Where to now for the Dick Smith Holdings Ltd share price?

Credit: hnnbz

Woolworths Limited (ASX: WOW) sold Dick Smith Holdings Ltd (ASX: DSH) to private equity firm Anchorage Capital in 2012 for $94 million (plus a $21 million working capital adjustment). In December 2013, Anchorage re-floated 78% of Dick Smith at $2.20 a share, paying itself a $15 million dividend and netting a cool $264 million profit in the process. Two years on and both Woolworths and Anchorage would be laughing all the way to the bank, with shares in Dick Smith trading near all time lows after falling 50% on Monday.

With the stock clawing back some of its steep losses on Tuesday, Dick Smith shares could be oversold and headed higher in the short-term. However, the recent gyrations in share price mean its buyer beware, thus conservative investors should stay away until more certainty is provided around 2016 full year (FY16) earnings.

Testing times

Dick Smith operates in the fickle industry of consumer electronics retailing; it competes against online companies which sell similar products as well as bricks-and-mortar heavyweights JB Hi FI Limited (ASX: JBH) and Harvey Norman Holdings Limited (ASX: HVN) (with the latter two being diversified through home appliances and personal electronic product offerings).

Following the recent announcement of a $60 million non-cash impairment charge (and profit downgrade at its November AGM), Dick Smith’s management faces testing times, with future share price performance relying on management’s ability to turn things around. Whilst I believe the sharp share price fall is unwarranted, given the non-cash nature of the impairment charge, part of the fall appears to be driven by a lack of faith in Dick Smith’s growth strategy.

Growth strategy

To refresh your memory, Dick Smith’s growth strategy is two-fold as follows:

  1. Dick Smith plans to increase its high-margin range of private label products in order to outprice online competitors (which sell similar, homogenous goods).
  1. Dick Smith also plans to expand its store footprint to compete against JB Hi Fi and Harvey Norman by opening 15 new stores each year in the near term.

In my opinion, this growth strategy is fraught with risk. Companies like Myer Holdings Ltd (ASX: MYR) have shown the downward spiral associated with price competition (as online stores will generally provide lower prices due to lack of fixed overheads).

Secondly, as was seen with Reject Shop Ltd (ASX: TRS), store roll-outs can go terribly wrong, with one false move spelling disaster to shareholder value. Given management’s indication at its AGM that consumer confidence is likely to remain soft, in my mind, a better strategy would be to focus on cutting costs (instead of expansion) and diversifying Dick Smith’s product offering into ancillary areas (like JB Hi Fi and Harvey Norman have done). However, this does not appear to be a pressing agenda item at the current time.

Accordingly, history shows that Dick Smith’s growth strategy might be flawed, meaning investors that buy into it today are betting things will go very right for the company to get back near its $2.20 issue price. Therefore, the price is likely to head higher in the short term. However, I beg to differ on its long term prospects; with management being quick to downgrade expectations after three months of trade, and refusing to reissue guidance on FY16 NPAT until February 2016, things could get worse before they get better. As such, investors trying to profit from the short-term bounce may get burnt.

Foolish takeaway

Stocks rise and fall everyday, but when a company experiences violent movements like those seen with Dick Smith Holdings Ltd, it takes a certain type of fool (without a capital F) to invest in it. Whilst I do believe Dick Smith shares may be headed higher in the short term, until more information comes to light about its FY16 profit guidance, investors are taking a punt on the company’s future.

Accordingly, it would be wise to stay out of Dick Smith for the time being and look elsewhere for better opportunities such as The Motley Fool's top dividend stock for 2015-2016

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Motley Fool contributor Rachit Dudhwala owns shares of Woolworths Limited. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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