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Morgans says these small cap retailers are set to become this reporting season’s heroes

This reporting season could shape up to be a battle between small cap and large cap retailers even as the outlook for the sector has suddenly gotten brighter following the June retail figures that revealed a burst of activity among consumers.

But not the whole sector will be joining in the party as the gap between the “haves” and “have-nots” in retail is widening with the first group best placed to withstand or capitalise on the online shopping revolution.

What’s interesting is that the trend favours small-cap retailers over the big and established players.

This makes sense as smaller emerging retailers are more nimble and better able to move with the times. They also tend to have been started as the online threat became more obvious – thus giving them a chance to be better prepared to take on the likes of Amazon.com.

Further, smaller retailers are typically niche players. Being great in a small segment of the market that is dominated by giants you can’t compete head-on with is usually the best strategy for building a business.

There are a couple of other themes that Morgans has picked up for this reporting season too. Investors can expect to see further growth in online sales and penetration (probably at the expense of traditional retail); strong growth in “statement fashion” (like jewellery and sneakers) as well as auto and household categories; and a softening in the New South Wales market but a pick-up in Western Australia.

“The retail sector currently comprises a wide divergence in trading multiples, with rare growth stories commanding extreme premiums. Conversely, traditional bricks-and-mortar rollout retailers trade at a material discount,” said the broker.

“We maintain a clear preference for the specialty retailers with dominant market positions, less Amazon exposure, solid earnings growth prospects (risk to the upside) and valuation support.”

On that note, there are four small cap retailers that Morgans thinks will standout during this month’s profit reporting season.

The first is women apparel retailer Noni B Limited (ASX: NBL). The stock is surging 6.3% in lunchtime trade to $3.42 when the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index has slipped 0.3% into the red.

Despite its strong performance, the stock is still looking reasonably priced with Morgans tipping further earnings growth as cost-outs are likely to exceed management’s target.

The second is home furnishing group Adairs Ltd (ASX: ADH). The broker thinks it’s trading on an attractive valuation of around 10 times price-earnings (P/E) for FY19 and believes there is upside to consensus forecasts for the group.

Baby products retailer Baby Bunting Group Ltd (ASX: BBN) may be a more controversial call given its earnings issues but that hasn’t stopped Morgans from highlighting it as a key pick even as the broker admits there is a chance it could miss earnings estimates again.

However, the closure of Toys ‘R’ Us is a re-rating catalyst for the stock and Morgans thinks it’s only a matter of time before Baby Bunting enjoys a surge in earnings.

Lastly, Apollo Tourism & Leisure Ltd (ASX: ATL) is another hot favourite. While the market might think the company will be hard pressed to beat its strong growth in FY18, Morgans think robust earnings growth is still achievable in the current financial year.

What’s more, the stock is trading at under 10 times P/E on its FY19 forecasts and the broker says earnings risk is to the upside.

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Motley Fool contributor Brendon Lau has no position in any of the 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 Scott Phillips.

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