Usually I'm not a fan of retail businesses because they are slaves to the consumer spending cycle and the internet is disrupting many parts of the industry. On the plus side, they can grow quickly by rolling out stores to new locations.
The following two businesses are not threatened by online competition because they sell products that people want to try before they buy. Furthermore, despite poor consumer sentiment over recent years, both of these companies have been able to grow profits consistently.
RCG Corporation Limited (ASX: RCG)
RCG owns The Athlete's Foot, a specialist shoe chain, and exclusive rights to distribute various brands such as Saucony, Merrell and Caterpillar in Australia.
Management hopes to soon complete the acquisition of Accent Group Limited which will more than double the profit of RCG. Accent owns the Platypus chain which sells casual shoes, and various brand exclusivity rights.
Whilst I'm normally sceptical about acquisitions, this one seems to make sense. The cost is just 6x earnings before interest tax depreciation and amortisation and Accent is a growing business that would fit well with the existing RCG operation. Also, management has a good track record with acquisitions having purchased the highly successful The Athlete's Foot business in 2010.
RCG's strategy of purchasing brand exclusivity also makes sense because it ensures that people who want specific brands have no choice but to buy them from its stores. The company also aims to provide exceptional service which is important to customers, particularly when buying specialist footwear such as running shoes.
Nick Scali Limited (ASX: NCK)
Furniture business Nick Scali was founded over 50 years ago and three members of the Scali family still run the company today. They also own 50% of its shares which ensures that they will strive to run the business with a long-term focus and in the interest of shareholders.
They have done an exceptional job so far, growing revenues to over $140 million and opening 39 stores across Australia. The Nick Scali brand is synonymous with quality thanks to clever product buying and advertising.
The strategy is simply to open new stores in areas with growth potential. The company has just opened its first stores in Western Australia and the region should provide further growth opportunities in the future.
Which is best?
I'd be comfortable holding shares in either of these companies, but prefer Nick Scali as a business. The reason is because of its organic business model which I believe is superior to RCG's acquisition model.
Since 2009, Nick Scali has nearly tripled its profit through this strategy whilst increasing fully franked dividends from 6 cents to 13 cents per share. Despite paying out so much to shareholders, its cash balance has more than doubled over the same period and the company has issued no new shares.
In contrast, RCG has slightly more than doubled profits, increased dividends from 1.5 cents to 4.5 cents per share, but its cash balance has fallen by more than 60%. It also raised over 60 million new shares over the period (excluding those raised for the Accent acquisition).
I estimate that RCG trades on a forward enterprise value to free cash flow multiple of 17 times after considering the Accent acquisition, compared to just 13 for Nick Scali. Not only does Nick Scali appear to be the superior business, it is also cheaper and would be my pick of the two stocks today.
