The Reject Shop: Model update and downgrade to HOLD

About the author:

Alexander Mees
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).

Investment 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:

  1. Fix – cost reduction;
  2. Reset – product and place reset; and
  3. 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.

Risks

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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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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