The impending release of Australian retail sales data tomorrow will put the focus on our listed retailers and help set the scene for next month's reporting season. But there's one stock with more to prove come February.
Economists are forecasting a 0.2% rise in retail spending for the month of November and there are early signs of buoyant Christmas sales thanks to discounting. That's good news for the retailers' topline but may not translate so well to their profit line.
This essentially sums up my expectation for Specialty Fashion Group Ltd (ASX: SFH), with the women's apparel retailer tipped to produce a notable uplift in sales but skinnier margins as it beds down last year's acquisition of Rivers.
The market is not ascribing much success on that front with the stock tumbling 22% in the last six months to near a two-year low of 71 cents.
Management's warning of heavy discounting at Rivers to clear the previous owner's inventory is one of the key drags on the group's performance that will last until February.
Specialty Fashion has not provided any guidance and the market is nervous given that a small change in sales can have a bigger disproportionate impact on earnings before interest, tax, depreciation and amortization (EBITDA) due to the group's fixed cost base.
I am forecasting a 12.6% increase in 2014-15 group revenue to $769.5 million but a 10% drop in operating EBITDA to $30.5 million. This implies a very steep one percentage point drop in its EBITDA margin to 3.95% compared with the 0.3 to 0.4 of a percentage point contraction that's expected for the broader retail sector.
If that comes to pass, there's a real risk that management will have to cut dividends for the current financial year. The group paid a 4 cent fully franked dividend in 2013-14.
But there is a silver lining. Even under this scenario and assuming modest inflation-like sales growth in the following years, the stock is worth 73 cents on a discounted cash flow basis with a relatively high 12% discount rate (the higher the discount rate the lower the valuation).
Further, I think the risk is to the upside if management can prove that it is able to extract greater synergies from Rivers than what I have factored in (which is very little). As I mentioned, a small positive change to sales will see a sharp increase to my valuation because of the group's operating leverage.
Hang on to your seats – we will get the first hint of this at the upcoming first half reporting season.
