Kogan VS The Reject Shop: Small Cap Retail Rallies
Richard Hemming, the Editor, gives his brief analysis of two Small Cap retailers, which both announced results to the ASX last week. Kogan's (ASX:KGN) share price dropped 15%, despite it being a genuine growth story. Whilst the discount retailer, The Reject Shop (ASX:TRS), has spiked 20%, but for how long?
Read more about Investing in Small Caps. Why we picked these ASX Small Cap gems and their outstanding performance.
Richard's Quickfire Analysis:
Before we get into stock details, the key is that KGN is priced like a growth stock, while TRS is a turnaround. Both face headwinds in the form of increasing costs relating to supply chain and labour, as well as the uncertainty related to Delta.
KGN has the advantage of higher price points leading to higher gross profit margins, which gives it a great deal of protection.
TRS has the advantage of its renewed focus on essential goods.
In my opinion, KGN is the big winner from Covid. While TRS outperformed expectations in its result, being a contrarian I like KGN because it's on a winner with tailwinds and controversy has always provided buying opportunities. Below are our analysts' comments:
Although the dramatic 15% fall in Kogan shares after the online retailer’s FY21 result was painful, bear in mind that the stock had risen by the same amount in the previous ten days. The stock remains above the price at which we issued a Spec Buy recommendation in April and May when we said that we thought that after a major fall from grace including a 60% fall from its highs, “shareholders can expect a long period of consolidation”. It is also a great lesson that stock prices should not be chased.
On the fundamental side of the equation, revenue increased 57% at $781m but this includes the benefit of the acquisition of Mighty Ape. Adjusted EPS rose 27% to 41 cents but actual EPS was 3 cents. The market hated the idea Kogan was unable to adjust its inventory in a timely manner, having over-estimated demand earlier in the year. Excess inventory caused excess storage and additional promotional costs, part of a $25m increase in variable costs. A further $7.7m demurrage costs were incurred for the product landed, which Kogan could not accept.
On 30 June inventories were $228m, more than double the prior year, and the net cash was reduced to $13m. Disappointment also emanated from the lack of a final dividend, but given the inventory problem we have previously outlined, this was not surprising.
Indeed, the advantage of being well stocked should have assisted Kogan due to supply chain difficulties, but there were no signs of that in these results. We await 1H22! The motto for the public for the rest of the year is, if you see it, buy it, and if Kogan has stock already landed, it is in a better position.
The Mighty Ape acquisition delivered the forecast $14.3m EBITDA on revenue of $80m. One of the reasons we like Kogan is relative transparency, with monthly updates. Sales in July grew 5% over FY20, accelerating in August. The extended lockdowns in Sydney and Melbourne may be assisting; the New Zealand lockdown should assist.
There are numerous opportunities to exploit the active customer group of 4 million people across Australia and New Zealand. The Kogan First loyalty program, and Kogan Marketplace where third parties use the Kogan platform to sell and fulfill their deals, are both growing fast. We continue to believe in the story, we are downgrading to hold while the market digests the current results, but remain positive on the story and would upgrade at slightly lower prices and given further good organic sales growth news.
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THE REJECT SHOP (ASX:TRS)
We have had a couple of profitable excursions in TRS over the last few years, after a slowdown in sales growth triggered a selldown in the stock in 2017, bringing it under the radar. We first recommended it at $3.65, took profits as high as $6.90, and had another go at it at $2.51 & $2.35 in 2018/19 before the Raphael Geminder interests purchased 19% and launched an unsuccessful bid.
The stock has spiked 20% after a stronger than expected FY21 result but remains 5% lower than its levels at the half-year result last February, where we had concerns about the continuing impact of Covid, which include supply chain issues that could cause inventory shortages at Christmas.
FY21 sales of $779m were down 5% on FY20 and 2% on FY19. Store sales in CBD locations and shopping centres were down 19% in FY19. The remaining portfolio was relatively flat. Metro and country stores in neighbourhood and strip malls are the key focus for growth, and performed relatively well, up 3.4% over FY19.
TRS faced shipping surcharges of about $9m, which held back EBITDA to $18.6m, for EBIT of $9.4m, which was still double the prior year, and NPAT of $8.3m.
The retailer’s financial performance was impressive. No JobKeeper subsidies were received in FY21, but profit margins still improved despite gross margin down 66 basis points to 40.3%. TRS’s cost of doing business was reduced by about $22m, 40% being admin costs and 60% store expenses. The latter was reduced by simplification and standardisation. The retailer continues to optimise its storefront and footprint, rotating to better locations.
Net cash reduced slightly as inventory was $29m higher than the prior year, down the inventory in June 2019. TRS needs to manage its inventory against shipping delays that are embedded in the system and now unavoidable, and the uncertainties of relatively volatile demand fluctuations. Elevated shipping costs, which had already been factored into the FY22 budget, continued to increase through August.
No guidance was provided for FY22, and the disruption of the current lockdowns is liable to cause additional demand deferral and hiatus.
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