Why shares in Vita Group Limited have been smacked today

The Vita Group Limited (ASX: VTG) share price has plunged more than 11% today to as low as $3.13, reversing most of the gains from Friday.

The telecommunications retailer saw its share price jump as much as 15% to $3.55 after agreeing to new commercial terms with Telstra Corporation Ltd (ASX: TLS). Vita Group currently runs 103 of Telstra’s retail stores, plus some of its business centres.

The new agreement is expected to see the number of stores Vita Group runs increase, although commissions appear likely to fall for some products. As the company says, ‘it expects to see volume improvement, but that will be offset by some margin compression’. In other words, Vita will be managing more stores and selling higher volumes of mobile phones, plans and other electronic devices and services, but Telstra is going to pay a lower rate.

Overall, it probably doesn’t mean much of a change to Vita’s 2017 financial year performance, although margin compression could see Vita issue an earnings downgrade.

But the issue does highlight the significant risk to Vita’s business – it’s dependence on Telstra. That is the most logical reason for the company’s move into men’s lifestyle retailing – as we noted last month.

The issue is also another warning light, coming on top of CEO Maxine Horne’s unexplained decision to sell 10 million shares for $49.5 million in late September and the new move into men’s fashion retail.

Not that Ms Horne needs to explain why she sold a large portion of her shareholding, but it’s always a bit disconcerting for other shareholders when company insiders sell large stakes. There are always very good reasons for insiders to sell too – to diversify their assets is one.

I’ve panned the men’s lifestyle move because I don’t see it as a similar business to Vita’s current business. It also means diverting resources and funding away from the existing business into an unproven one.

The fact that Telstra can renegotiate the terms of its contract with Vita, and the large telco virtually dictate terms means Vita is a much higher risk retailer than it appears.

Foolish takeaway

At the current price, Vita Group is trading on a trailing P/E of around 14x, which seems cheap, and paying a fully franked dividend yield of 4.4%. However, the risks are rising, and earnings growth may be much harder to come by. Despite the price fall, Vita is not the bargain it appears to be.

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Motley Fool writer/analyst Mike King owns shares in Vita Group. You can follow Mike on Twitter @TMFKinga

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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