One of the best performers in the retail sector in the last six months has been fashion jewellery retailer Lovisa Holdings Ltd (ASX: LOV).
Despite the weak Australian dollar impacting margins, investors appear to be impressed with the strong sales performance from its 262 stores. In FY 2016 the company reported same store sales growth of 5.5%.
As a result its shares have rallied a whopping 75% in the last six months, compared to the 3% gain from the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
Whilst the same store sales growth is impressive and is up there with fellow retailers Premier Investments Limited (ASX: PMV) and OrotonGroup Limited (ASX: ORL), I cannot help but feel that growth will be impeded by the weakening Australian dollar.
With the U.S. dollar at a decade high, I believe it is only the recent rally in commodity prices preventing the Australian dollar from sinking below 70 U.S. cents again. But if that rally fizzles out, the local currency could also.
In Lovisa's FY 2016 the Australian dollar averaged 75 U.S. cents, resulting in its gross margin dropping from 77% to 74%. On the bottom line this led to a 6% drop in net profit to $16.6 million. As I expect the Australian dollar to slide lower over the next few months, I believe Lovisa's gross margin will continue to narrow and squeeze profitability.
The company has attempted to combat this with retail price increases. So far these increases appear to have been received well, but should the company need to hike prices further to offset higher costs then there is a danger that consumers will object and move on.
Which is a real shame because management is doing a great job in my opinion. Especially with its international expansion. Lovisa has expanded successfully into 10 territories, after recently entering the UK market with store openings in Leeds, Bromley, Brighton and Manchester.
If the Australian dollar were to strengthen beyond 75 U.S. cents in FY 2017 then Lovisa could prove to be a good investment. But with the Aussie likely to fall, I don't believe the company will be in a position to grow earnings at a rate that justifies the current 20x full year earnings price tag.
