The Reject Shop: Model update and downgrade to HOLD
About the author:
- Author name:
- By Alexander Mees
- Job title:
- Co-Head of Research and Senior Analyst
- Date posted:
- 10 January 2022, 12:00 PM
- Sectors Covered:
- Gaming and Retail
- We have remodelled The Reject Shop (ASX:TRS) on the basis of the AASB 16 lease accounting standard. There are no material changes to our estimates on a pre-AASB 16 basis.
- Changes to peer company multiples since we last published on TRS increase our target price from (login to view), but the share price has now passed both our previous and updated targets. We think it’s time to take profits and downgrade from ADD to HOLD accordingly.
Forecast and valuation update
On a pre-AASB 16 basis, we have made no major changes to our estimates. Our revised FY22 pre-AASB 16 EBITDA estimate is $26.7m, 1.8% lower than our previous estimate of $27.3m.
The introduction of AASB 16 lease accounting has a substantial impact on the calculation and presentation of EBITDA. Our FY22 EBITDA forecast post-AASB 16 is $125.4m, 2.4% lower than the equivalent reported figure for FY21 of $128.5m. There is a correspondingly large increase in our depreciation estimates under AASB 16. Our updated model assumes D&A of $106.3m in FY22, $13.2m on a pre-AASB 16 basis, excluding depreciation of right-of-use assets.
Although there are no material changes to our underlying earnings estimates, an increase in the average FY2 EV/EBIT multiple of the stocks in our peer group (BME-GB, DG-US, DLTR-US, JBH-AU, SUL-AU, TGT-US) takes our 12-month target price up from (login to view).
TRS is a well-established retailer with a large footprint and over 40 years’ history in the sector. Despite this, elements of the investment case are resonant of a turnaround story. TRS itself has mapped out a three-phase strategic plan:
- Fix – cost reduction;
- Reset – product and place reset; and
- Grow – customer growth.
The first phase was well progressed at the start of FY22 (and has continued into this year) and the primary focus of the current financial year is the second phase, which places the customer experience at the centre of the plan.
We see the attraction from an investment perspective. TRS shareholders can expect to see better returns and a resumption of dividends once the strategic plan has been completed. And yet, we see near-term challenges that are perhaps more acute than when the strategic plan was first penned.
Supply chain issues leading to cost inflation will combine with TRS’s commitment to lowest prices to affect margins, while reduced shopping centre footfall as a result of Omicron will have a particular impact on retailers like TRS without a substantial online business.
The share price has rallied by more than 40% since it dipped below $5 in August. With the FY23F P/E now sitting around 20x, we think it’s time to take profits. Downgrade to HOLD.
Sustained downturn in shopping centre footfall.
Impact on margins of inflation on low price structure retail model.
Failure to achieve margin and growth improvements from strategic plan.
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