This is when stocks will hit rock bottom then recover

It’s not all bad news at the moment and these companies could re-rate rapidly quite soon, according to this City expert.

Top picks Next (LSE:NXT), Currys (LSE:CURY) and Fevertree Drinks (LSE:FEVR) are being backed for a rapid re-rating after a City firm today called the bottom for the consumer discretionary sector early next year.

Other stocks favoured by broker Liberum for an early cycle recovery include Frasers Group (LSE:FRAS), Card Factory (LSE:CARD), Virgin Wines UK (LSE:VINO), Superdry (LSE:SDRY), Wickes Group (LSE:WIX) and the tissue supplier Accrol Group Holdings (LSE:ACRL).

It recommends buying into consumer stocks after the Christmas updates are done in January, adding that current valuations already take into account potential downgrades in 2023.

• Read about: Free regular investing | Opening a Stocks & Shares ISA | Cashback Offers

Out of 26 consumer discretionary stocks in Liberum’s coverage, all apart from shares in Frasers are in negative territory over the last 12 months. Heavy fallers include fashion retailer Superdry and tonics firm Fevertree Drinks with declines of more than 50%.

Rising supply chain costs and the squeeze on household spending power have derailed valuations, but Liberum points out the news flow is not all negative as employment, wage mobility and high levels of savings offer encouragement.

Liberum expects that inflation of 4-5% and mid-single digit interest rates will be the new economic reality that could last a decade: it adds “Those with pricing power can take advantage and inflation is generally good for retail.”

Its selections focus on companies with forecasts for revenues ahead of pre-pandemic levels, or improving margins and strong balance sheets.

The broker said: “Our top picks reflect a balanced mix of quality, growth and value, which should provide early cycle recovery.

“We feel these will re-rate rapidly, probably earlier cycle than many growth stocks that offer deep value. Due to quality dynamics, they should provide safety if re-ratings happen a little later than anticipated.”

Next, which highlighted its continued resilience in today’s third-quarter update, is backed with a target price of 7,500p.

• Relief as Next avoids major shocks in Q3 results
• Amazing share price surge turns FTSE 100 losers into winners

Liberum says the retail chain has entered challenging times from a position of financial strength, with levels of debt significantly lower than they were before the pandemic.

Over the medium term, it believes Next should continue to provide consistent double-digit returns driven by the success of its Label business as a partner for existing brands.

It also likes Superdry shares since the return to the helm of founder Julian Dunkerton, who has overseen strategic progress including through improved ranges.

Liberum, which has a 500p target price, said: “We think Superdry is at the cusp of breaking through. Yes, revenues are down versus pre-pandemic, but gross margins are up, costs are down, and cash is up with impressive working capital management.

“The only thing it needs to prove is that the top-line can now live up to expectations having reinvigorated all the product and developed an influencer-led marketing strategy.”

Liberum notes that Frasers has come a long way from the Sports Direct of old, becoming a multi-brand, multi-fascia, omni-channel retailer across fashion, sports, luxury, outdoor and lifestyle with a significantly broader addressable market.

Noting a 1,000p target, the broker said: “Frasers’ strategic foundations are now firmly in place and the current valuation looks extremely cheap. The share price fall of close to 30% since the prelims in July makes little sense considering the confidence in guidance, strong trading momentum and cash generation.”

It is backing Currys to reach 150p based on a dominant market share, highly profitable European business and the company’s significant recovery and growth opportunity.

Liberum said: “Despite having by far the market leading position with 25% share of the UK electricals market, it serves 80% of UK households but takes less than 30% of their electricals spend.”

• Daily Trading Flash: 10 most-traded shares 2 November 2022
• 10 high-yield dividend shares with a great track record

The resilience of the UK’s £1.4 billion greetings card market means Liberum likes Card Factory and its vertically integrated business model, which means the retailer designs, prints and manufactures most of the cards itself.

Liberum has a price target of 110p and notes that if the company can get free cash flow back to half the historical level at £30 million a year this would imply an approximate 20% yield.

At Fevertree, underlying margins have declined from a peak of 35.1% in 2016 to 13.6% in the first half of 2022. But Liberum believes the prospects for some near-term earnings recovery look strong as the company benefits from its many self-help levers.

It said: “We think the shares are not pricing any recovery in margins, do not reflect what has been a strong revenue performance since Covid, ignores the free cash flow profile and what is a very robust balance sheet.”

Wickes Group ticks the boxes on cash flow and balance sheet strength, but Liberum says revenues are much more defensive than many first think. The shares have fallen 40% over 12 months despite profit upgrades of over 50% in the same period, leading to a price target of 360p.

Two of the smaller stocks on the list are AIM-listed Virgin Wines and Accrol, with price targets of 100p and 60p respectively.