3 cheap retail stocks for the next bull market

Credit: Newyorklegoboy

Retail businesses have the potential to generate exceptional returns on capital and strong cash flows because of their capital light business models. However, they are also among the first to suffer in a recession which can make share prices volatile. With low interest rates seemingly here to stay, now might be a good time to take a look at some of the ASX’s best retailers.

Footwear company RCG Corporation Limited (ASX: RCG) owns the Athlete’s Foot and Platypus chains. The company has been in acquisition mode over recent years having purchased Accent Group for $200 million in 2015 and announcing the proposed acquisition of Hype DC for $105 million at the start of this month.

The market has responded well to the roll-up strategy with RCG’s share price rising 188.4% in the last two years. Should the latest acquisition go ahead, company stores would grow to more than 350 extending RCG’s position as the regional leader of branded footwear with exclusive rights for 12 brands.

The company has guided for an underlying annualised earnings before interest, tax, depreciation and amortisation (EBITDA) of $90 million in 2017 should the Accent transaction go ahead. I estimate that RCG’s debt levels would increase to $116.9 million following the acquisition giving it an enterprise value of roughly $1.1 billion at current prices after accounting for new shares issued to Accent vendors.

Furniture retailer Nick Scali Limited (ASX: NCK) operates 48 stores including five under its Sofas2Go brand. It follows a more conservative growth strategy than RCG of rolling out new stores rather than acquiring them.

Whilst rising store numbers have contributed to higher profits over recent years, same store sales have also grown significantly. For example, for the first half of this year same store sales grew by 11.6% making a significant contribution to total revenue growth of 32% to $102.5 million.

This is an impressive result in a competitive marketplace, especially given the company also managed to preserve its 60% gross margins. Nick Scali sources many of its products abroad and given recent unfavourable currency moves would have had to raise selling prices or negotiate lower purchase prices to achieve this result.

Members of the Scali family remain the company’s largest shareholders, although they sold down some of their collective holding to institutional shareholders earlier this year. Managing director, Nick Scali, actually increased his personal interest from 16.7% to 27.3% as other family members chose to cash in and cease involvement with the company.

Nick Scali recently upgraded its net profit after tax (NPAT) guidance for 2016 to between $24 million and $26 million. With net cash of $6.4 million as at 31 December 2016 and a market capitalisation of $393.7 million, the company is trading on a reasonable enterprise value-to-earnings multiple (EV/E) of 16.

Australia’s largest retailer of baby products, Baby Bunting Group Ltd (ASX: BBN), debuted on the ASX in October last year. Therefore, unlike the above two companies it does not yet have much of a track record as a listed company.

However, it has made a good start to listed life delivering same store sales growth of 9.2% for the first half of 2016 and NPAT of $4.3 million, up 54.7% on the prior year. The strong same store sales growth is mainly due to maturing stores given that 46% of them are less than three years old.

Baby Bunting currently has just 35 stores and so there is a significant opportunity for it to win market share as the leader in a fragmented market. The company estimates the addressable market at $2.3 billion, around 10 times its full year 2016 forecast sales of between $225 million to $235 million.

Baby Bunting is guiding for EBITDA of between $16.5 million and $18.5 million for the full year and had $7.2 million in cash and no debt at 31 December 2015. Based on an estimated EBITDA run rate of $10 million for the second half of 2016 translating to underlying annualised NPAT of $12 million, the stock is trading on an EV/E of around 26.

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Motley Fool contributor Matt Brazier 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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