I believe there are three must-haves when investing in retail companies. Without these characteristics I believe investors have a much lower probability of the company being successful over the long term:
- They must have growing like-for-like sales;
- They must have the ability to expand store numbers without meaningful cannibalisation; and
- They must have a point of difference – a niche they sell to, a price point that others cannot match, a historic brand name, or a superior product.
Running through the list of big-name retails stocks on the ASX, it's staggering how many do not satisfy these simple conditions. Department stores Myer Holdings Ltd (ASX: MYR) and David Jones Limited (ASX: DJS) don't appear to satisfy any of them – although there could be some debate about the third one – while the likes of investor favourite The Reject Shop Ltd (ASX: TRS) have recently disappointed in like-for-like sales. Of course, the Reject Shop could prove that recent results were mere blips on an otherwise impressive history by delivering a better second half to the financial year.
The best retailers
Until the time when the turnaround is in motion however, I believe there are a couple of names that stand out as exceptional retail opportunities right now. The first is Super Retail Group Ltd (ASX: SUL). Super Retail disappointed investors earlier this year when first-half earnings growth came in lower than expected. I think the 20% drop in price between November and now is an overreaction as the company has a number of strong brands with superior products, and it's still meaningfully growing life-for-like sales (up 5.8% in the first half).
Similarly, Kathmandu Holdings Limited (ASX: KMD) operates 140 Kathmandu stores around Australia, New Zealand and the UK. The company has been able to grow like-for-like sales by 8.5% on average for the last three years, thanks to a strong brand name, quality products and only selling via Kathmandu branded stores. A target of 180 stores within the next five years appears reasonable in order to sustain its 60% gross margins on sales. The company sells a range of outdoor gear aimed at mid-to-upper-middle income earners. Statistics are saying that this group of people is growing at 5-6% rate annually which should help to sustain earnings per share growth in the coming years.
Foolish takeaway
Investors should always search for a competitive advantage when analysing companies. This advantage should allow the company to consistently raise prices or grow like-for-like sales. Super Retail and Kathmandu have shown that their companies have quality to deliver exceptional shareholder returns and I believe there will be many more good years to come for patient investors.
