Why the Reject Shop Ltd share price is plunging today

Shares in bargain-box retailer Reject Shop Ltd (ASX: TRS) plunged 7% to $13.07 after the company released an announcement on an outsourcing strategy for its Victorian distribution centre (“DC”).

Reject Shop has outsourced management of its new Victorian DC to Toyota Tsusho Logistics, and will close its existing Tullamarine DC. The re-arrangement will cost a hefty $7.2 million in redundancy costs this year, although the long-term benefits are expected to significantly outweigh these costs. Cost savings in the first full year of operation (Financial Year 2018) are expected to be around $2 million.

Management assured investors that the costs would be met by the company entirely from its operating funds and existing finance facilities. Nevertheless, $7 million is a significant expense for a company that earned $18 million profit after tax in its most recent half.

Due to the nature of its business, which involves bulk importing and sale of high-volume, low-cost goods, investment in improving logistics is both a necessary evil, and a viable way of improving operating performance over the long term.

Previous investments in additional distribution centres, such as the 2014 expansion in Western Australia, have paid off by lowering the cost of doing business. In a business like the Reject Shop, which sells high volumes of goods with low profit margins, small reductions in cost can have a significant flow through effect on profits and today looks to be another sound investment in the company’s long-term future, even if the market didn’t want to hear it.

Well, should I buy it? 

I would call Reject Shop a ‘Hold’ today. I don’t believe that shares have enough of a margin of safety in them to make a decent purchase, especially when investors consider that the company is a high-volume retailer that is vulnerable to a weaker Australian dollar, operating in an intensely competitive segment. (For full disclosure, I sold my shares in Reject Shop four weeks ago to focus on higher-margin healthcare and tech stocks). Reject Shop does have capable, forward-looking management so it’s entirely possible that shares will rise further from here. But at this price, I think there are probably better alternatives out there.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. 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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