The retail stock "delivering in spades" with 116% profit jump

When the economy is under the pinch and volatility is high, the consumer discretionary sector is usually one of the first things to go south. Add to that the shift we've seen from goods to services, and you'd be forgiven for dismissing a jewellery retailer like Lovisa as a stock not worth having. 

But think again.   

The company just reported profit of over $60 million (116% YoY increase), has strong sales, strong net cash position, and best of all - it services a part of the retail market that's less exposed to interest rates. 

And it's opening up new stores at a rate of knots, with 55 stores opened in the second half of FY22. That includes two new markets with stores opened in Hong Kong and Namibia.

If a stock could ever be called 'secular-discretionary', this might be it!

The stock currently sits just 2% down this calendar year, at $19.55. 

"Pleasingly Lovisa delivered in spades with a very strong result and outlook commentary," says Shaun Weick from Wilson Asset Management.  

In this wire, Weick puts the results in context, explains why he believes Lovisa is ideally buttressed against the sector's headwinds. And most importantly, why WAM are buyers of the stock. 

Lovisa (ASX: LOV) FY22 key results

• Revenue of $458.7 million (+59.3%) 
• Net profit of $59.9 million (+116.3%)
• EBITDA  of $143.4 million (+46.4%) 
• Comparable store sales +19.9% y/y
• Net cash of $24.2 million
• Final dividend 37.0 cents per share (30% franked) payable October 20

Note: This interview took place on Monday 29th August 2022. Wilson Asset Management currently hold Lovisa. 

What were the key takeaways from this result? What surprised you the most?

Overall this was a very strong result across the board for Lovisa, delivering EBIT growth of 87% YoY which was +13% ahead of analyst consensus expectations.

The key takeaways of the result included the acceleration in revenue and earnings growth in 2H22 underpinned by strong comparable sales growth of +21.5%. Within this, the European business materially outperformed market expectations with strong sales growth delivered despite concerns over the knock-on effects of the Russia/Ukraine crisis impacting demand. The North American business has continued its robust momentum, while Asia bounced back as covid headwinds continue to ease. 

The acceleration in store rollout was the other key takeaway as Lovisa continues to expand its global footprint. 55 gross stores opened in 2H22 (104 full year) and 6 new markets launched in June/July which underpins a strong outlook into FY23.

On this point, the company noted a strong start to the year, with total sales over the first 7 weeks +66% YoY and 22 new stores already opened. Price increases late in the period will also annualise into FY23 with no impacts on demand seen to date. The balance sheet is in a very strong position with $24m net cash and stock being managed well to support strong sales growth and roll-out.

What was the market’s reaction to this result? Was this an overreaction, an under reaction or appropriate?

The stock rallied over 50% off the one-year lows it hit in the June sell-off, materially outperforming retail peers suggesting the markets expectations were relatively high. 

Pleasingly Lovisa delivered in spades with a very strong result and outlook commentary. 

The US market lead (consumer discretionary stocks closed down 5% on Friday) has not helped but we expected the stock to be up around 10%.

Would you buy, hold or sell Lovisa on the back of these results?

We are buyers on the back of these results and expect the update to trigger consensus earnings upgrades. 

It is the extent of the store rollout opportunity that makes Lovisa one of the most attractive medium term investment opportunities within the ASX consumer sector from our perspective. Management are flagging that momentum will accelerate from here. We see opportunity for the footprint to expand at 15-20%+ per annum and for the overall store base to double over the medium term with North America and Europe key drivers, underpinning strong earnings growth. Management's incentives provide a good indication of the aggressive growth targeted for the business, with the FY23 EBIT hurdles implying >30% growth at the upper end.

What’s your outlook on Lovisa and its sector over FY23?

The market is pricing in a weaker consumer environment over the coming year and Lovisa is not completely immune to this. However consistent with prior cycles, as a fast fashion jewellery retailer we believe Lovisa’s core customer cohort will prove resilient given the underlying demographic (i.e. 18-35 year old females who are less exposed to rising interest rates), low average transaction values (~$30) which benefit from trading down in tougher times, and finally, a product set that benefits from the “re-opening” as consumers return to events and offices. The vertically integrated nature of Lovisa’s supply chain facilitates constant innovation of the offering and provides pricing opportunities which underpin strong margins.

Significant investment has been made ahead of the curve to put the operational infrastructure in place to support Lovisa’s global store rollout ambitions. 

While this has delayed operating leverage in the past few years, incremental margins should begin to expand from here as we saw in 2H22. Maturation of stores will also be a factor here. Acceleration in store openings will be a core driver for the business in FY23.

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

A deterioration in consumer sentiment is the key macro level risk facing the business, although the impact of rising interest rates is of less importance to the Lovisa costumer. Clearly the environment in Europe is not great at the moment but the 2H was strong and we are closely watching developments here. 

The question on that front is whether these risks have been priced appropriately by the market and factored into consensus expectations and investors will need to make their own evaluation of that.

In addition, there are company-specific execution risks. Recently appointed CEO Victor Herrero’s expertise lies in managing global businesses and store roll outs which gives us comfort in execution on this front. From a product perspective, demand for fast fashion jewellery is reliant on being “on trend”; Lovisa has a global buying team that has done this for many years and proven adept at reacting appropriately to market circumstances and a key benefit is product is non-seasonal in nature.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Rating: 3

The ASX 300 is currently trading on ~18x 12mth forward earnings which is in-line with the 5-year average. Overall this would put the market at around a 3 or fair value and from here company earnings expectations are likely to be the main driver of share prices.

As bottom up fundamental stockpickers, we focus on identifying undervalued growth companies where we can identify a catalyst to re-rate the share price; within this lens we continue to see good opportunities in the market. There a sectors that are trading at significant discounts to long term averages and reflect pessimistic sentiment, with pockets such as consumer/retail and building materials coming to mind. On the other side, “expensive defensives” where we think investors are “hiding” look somewhat vulnerable to us with reporting season again demonstrates the importance of expectations as these companies are often the most vulnerable to a misstep.

Company balance sheets are in excellent shape and I tend to lean towards optimism given markets go up over 70% of the time. 

The strong rally in July demonstrated the effects of positioning in the market and becoming too bearish so I think it is important to remain open minded.

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