The Reject Shop: Shares up 5%, stock no retail reject

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The Reject Shop Limited (ASX: TRS) today released its first half results with net profit of $16.6m being more than 2011's full year results, and an increase of 4% over previous corresponding period. The market is pleased, send the stock up over 5 per cent.

Same stores sales fell by 1.6% over the six months, but it was encouraging that in the last three months, The Reject Shop recorded positive 1% same store sales growth, and comparable sales since December have been positive.

The company has forecast net profit after tax to be in the range of $20.5m to $22m (53 weeks), which is up 27% to 36% on prior year. Reject Shop's 2011 performance was severely impacted by the floods in Queensland and damage to its Ipswich Distribution Centre.

About Reject Shop the company

The Reject Shop currently operates approximately 218 discount variety stores throughout Australia. It offers a range of general consumer merchandise, including toiletries, cosmetics, homewares, personal care products, hardware, basic furniture, household cleaning products, kitchenware, confectionery, and snack food products; and lifestyle and seasonal merchandise, such as seasonal gifts, cards and wrapping, toys, leisure items, and home decorations.

Worrying signs

There are some worrying signs appearing. What is disconcerting for me is that based on first half net profit of $16.6m, and the company's forecast of around $20.5m for the full year, the company only expects a net profit of $3.9m for the six months to Jun 2012.

Another issue is declining numbers of new stores, which will hamper further growth. Reject Shop opened 27 stores in 2010, 23 in 2011, expects to open 17 in 2012 and so far, has 13 stores approved for opening in 2013 (although the company is still seeking other sites). The company also noted that it expects some potential closures in 2013. While the number is likely to rise from 13 new stores, it's still a worrying trend.

Source: Company Presentation (my estimates for 2013)

Like all companies expanding through the roll-out of new stores, eventually they reach saturation levels, where new stores have lower profit margins, detract from profits and make the company less efficient. It appears that The Reject Shop may be approaching saturation.

On a positive note, debt has been significantly reduced from $38.3m as at June 2011, to $8.8m as at 31 Dec 2011, but is forecast to grow to $27m as at June 2012.

The Foolish bottom line

The Reject Shop is currently trading on a forecast PE of 14.8, with a forecast dividend yield of 4.8%, fully franked. While the company appears to currently be performing better than some retail stocks such as JB Hi-Fi Limited (ASX: JBH), David Jones Limited (ASX: DJS) and Myer Holdings Limited (ASX: MYR), it appears to have challenges on the horizon.

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Motley Fool contributor Mike King doesn't own shares in The Reject Shop. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool's disclosure policy

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