfolio.
They are a retailer who I suspect most won’t know simply by name, as they have a huge catalogue of brands under the N Brown umbrella – Jacamo and Simply Be are the two that rung the most bells with me, but the list is truly extensive. It being a retailer is great, because I like retailers; especially since very few institutional investors seem to at the moment. The sector is riddled with the likes of Home Retail Group, HMV and Game, trading on tiny P/Es. The market isn’t buying a maintenance of their profits. I buy into N Brown, though, and I buy in fairly solidly – I had decided fairly quickly that it was a business that I liked the look of, and after finding no particular warts in their annual accounts, I was sold.
The business to start, then. I think a comparison to the sector is relevant here. Why are investors sceptical about retail? Firstly, the recovery is uncertain and consumers are being squeezed. Wages aren’t keeping track with inflation and credit growth remains considerably lower than pre-crisis. There’s not much N Brown can do about this wide, macro picture, so we’ll come on to that later. But sectorally, there’s other reasons for the decline in retail. High street rents fixed with the operating leases so discussed around the blogosphere lead to high fixed costs – and with the advent of the internet and its astronomical rise to the height of consumer focus, physical retailers are being hit. This, of course, all comes to a head during the recession. Consumers shop around more, businesses have less unit contribution to pay their fixed costs, and the sector gets hammered.
N Brown avoids this fairly neatly by operating in two more cost-effective channels- online and catalogue. Online makes up about 45% of their sales, and this percentage is growing fast. This mix means they keep more of the lovely gross margin – 54(!)% – for themselves, as operating margin sits at 14% last year. This seems very reasonable for a company operating in the midst of a recession. The chart top right shows their strong and steady revenue and profit increases. In fact, only one year in the last ten did they fail to improve revenues – and it wasn’t recent!
I think part of their resilience comes from their strategy. Their numerous brands are all specialised, niche operations. Jacamo, for which I recall the advertising campaign, made a big song and dance about having clothes in much larger sizes than most other retailers. Simply Be has a similar mission – bringing fashionable clothes in sizes that have a far broader audience that the usual 4-16 slimline fare. I love this strategy. Instead of having one big store, they split up their operations to make it easy for the consumers. Instead of digging through 100 different websites looking for clothes that may fit them, why not go to one place? It’s not just size related, either. They also segregate according to age (carefully, of course!) – splitting up their younger, midlife, and older brands. I think this gives them an enduring competitive advantage – customers so well targeted are likely to be more connected to business and more loyal. Repeat business is what retailers love, as it cuts down some of the cost competition.
They also plan to expand, and expand in a way I like – steadily and logically. They’re looking to tap into the US market, which is always difficult but potentially lucrative – and they’re trying to grab a slice of the health and beauty sector. This last one ties in to their focus on cross selling – when selling women a pair of shoes, why not get them to stick with a partner site for their lingerie and eveningwear? As you can probably tell, I think the ‘great business’ part is fairly wrapped up for me. Of course, that’s only half of the story – what about the ‘reasonable price’? Well, N Brown is currently priced at a market cap of around £760m. This puts them on a P/E of 11ish, which is fine by me. Given the current conditions in the market, I have no problem with paying this price for a mid-cap business with growth prospects.
Finally, I feel I should probably address my wider macro view on retail, and explain why I was actively searching for some exposure in my portfolio. The chart above left shows UK retail sales (clothing, footwear, textiles) over the last 10 years. Interesting to note, for me, is that the recession we’ve just exited was actually just a period of nominally flat retail sales. In real terms, of course, it declined – and this was significant with the high level of inflation. Still, over the 08-09 period N Brown grew strongly. I won’t make predictions about the future of retail sales, but even if it were to fall back down to the 0% line, which seems unlikely to me, it does not make sense to call for revenue to fall unless you see N Brown losing market share – and I certainly don’t. Indeed, in the last period of nominally flat sales, they saw decent growth.
Cost pressure wise, I expect the right chart above may explain some of the picture. The cotton price has increase 400% recently, though forecasts expect it to tail off in the near-term. Still, as far as I’m aware, the vast majority of manufacturing cost goes into labour, and I expect transportation plays a non-negligible role. In essence, on the cost side, I’m shooting in the dark a little. As ever, I place my trust in the invisible hand for normalising commodity prices. While China may be modernising fast and wage costs there rising, there’s still a pool of cheap labour in Asia which I think will remain at least in the near-mid term.
Still, I’ve explained my sectoral view, and it’s not completely firm in some points, so the most logical thing to do is to compare to other sector stocks. On PE terms, they’re only slightly more expensive than Next, who are saddled with considerably more debt and has seen sluggish growth recently. The same story applies with Debenhams, and in that case you’re also buying years of onerous lease commitments totalling over 5 times their market cap. Perhaps the fairest comparison is with ASOS, though that’s also imperfect. Asos is seen as a growth business, which explains their P/E. This ranges somewhere from 90ish to a stratospheric 180, depending on whether you take pre or post exceptionals.
If I was running a hedge fund I’d be long N Brown and short ASOS in a snap. One is pricing in a decline, the other is pricing in a phenomenal rise. But I’m not, and with this portfolio I’ll be keeping things simple, so I’ll just buy into N Brown for growth prospects, reasonable valuation even given no growth, and a sound business.