Stockwatch: Directors buying the drop, should you?

Is JD Sports's risk/reward profile still attractive? This mid-250 sports fashion wear retailer is a success story, soaring from about 150p in 2012 to currently test 1,330p.

I have drawn attention variously since August 2010 at 181p - adjusting for a 1:4 stock split in 2014 - believing management had its act together with regard to sports fashion, without the market cottoning on. Instead, it was enthusing over Sports Direct in 2012/2013. Nowadays market sentiment combines with strong fundamentals, justifiably.

Ripe for shareholder returns

All recent broker coverage on JD asserts 'buy' after its very strong financial progress since 2014. As yet the dividend yield is a scant 0.6% with management prioritising investment for growth, so the valuation emphasis is largely earnings/cash flow.

On a strict arithmetic basis the forward price/earnings multiple is about 17 times following the last trading update and earnings upgrades. The forward price/earnings growth ratio is 1.5 reducing to 1.3. Strictly, this growth stock measure implies value below 1.0, although the late Jim Slater - who popularised it - reckoned sub-1.5 could also be attractive for a high-calibre business.

Unless JD has serious acquisitions in mind, the time looks ripe to distribute more cashMoreover the table shows cash flow per share often substantially ahead of earnings. Some analysts or investors may prefer a cash flow valuation - i.e. implying lower multiples. Net cash was up from £84.2 million to £209.4 million at JD's end-January 2016 year-end, despite the annual results' cash flow statement showing net cash used in investment up from £59.8 million near £82.0 million. So dividend cover on the ordinary pay-out looks excessive: over nine times based on earnings and over 10 times on net cash flow.

Unless the board has serious acquisitions and development in mind, the situation looks ripe to distribute more cash and/or pay a special dividend. This would add something new to an investment story and help smooth the risk profile.

Besides the fast-moving aspects of fashion-wear retailing, lower sterling means higher costs of importing clothes made abroad. It's not possible to decipher what extent from JD's accounts but with 77% of group revenue UK-derived and most clothing retailers importing from Asia, lower sterling is a proverbial headwind. It's possible astute marketing and commercial momentum overcomes this - just be aware.

Directors buying

The Brexit vote triggered a slump below 1,050p, prompting JD's executive chairman to buy 15,000 shares at 1,156p i.e. £173,400 worth, taking his stake to 1,676,052.

With few businesses like JD available, a premium for scarcity value looks likelyThis was followed on 7 July by the chief financial officer adding 5,000 shares at 1,092p to own 100,000 after affirming a boost to sales from the European football championship in its 17 June AGM statement.

Headline pre-tax profit for year to end-January 2017 is expected at the upper end of market expectations for £170- 190 million, so expect the £179 million consensus to rise, despite strong comparatives for the remainder of the year.

All this signals a growth business in prime health, with the kind of cash profile investors look for. With very few such available, a premium for scarcity value looks likely.

International development evolves

Aside from the UK, the last financial year showed 22% of revenue as continental European derived and 1% rest-of-world. This compares with SuperGroup with 59% UK, 34% Europe and 7% rest-of-world, while ASOS shows 43% UK, 26% EU, 21% rest-of-world and 10% US.

Presently JD is closer to Sports Direct with its 79% UK, 21% non-UK (mainly Europe) split, although Sports Direct is more a discount sportswear and kit supplier than branded quality fashion with international scope. So there is more JD could be doing, which may help explain the board's caution at increasing pay-outs as yet.

With new European business in focus, the Brexit vote naturally poses questionsThe 2015/16 annual results showed the European rollout continuing with a net 38 stores increase for the JD fascia across Europe; sports fashion benefiting from past years' investments e.g. to develop multi-channel capabilities, buying and merchandising - such that operating profit soared 49% to £162.9 million while like-for-like stores growth rose over 10% for a second consecutive year.

Larger-spaced flagship JD stores in London, Glasgow, Newcastle and Amsterdam have been introduced. With Europe presently in focus the Brexit vote naturally poses questions, although Britain won't formally leave the EU for at least another two years. Meanwhile, mitigating actions are being stepped up against euro volatility impacting margins.

Global brand partners are said to support continued international development and further significant investments; which sounds polite terminology for the way Tesco was exposed for exacting financial sponsorship from suppliers. Such is modern retail.

Management sees the need for greater product differentiation from other retailersAnother reason JD's rating has been able to advance was its January 2012 acquisition of Blacks Leisure, including Millets outdoor clothing, footwear and equipment - stubbornly problematic turnarounds.

So the "outdoors" division remains a bit odd alongside hugely successful sports fashion, last year reducing its operating loss to £4.0 million from £7.1 million on £155.3 million revenue. Blacks and Millets broke even; the loss resulted from trialling a new format, Ultimate Outdoors. Hiking and camping could benefit from "stay-cationing" in the UK if lower sterling inhibits foreign travel, but mind such kit-retail is a competitive area.

At least management recognises a need for greater product differentiation from other retailers, to grow margin. Other major brands support this side of the group too.

Enhancing dividends

Commercially, the JD brand looks to have further mileage, with no signs of enthusiasm for sports fashion-wear peaking. The group ought therefore to continue distinguishing itself among retailers, its growth inevitably prompting calls for higher returns of cash. Hopefully you see why directors are buying any drop, and this will continue to pay.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.