Stockwatch: The niche retailers to follow

Despite Brexit uncertainty there could be opportunities in the retail sector, argues companies analyst Edmond Jackson. These three are worth tracking.

As the UK government steels people and businesses for a "no-deal Brexit" it is worth considering how the months ahead could affect firms' growth prospects in Continental Europe. 

Two broad truths are evident: that the EU will do its negotiating best to demonstrate Britain as worse-off for departing – at least in the short term – with sterling likely to remain pressured without a satisfactory negotiations breakthrough. 

Thus, a double-edged sword for UK exporters: a low currency boosting price competitiveness, versus the prospect of higher EU trade costs.  Larger firms may be able to avoid them by creating a European base but only time will tell. 

The net upshot is likely bullish for the near term as currency factors predominate, time will tell as to whatever extra costs.  Much will depend on individual firms’ adeptness to seize marketing opportunities and manage hurdles.

Online retail as a concentrated example

Website marketing tailored to local European markets offers a big opportunity to leverage sales and is partly why for example AIM-listed Gear4music (G4M), which sells musical instruments/equipment, trades on a price/earnings (PE) ratio of over 50 times, and AIM-listed Angling Direct (ANG) selling fishing tackle is rated similarly at 104p since it listed a year ago at 64p. 

Neither stock pays dividends and both trade at big premiums to underlying assets, so they are highly attuned to management's narrative.  If strong sales do evolve to the EU in years ahead, such companies can grow into their stocks' demanding ratings; but mind they leave no scope for any adverse change.

Source: interactive investor      Past performance is not a guide to future performance

UK consolidator looks to Germany, France, Benelux

Angling Direct raised £9 million with an objective to build scale in a fragmented UK industry – over 2,000 mainly owner-managed fishing gear stores, with total annual revenue around £600 million.  It is already the largest with 23 stores and a website citing a 30% rise in unique users for the six months to July, and has successfully launched a German website with "encouraging" results. "Other European websites will follow later in the year supported by local customer service teams".

In terms of read-across, Gear4Music already has European distribution centres fully operational as part of its goal to become a leading European online retailer in this specialist space, despite a mere 1% share lately.  In its last financial year to end-February 2018, this company achieved 69% international revenue growth to £35.8 million (45% of group total) relative to 124% growth in the prior year, showing the extent of opportunity but also to mind exciting percentages when growth is from a low base. 

Angling Direct is much earlier-stage in Europe and has not disclosed whether it aims to fulfil orders by operating its own distribution centres (vertical integration) or use third party logistics groups (more likely at this stage).  But, on a long-term view, both companies' aims in continental markets could massively re-rate earnings so long as Brexit does not dump sand into the developments.

Already claims to be growing online sales by 60%

Mind the language used in Angling Direct's half-year update to end-July which proclaims "online sales up 60% to £11.69 million due to continued investment in the company's e-commerce platform" (my italics) alongside retail store sales up 60% to £9.93 million, and group revenue up 56%, ahead of management's expectations. 

It's easy to assume such "continued investment in the platform" means organic growth and, indeed, the number of unique users visiting the company's website has risen 30% over six months. However, later in the release, like-for-like group sales are cited up just 4.2% - the chief executive says that's still "pleasing" due to the adverse winter and very hot summer. So the exciting online growth may well have an element of being bought-in by acquisition, than purely organic. 

I would also mind, while Angling Direct proclaims a sales team with over 30 years in the fishing trade, investors have yet to see exactly how this business fares in a consumer downturn. 

It shouldn't be badly exposed to a fall in discretionary spending – enthusiastic hobbyists may maintain their spending versus, say, on home improvements – although reels, rods and floats/hooks comprise over 40% of Direct’s revenue, which aren't daily essentials compared with bait at 9% of revenue.

Not exactly a business protected by 'moats'

A read-across to Fishing Republic (FISH) reveals a very different story in tackle sales, but which appears to have involved management issues. Republic is now (hopefully) a turnaround in the making, its AIM-listed stock down from a mid-40p range a year or two ago, at a current low around 6.5p which capitalises the business at just £3.5 million versus 2017 sales of £9.2 million. 

Like Angling Direct, it doesn't pay dividends, but Republic does have tangible net assets per share of 10.7p. So, if the recently refreshed management team can get to grips, then the stock's risk/reward profile will be attractive. 

In terms of industry risks, though, Republic's debacle involved a sharp fall in sales towards the end of the 2017 fishing season amid "severe price competition as major competitors and independent stores aggressively sought to maintain their market share and offload excess stock."

Angling Direct hasn't complained as such, so either it managed through this phase and/or acquisitions helped mask it and management didn't want to sully its narrative by going into detail. 

Looking at operating margins, Republic was enjoying over 7% until 2017 versus Direct bumping along around 3% - i.e. Republic could have been exposed to price-cutting anyway. 

A circa 3% margin isn't great though, especially if consumer spending slows and Direct becomes exposed to a longer period of price-cutting in the industry.  Occasionally in online customer reviews of Direct it's possible to see prices alleged to be higher in the shops than online, i.e. potentially margin to cede.

Both listed fishing tackle retailers merit following

Direct and Republic alike get overall "Excellent" scores in customer reviews, notwithstanding a few frustrated complaints about deliveries and the like – inevitable in this kind of business and tend to get funnelled only review sites. 

Overall this appears a lively dedicated retail niche below the radar of mass-market operators such as Argos or Amazon, as if hobbyists are meant for specialist stores. 

I would not be inclined to buy either stock just yet though.  Direct could be on the verge of leveraging its sales impressively to Europe, but that's very early-stage and Brexit terms of trade are unknown. 

Moreover, its PE multiple is in the 50-plus stratosphere that has coincided with Gear4music's stock trading volatile-sideways in the last year, despite its encouraging narrative.  Some will say PE's are a misguided way of looking at online businesses, you'd have missed spectacular growth e.g. at Amazon/ASOS. 

I would reply, there's no intrinsic support to Angling Direct in its current price trading area if its narrative changes.  Yet its European development merits attention, likewise at Gear4music, if low sterling combines with none too onerous tariffs post Brexit. 

I'd be inclined also to keep an eye on Fishing Republic which last May anticipated "a year of transition" after a £2.3 million pre-tax loss, but appears to rate just as well with customers.  Right now, with fresh money: Avoid.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.