AX1 - Accent Group

[NotWarrenBuffet]

WAM's Chris Stott on RCG's share price plunge this past week:

"On Thursday, footwear retailer RCG Corporation (ASX: RCG) reported its full year results, with underlying FY16 earnings before interest, tax, depreciation and amortisation (EBITDA) of $60.4 million, in line with the company’s July market update. Shares in RCG fell following the announcement and closed down 9.7% for the week on the back of slower than expected start to FY17 trading."

 

[galumay]

WAM's Chris Stott on RCG's share price plunge this past week:

...

I reckon the price makes it very attractive for someone wanting to enter or build an existing positition. Thanks again to the irrational Mr Market!

 

[rnr]

Having lost some 48% of its share price since the high in July 2016, is a reversal now imminent for RCG Corp?

 

[Knobby22]

View attachment 70658

Having lost some 48% of its share price since the high in July 2016, is a reversal now imminent for RCG Corp?

Maybe.
But if it gets through $1 then 80c is where it will go to. Too risky for me.

 

[Wyatt]

Bottom pickers/mean reverters must be in a frenzy over this one. Friday, biggest volume day since 2010, so a major change of ownership, 6% Divie F/F. SOL in. Near major support?
Recent 6% downgrade in FY17 outlook has hurt confidence, otherwise rapidly increasing profits, anyone buying?
No position held

 

[Knobby22]

Don't forget headwinds.
Amazon entering market this year. This is probably a cause of the sentiment.

 

[Knobby22]

Taken off. Will it last?.

 

[Wyatt]

Good point Knobby22, Amazon is the future of online shopping, but do people buy shoes online? Sure I have looked at buying shoes online myself, but I wanted to replace what I already had, so no worry about comfort etc, but what % of shoppers are replacing an item and what % are adding to their collection?

I wonder who bought /sold recently

 

[galumay]

I agree that the sentiment around retailers and Amazon is part of the story. I think its unwarranted, especially for things like shoes.

I also think the price ran well ahead of value so the re-rate was stronger than it might otherwise have been.

 

[So_Cynical]

Bottom pickers/mean reverters must be in a frenzy over this one.

No, no frenzy here - retail sucks

I mean the disruption just get bigger, retail shops are in a death spiral, clothing, cheap crap (TRS), electronics, everything, its a race to destruction.

Good point Knobby22, Amazon is the future of online shopping, but do people buy shoes online?

Yes they do, it costs nothing to send them back, total refund no questions asked.

 

[galumay]

I mean the disruption just get bigger, retail shops are in a death spiral, clothing, cheap crap (TRS), electronics, everything, its a race to destruction.

Honestly, I think thats a bit melodramatic. Sure there is some adjustment in process, but there is no sign of bricks and mortar shopping disappearing or its "destruction". No retail sales figures support that sort of change, nor does the anectdotal evidence of visiting packed shopping centers!

While the growth or online shopping will have some overlap with declines in retail shops there is also organic growth for online. It seems most plausible to me that both forms of retail have their place and will happily continue to co-exist.

Yes they do, it costs nothing to send them back, total refund no questions asked.

Some people will, but shoes are actually a good example of something most people are unwilling to buy online - and the need to put the shoes on to feel how they fit is the biggest reason. Even if free returns and total refund were offered that wouldnt sway most people to purchase shoes online.

It seems to me there is an increasing liklihood that the supposed 'disrupters' dont really have nearly as much long term impact as the popularist press would have us believe. They tend to end up just being another way of doing things. There is an awful lot of capital that has flowed into incredibly unprofitable 'disrupters' on the back of this fad!

 

[skc]

Honestly, I think thats a bit melodramatic. Sure there is some adjustment in process, but there is no sign of bricks and mortar shopping disappearing or its "destruction". No retail sales figures support that sort of change, nor does the anectdotal evidence of visiting packed shopping centers!

While the growth or online shopping will have some overlap with declines in retail shops there is also organic growth for online. It seems most plausible to me that both forms of retail have their place and will happily continue to co-exist.

I think traditional retail will continue to evolve. Shopping malls will stay packed, but the thriving retailers will be those who offer experiences, unique products and impulse satisfaction. There may also be more hybrid "bricks and mortar showroom" + online backend type businesses...

Some people will, but shoes are actually a good example of something most people are unwilling to buy online - and the need to put the shoes on to feel how they fit is the biggest reason. Even if free returns and total refund were offered that wouldnt sway most people to purchase shoes online.

My wife's expense on shoes will easily be 10x that of mine... and she buys shoes online. The real answer to "How many people will buy shoes online today and in the future?" is probably difficult to extrapolate from personal experience/anecdote. But if you have seen a research/survey/hard figures or something... feel free to share them.

The problem with shoe shops is that it has an expensive service model. A potential customer walks into the shop, try on 4 different pairs, then try 3 sizes on the preferred pair, then decided to have a think over lunch, when she browsed online and found the same shoe 15% cheaper. Meanwhile, the shop has incurred 1/2 hour cost of a shop assistant and 2 missed sales. It's a tough gig!

It seems to me there is an increasing liklihood that the supposed 'disrupters' dont really have nearly as much long term impact as the popularist press would have us believe. They tend to end up just being another way of doing things. There is an awful lot of capital that has flowed into incredibly unprofitable 'disrupters' on the back of this fad!

I remember calling the death of department stores 10 years ago, but in truth the US stores are starting to die out only now.

Having said all that... I don't know RCG's weakness is really attributed to the threat of Amazon. It has reported weaker sales growth and other retailers have generally been somewhere between weak (JBH, SUL, HVN) to smashed (TRS, ADH, ORL). Perhaps the threat of rising mortgage rates on discretionary spending is a much more imminent headwind.

 

[Ves]

Having said all that... I don't know RCG's weakness is really attributed to the threat of Amazon. It has reported weaker sales growth and other retailers have generally been somewhere between weak (JBH, SUL, HVN) to smashed (TRS, ADH, ORL). Perhaps the threat of rising mortgage rates on discretionary spending is a much more imminent headwind.

I think this is more close to the current narrative.

Retail is a pretty tough gig when discretionary spending grinds to a halt. I think private debt to GDP is growing but surely it cannot rise at the current rate forever. How much does that affect private spending when it does?

The off-balance sheet liabilities like lease commitments are something I'd really keep an eye on and arguably this is where online retailers really get a free-kick - the only space they need to pay for is their headquarters and their distribution centres. For a retailer with physical shop space you have to make lease repayments regardless of how many people are coming into your stores. If there is a bad recession and stores in marginal areas need to close how much is the ongoing lease liability in the worst case scenario?

Net debt is also $50m (not sure how seasonal the cash is so it could be a bit more). I'm not sure how recession proof that is either, but I assume discretionary retailers would ideally operate with little to no debt when times get tough to provide funding flexibility.

It's pretty hard to get a feel for what happens in bad times in Australia because most of these businesses, outside of the GFC blip, really haven't faced massive amounts of economic duress.

 

[skc]

The off-balance sheet liabilities like lease commitments are something I'd really keep an eye on and arguably this is where online retailers really get a free-kick - the only space they need to pay for is their headquarters and their distribution centres. For a retailer with physical shop space you have to make lease repayments regardless of how many people are coming into your stores. If there is a bad recession and stores in marginal areas need to close how much is the ongoing lease liability in the worst case scenario?

Stupid question... do retail lease work like residential lease when it comes to breaking the lease? If another business wants to use the space vacated and make the lease payments, does that mean the previous lease holder is off the hook?

Net debt is also $50m (not sure how seasonal the cash is so it could be a bit more). I'm not sure how recession proof that is either, but I assume discretionary retailers would ideally operate with little to no debt when times get tough to provide funding flexibility.

By no means drawing a comparison... but from memory DickSmith had no net debt 12 months before it's collapse.

 

[Ves]

Stupid question... do retail lease work like residential lease when it comes to breaking the lease? If another business wants to use the space vacated and make the lease payments, does that mean the previous lease holder is off the hook?

I believe you can in most cases but it depends on the lease and the circumstances. Obviously you also need to find a new tenant and if your own business is struggling is the chance of this very high?

Here is a pretty basic guide outlining some of the issues.

https://www.bartier.com.au/insights/subleases-what-you-should-know-as-a-head-tenant/

It sounds like this could get pretty complicated from a legal side. I don't think by inserting a sub-tenant you necessarily walk away from your responsibilities.

By no means drawing a comparison... but from memory DickSmith had no net debt 12 months before it's collapse.

Indeed, that is why discretionary retailers generally have conservative balance sheets because their working capital and cash cycles can become onerous very quickly if they are struggling. Retailers technically can be profitable (in an accounting sense) and still fail.

 

[galumay]

Stupid question... do retail lease work like residential lease when it comes to breaking the lease? If another business wants to use the space vacated and make the lease payments, does that mean the previous lease holder is off the hook?

In my experience of commercial leases, if you break the lease you will have to pay out the balance of the lease for the contracted period - something that rarely happens in residential leases. Generally sub-letting is not allowed.

 

[So_Cynical]

Honestly, I think thats a bit melodramatic. Sure there is some adjustment in process, but there is no sign of bricks and mortar shopping disappearing or its "destruction".

Yeah sure a little dramatic, but where is the compelling investment case for retail? whats the driver to make people turn away from online and back to the shops? - there isn't one. The shopping centers are full, but spend some time looking at who is buying and what they are buying, the majority of specialist retailers are struggling.

There are other stocks and sectors that are not undergoing massive disruption, less risk.

 

[galumay]

Yeah sure a little dramatic, but where is the compelling investment case for retail?

Same as always, well run businesses, with good management and continuing growth. Maybe you have to look a little harder with consumer sentiment currently, but I dont think there is nearly as much 'disruption' as some would have us believe.

Other sectors have different hazards, its the nature of the game!

Personally I dont worry too much about that sort of macro economic, crystal ball gazing. Its not so long ago the same 'experts' were writing off the mining and mining services sector, no one was predicting the turn around we have seen in the last 6 months or so.

None the less, your strong viewpoint on retail has made me revisit my analysis for the retailers that I hold and consider how well positioned they are to face the challenges of low growth and growing online competition. That is one of the advantages of the variety of opinions on ASF, it helps inform ones decision making process and encourages challenging my biases!

In the case of RCG I do feel that shoes are much less at risk of loss of market share to online retail and are also less discretionary than a lot of other retail products. Financially it has been a good business for my SMSF, delivering nearly 100% increase in SP and gross dividends of nearly 25% in the 2 years I have held - it would need to be a compelling case to make me think my money would be better somewhere else!

 

[Klogg]

Same as always, well run businesses, with good management and continuing growth. Maybe you have to look a little harder with consumer sentiment currently, but I dont think there is nearly as much 'disruption' as some would have us believe.

Other sectors have different hazards, its the nature of the game!

Personally I dont worry too much about that sort of macro economic, crystal ball gazing. Its not so long ago the same 'experts' were writing off the mining and mining services sector, no one was predicting the turn around we have seen in the last 6 months or so.

None the less, your strong viewpoint on retail has made me revisit my analysis for the retailers that I hold and consider how well positioned they are to face the challenges of low growth and growing online competition. That is one of the advantages of the variety of opinions on ASF, it helps inform ones decision making process and encourages challenging my biases!

In the case of RCG I do feel that shoes are much less at risk of loss of market share to online retail and are also less discretionary than a lot of other retail products. Financially it has been a good business for my SMSF, delivering nearly 100% increase in SP and gross dividends of nearly 25% in the 2 years I have held - it would need to be a compelling case to make me think my money would be better somewhere else!

I bought this in '09, sold just after the Accent Group acquisition. Management are definitely talented, but don't forget this is not the company it used to be.
Their Wholesaling division had a currency tailwind (stronger AUD, helping with imports), and they had net cash. Further, the TAF business is largely a franchise model, so they just take a percentage of revenue, with minimal downside risk (e.g. no capital at risk).

Now, they have a significant debt load for a retailer, and any benefits from currency are reversing (not that I'm forecasting AUDUSD rates, only stating what has happened to date).


Having looked into it, I don't think one should expect higher sales from store maturity as you would in say a furniture retailer (Nick Scali as an example), especially from something like HypeDC. Simply witness the opening of a HypeDC store, which usually coincides with the release of some form of limited edition shoes, and you can see the 100 person queue to buy some ridiculously overpriced Nike invention (or similar)

As for Accent Group, it's is still doing very, very nicely, and would be the basis for any purchase I make in this company. 20% LFL (targeted 7% for the year) plus increasing GP margins make it attractive.


"Financially it has been a good business for my SMSF, delivering nearly 100% increase in SP and gross dividends of nearly 25% in the 2 years I have held"
If the business valuation hasn't moved in line with the SP increase (100% in 2 years is a big ask), then this is an argument against holding, all else being equal.

 

[galumay]

If the business valuation hasn't moved in line with the SP increase (100% in 2 years is a big ask), then this is an argument against holding, all else being equal.

Thanks for the indepth analysis Klogg, great reading as always. My range of valuation for RCG last year was around $1:30-40 so I was comfortable continuing to hold in the light of your comment I have quoted. I did give it some more thought when they ran all the way to $1:80 or so, in hindsight that was a good exit point on the basis of being over valued by the market.

In the end I decided to hold because although it was considerably higher than my range of valuation, I am always reluctant to sell down my holdings unless I am very confident there is a compelling argument for a new home for the capital. I am still finding that decisions about timing of selling are much more difficult than decisions about timing of buying!