On Monday, shares in Australia's largest footwear retailer RCG Corporation Ltd (ASX: RCG) plummeted over 28.5% after management announced a second profit downgrade in the space of three months.
Investors spoke with their feet and headed for the exits (presumably not in Skechers), as the once high-flying owner of The Athlete's Foot, HYPE DC and the Accent Group (which in turn owns Dr Martens, Vans and Platypus shoes amongst others) said tough retail conditions continued to impact sales.
Whilst this competitive retail environment sentiment is shared by listed discretionary retailing peers OrotonGroup Limited (ASX: ORL) and Myer Holdings Ltd (ASX: MYR), I think the savage sell-off in RCG's share price may be overdone. Here's why.
Company financials
Make no mistake. Two profit downgrades in the space of a quarter is inexcusable for any company.
However, there also comes a point when investors need to look past the market noise and assess an investment on its merits. In this regard, I believe RCG's current share price stacks up well against its future prospects (and downside risks).
Earnings & profit
For the half-year ended 25 December 2016, RCG recorded a whopping 42% increase to underlying earnings (EBITDA). This translated to a 17% increase to earnings per share on the prior corresponding period.
Underlying net profit after tax (NPAT) for the half swelled 34% to $23.3 million, with like-for-like sales growing 7.6% in RCG's Accent Group division – a standout result.
However, the good news appeared to end there with management announcing in February that full-year EBITDA was likely to fall to $85 million to $88 million (down from previous guidance of $90 million).
Outlook
On Monday, RCG added to its woes by reducing full-year underlying EBITDA guidance again to $74 million to $80 million. Though this is a stark 18% departure from its guidance of $90 million at the end of FY16, investors must remember that the downgraded guidance still represents an admirable 22.5% growth rate from its 2016 full-year earnings of $60.4 million.
Strong footing
Even though the profit downgrade is nothing to be sneezed at, investors must put it in context of the near 60% drop in share price since the start of 2017.
Driving this decline is also fears of Amazon's impact on Australia's retail market. Though Amazon is a real threat for footwear retailing, I believe RCG is well placed to weather the storm given its strong brand names and vertically integrated network.
Foolish takeaway
One thing I am wary of is that profit downgrades come in droves.
As shareholders of iSentia Group Ltd (ASX: ISD) and Vocus Group Ltd (ASX: VOC) have experienced, management seldom gets profit downgrades right the first few times around. As such, there is potential for the company to announce a further downgrade if retail conditions don't pick up any time soon.
Though this is a real prospect, based on Tuesday's closing price of 70 cents per share, RCG's shares trade at a forward price-earnings of about 8.5x (if lower end of guidance is achieved) and a trailing fully-franked yield of 8.6% (if dividends are maintained). This makes it extremely cheap for a company delivering profit and earnings growth.
Accordingly, whilst risks remain around Amazon's arrival and further profit downgrades, I believe the current share price of RCG demands a closer look as a speculative buy.
