2 high-margin retail shares for your portfolio

The ability to charge a price premium over competitors is part of the reason why the a2 Milk Company Ltd (ASX:A2M) and Nick Scali Limited (ASX:NCK) could be standout additions to your portfolio.

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One of the most important things to look for if you are trying to identify stocks to buy and hold for the long term is an ability to raise prices, or to charge prices that are higher than competitors.

If a company can raise prices or command a price premium above comparative products from peers, it’s usually an indication of operational efficiency or a unique value proposition.

In 2016, retail is one of the hardest sectors to achieve pricing power because of the high number of market participants and how quickly products can be imitated.

So how do the two stocks on this list achieve these advantages over their competitors?

The a2 Milk Company Ltd (ASX: A2M) may have grabbed headlines for its exposure to the China baby milk formula boom, but its core product has been around for much longer, and has an enviable position in the market.

Almost all dairy milk on the Australian market contains both A1 and A2 protein. However, a2 only distributes and markets milk that contains 100% A2 protein. That’s because a growing body of research shows that in many people, the A1 protein could cause digestive discomfort.

The proposition that milk could and should be easier to digest, coupled with clever marketing and a low “cost to trial” have seen a2 capture around 10% market share in the fresh milk market. This feat is even more impressive given it has occurred at the same time as the grocery giants have been engaged in a price war over milk, cutting prices to $1 per litre, while a2 retails for around $2.35 a litre.

Growing to 10% share while charging double the price of a comparable product is clear evidence of customers willingness to pay a brand premium, and of a company able to earn strong margins.

The company is now applying the same strategy to the comparable, but larger, UK and US markets, which could see revenues and profits expand substantially in coming years.

Nick Scali Limited (ASX: NCK) is proof that a business does not need to be all things to all people in order to prosper. In comparison to its main competitors, Nick Scali is one of the only businesses nationally to occupy the premium mass market position for furniture.

As such, its stores are more like high end showrooms rather than warehouses, and its customers generally come from more affluent households. This means that it is better shielded from swings in consumer confidence and discretionary retail spending, as it targets a smaller, less price sensitive market.

Nick Scali is able earn higher margins in part because of a differentiated offering brought about by a perceived quality premium over its rivals. The second part of the strategy is the leverage its buyers achieve by having an Australia-wide store network, allowing it to procure goods for lower costs, which mean higher margins.

Foolish takeaway

Finding businesses that are able to charge premium prices is a good step toward finding good investments. Of the two companies, Nick Scali has a well established store footprint and premium position in the Australian market. Although it is the riskier investment proposition, a2 has strong market share in Australia with the possibility of replicating it in one or more offshore markets, giving it more potential upside than Nick Scali.

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Motley Fool contributor Ry Padarath has no position in any stocks mentioned. 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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