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Reject Shop Ltd attracts bargain hunters as share price surges on strong result

Shares in Reject Shop Ltd (ASX: TRS) surged to a 10-month high this morning after the discount variety chain handed in its earnings report card for the six months to end December 2017.

Reject Shop is attracting bargain hunters from all over as the perennial underperformer surged 10.7% to $6.53 – the highest level since its disastrous profit warning last April.

A modest increase in profit and sales may have been a welcome relief for embattled shareholders betting on a turnaround in the business but it’s the outlook that is particularly pleasing, in my view.

Management reported a 1.1% increase in first half sales to $437.6 million and a similar increase in net profit to $17.7 million.

The profit figure was comfortably above management’s guidance of $16 million to $17 million, and the beat is thanks to improving sales momentum with same store sales (SSS) staging a dramatic turnaround.

The December quarter SSS growth jumped 2.2% after contracting 1.9% in the previous quarter as Reject Shop benefited from a strong Christmas trading period. SSS, or comparable store sales, measures sales growth from outlets that have been operating for at least a year.

It looks like the worst is behind the retailer that warned of falling sales and foot traffic nearly a year ago due to problems getting its merchandising-mix right.

The sales momentum is carrying through to the second half and the retailer is tipping a significant improvement to its full year net profit. Management is guiding for a FY18 net profit of between $16.5 million and $17.5 million compared with last year’s net profit of $12.3 million.

It’s also notable that Reject Shop has managed to sustain its margins in the face of the volatile exchange rate and as it undertakes its turnaround strategy. Most companies have to sacrifice margins when management is trying to right the ship.

On the downside, there isn’t much light at the end of the tunnel for its Western Australian operations as SSS continued to contract due to intense competition and weak economic conditions. But given that mining is firing up again, one has to wonder why this has yet to flow through to the Reject Shop.

It looks like there is plenty of room for the stock to climb given that it is still 19% in the red over the past 12 months when the S&P/ASX 200 Cons Disc (Index:^AXDJ) (ASX:XDJ) index is up by over 10%.

Reject Shop is one of the worse performing retailers if we ignore department store Myer Holdings Ltd (ASX: MRY) but that means it is probably only at the start of its re-rating – assuming that management can sustain the turnaround of the business.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has recommended The Reject Shop Limited. 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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