Brokers are betting this retailer will bounce back in 2018

The sky hasn’t fallen in on the retail sector despite some high-profile blow-ups and investors will soon be hunting for bargains in the sector, which looks poised for a re-rating this year.

Investors were expecting wide-spread pain due to the structural change in consumer spending patterns that is epitomised by the arrival of, record high household debt, and weak wages growth.

The headwinds have hammered some retailers like embattled department store Myer Holdings Ltd (ASX: MYR) and Super Retail Group Ltd (ASX: SUL) but they are no “canaries in the coalmine” for the sector.

Retail is a tough environment – but it always has been. Smart retailers are adapting and their efforts are translating into strong profits. You only need to look at the likes of Reject Shop Ltd (ASX: TRS), JB Hi-Fi Limited (ASX: JBH), Breville Group Ltd (ASX: BRG) and Flight Centre Travel Group Ltd (ASX: FLT) to see why sentiment towards consumer-facing stocks is coming back from the cold.

In that light, I suspect we could see Michael Hill International Ltd (ASX: MHJ) outperform as the sector gets re-rated. There are a few reasons for this despite the company posting a disappointing first half result.

For one, the stock has massively underperformed over the past year as the share price of the jewellery retailer slumped over 16% into the red, while the All Ordinaries (Index:^AORD) (ASX:XAO) has gained nearly 6%.

The underperformance has left the stock trading on depressed valuations and while the outlook for Michael Hill is far from rosy, there are reasons to believe that things are at, or close to bottoming, for the retailer.

This turnaround prediction was echoed by Credit Suisse when it upgraded the embattled stock to “outperform” from “neutral” as it welcomed management’s decision to exit the US market and reposition the underperforming Emma & Roe business.

These two businesses are the biggest drag on Michael Hill’s results, although its Australian business is also under margin pressure due to increased marketing expenses and costs associated with its payment plan program.

But if the earnings hole from the US can be plugged in the next six months or so and management can stem the bleeding from Emma & Roe, Michael Hill is able to deliver a nice profit uplift in FY19.

In other words, Michael Hill could be the next Reject Shop!

But this is only for investors with a higher appetite for risk. Others might want to wait for more concrete signs of a turnaround (probably by the August reporting season) before jumping in although it is worth noting that of the four brokers polled on Reuters, three are recommending the stock as a buy while one is a hold.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Flight Centre Travel Group Limited. The Motley Fool Australia owns shares of Super Retail Group Limited. 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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