With many retailers looking cheap, Dean Morel of The Motley Fool takes a closer look.

With two large US value funds, Motley Fool’s Scott Phillips and a couple international analysts I respect all seeing value in the Australian retailers, it’s time for a closer look.

After digging through the sector I found one stock I’d consider buying.

For this week’s stock on our radar I choose Specialty Fashion Group (ASX: SFH) ahead of six better known retailers.

But before choosing the owner of the Katies and Millers brands, I wanted to double-check whether value had re-emerged in Myer Holdings (ASX: MYR), David Jones (ASX: DJS) and Harvey Norman Holdings (ASX: HVN).

It hadn’t.

Instead of value, I continued to see value traps.

More promise in high returns

I found more promise in the historically high returns on capital offered by The Reject Shop (ASX: TRS), JB Hi‑Fi (ASX: JBH) and OrotonGroup (ASX: ORL).

All three offer the possibility of brighter days ahead. They are well managed, though Oroton’s and JB Hi-Fi’s brand-power elevates them to the top of the pack.

How’s that working out for you?

Circling back to those large US value funds, we find Matthews International Capital Management started buying DJs back in May, while Harris Associates started accumulating Myer in April. Both funds were buyers of their preferred department stores at substantially higher stock prices, and both have since doubled down on their investments.

I can’t fathom what those funds were thinking earlier this year. Buying retailers at fair value, in the face of dwindling consumer confidence and an increasing saving rate, is a high risk investment – to put it politely.

At least their recent purchases have the ring of value about them. That is, if you believe department stores have a reasonable future in the retail landscape.

The Foolish bottom line

Finally, let’s revisit my stock of the week, Specialty Fashion.

As the chart below shows, Specialty has better value credentials than either of the beaten down department stores or the beleaguered Harvey Norman. While at the same time it sports a return on shareholders’ funds that allows it to stand proud alongside three of Australia’s best retailers.

Specialty Fashion sports great returns on equity, multiple possible catalysts and lies discarded in the bargain bin. No wonder it’s a stock firmly on my radar.

Retailer multiples and ratiosSource: Capital IQ – Click Image to Enlarge. Enterprise Value to EBITDA & Price to Book Value use left axis, return on equity or revenue growth use right axis.

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Dean Morel is The Motley Fool’s Investment Analyst. Dean has no position in Specialty Fashion Group or any other Australian retailer at this time, despite being sorely tempted by a couple bargains last week. The Motley Fool has an upstanding disclosure policy.

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