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Why Credit Suisse upgraded the Kathmandu Holdings share price

The Kathmandu Holdings Ltd (ASX: KMD) share price struggled to make gains today even after an upgrade by a leading broker and as the consumer discretionary sector led the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index higher.

Retail exposed stocks have shaken-off their post-Christmas blues with the Super Retail Group Ltd (ASX: SUL) share price surging 4.1% to $6.99, the Premier Investments Limited (ASX: PMV) share price gaining 1.9% to $14.68 and the JB Hi-Fi Limited (ASX: JBH) share price jumping 1.2% to $21.86 during lunch time trade.

Worries about weaker sales over the all-important holiday period have cast a long shadow over the sector as the property price slump dragged on consumer confidence.

Downgrade that triggered the upgrade

These concerns drove a close to 30% crash in the KMD share price since it’s August peak with Kathmandu shedding another 1.3% to $2.27 at the time of writing, although Credit Suisse thinks this is a good opportunity to buy the beaten down stock and has upgraded it to “outperform” from “neutral”.

“While the announcement of disappointing Christmas trading drove 10% of this fall, we believe the current share price overstates the impact from weak trading in a period that typically contributes only 25%-30% of full-year EBIT,” said Credit Suisse who pegged a price target of $2.90 a share on Kathmandu.

“In addition, we believe KMD trading at 10x forward P/E [price-earnings] and a modest discount to the broader retail sector offers attractive value for a company that continues to guide towards earnings growth, has a strong balance sheet and attractive capital light growth options.”

Bright spots

There are a few other things going in the outdoor clothing retailer’s favour. The performance of its Oboz brand is trending strongly with a 35% lift in revenue year-on-year.

Credit Suisse also likes the group’s expansion into wholesale (a less capital intensive business) and noted that Kathmandu’s balance sheet is strong enough to take on another bolt-on acquisition that’s similar to Oboz.

While same store sales contracted in Australian and New Zealand over Christmas, Kathmandu reported higher gross margin thanks to higher average selling prices. This was due to the fact that the retailer had fewer sales and promotions over the period.

However, what this may also mean is that Kathmandu may need to launch more discounted sales campaigns to restart sales growth and this will come at the expense of margins.

I think it will be a struggle for most retailers to growth revenue without resorting to discounts in this environment.

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Motley Fool contributor Brendon Lau owns shares of Premier Investments Limited. The Motley Fool Australia owns shares of and has recommended Premier Investments Limited. The Motley Fool Australia owns shares of Super Retail Group 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 Scott Phillips.

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