Is Reject Shop Ltd (ASX: TRS) a buying opportunity, or the classic 'falling knife' that is better off not being caught?
Shares in the company surged 20% in February after the half-year report was released, with many buyers apparently spotting an opportunity despite a continued decline in net profit.
Since then shares have begun to decline again, from recent highs of over $7 to this morning's price of $6.64.
So, should you buy, sell, or hold your Reject Shop shares?
Let's look at the three cases:
BUY
- Reject Shop appears cheap, trading on a Price to Earnings (P/E) ratio of ~9, despite further falls in earnings predicted by analysts
- Benefits of 'parallel importing', taking advantage of lower cost of wages in foreign nations to provide cheaper products to consumers in Oz (this is also a negative, see foreign currency exposure in the SELL section)
- Management has a conservative focus, streamlining the business, limiting new store openings and focusing on paying down debt; a wise strategy after years of rapid expansion
SELL
- Company misses its own guidance for earnings (from the half-yearly report: 'Company EBIT was well down on expectations..') – whether through mistaken assumptions or unforeseeable circumstances, this creates an extra degree of uncertainty for shareholders
- Potential for increased competition from companies like Aldi, who also take advantage of lower overseas wages and is benefited by huge scale and private ownership
- Aussie dollar is weaker against foreign currencies (the currencies TRS buys its stock in) which could squeeze margins and/or force prices to rise, hurting sales. Latest half-year report showed the company maintained its gross profit margins however.
HOLD
- Retailers in Australia in general aren't faring well at the moment, with even major companies like Woolworths Limited (ASX: WOW) and Kathmandu Holdings Ltd (ASX: KMD) struggling to achieve growth
- Reject Shop is struggling to grow vital sales of lower-volume, higher-margin items. While all businesses face headwinds at times, it is uncertain whether this will become a real problem or if management can turn it around
- New distribution centres may or may not lead to sustained lower costs over the long term
- The 'rot' of lower sales, higher costs of doing business (becoming a larger percentage of a smaller sales figure), clearance of winter items that sold poorly, and so on are weighing on the share price, but should become issues of the past as efficiency and inventory controls are improved
With an equally compelling case in both the 'Buy' and 'Sell' camps and a large number of unknowns (as outlined in the 'Hold' section), I conclude that Reject Shop shares are a Hold.
There is simply too much uncertainty around the company's medium-term outlook to be making a snap decision either way, and I wait to see how the situation evolves over the next few reporting periods.
In the meantime, however, there are a number of other opportunities available right now – including The Motley Fool's Top Dividend Stock of 2015, which has a much clearer alleyway for growth than Reject Shop, trades on an attractive price and – of course – offers an enticing dividend to boot.
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