Stockwatch: A proven winner still worth owning

Can JD Sports Fashion keep strengthening versus the example of Sports Direct International losing its growth halo? It's an intriguing exchange of baton after I recall first drawing attention to JD at a pre-stock splits equivalent price of 36.2p in August 2010 given its underlying earnings growth rate was not reflected in the price/earnings (PE) rating.

From 2012, SPD advanced to enjoy a PE in the mid-twenties, but the summary table for JD shows this was only achieved by 2016 and, if forecasts are fair, then at about 450p a share currently the rating is still around 20 times on a 12-months forward basis.

Yet, unless analysts are under-estimating JD's international development, the situation has changed from a persistent "earnings-at-a-discount to the PE". See from the table how despite upgrades in response to prelims showing revenue up 31% - driven organically - and earnings per share (EPS) measures soaring over 50%, the price/earnings-to-growth (PEG) rating is now about 1.4 in respect of the year to 30 January 2019. Not to over-react to a snapshot medium-term view but, as JD acquires a halo, it's wise to be alert to dynamics.

Perception can hinge on growth rate changes

Presently, JD is in a purple patch of beating estimates. Prior to the results, consensus was for the earnings growth rate to slip from about 52% to below 40%, but JD actually delivered what was forecast for the year to 30 January 2018. Very strong cash flow also meant end-January cash of £213.6 million despite £88 million capital expenditure. The outlook statement cites inflationary/Brexit issues, "external influences which may impact the latter part of the year" albeit there is confidence the group is "well-positioned for further profitable growth."

One reason for caution towards Sports Direct has been US dollar strength given it buys goods in dollars and a currency hedge is due to expire this month with no hedging in place for its year to 24 April 2018.

JD benefited from currency translation in 2016 due to relative strength in the euro when translating European revenues into sterling, although management now cautions, quite like Sports Direct, that sterling/dollar weakness means some margin headwinds in 2017 but that it's "working with our global brand partners we believe we are in a reasonable position to mitigate against these". The currency situation may not be as challenging as SPD if hard to quantify.

Risk factors in UK and Europe

Towards the end of the prelims release the geographic analysis implies JD's UK exposure remains a dominant 69.6% of the total, down from 77.3%, with Europe up to 27.1% from 21.5% and rest-of-world from 1.2% to 2.8%.

JD's marketing and relations with suppliers position the group strongly for further advances, but it's important to watch whether UK credit card borrowing peaks as inflation rises. Clothing is a discretionary purchase and growth companies such as JD and Boohoo will have benefited from a liberal attitude to credit. People's average earnings are growing at about 2%, currently above inflation, but energy and food prices are also rising.

More significantly perhaps for JD, the status of British companies operating within the EU single market remains an open question: public debate obsesses over exporters potentially incurring tariffs, but there is no consideration of the status and freedom of British companies setting up shop in the EU post-Brexit.

JD's accelerated development in Europe showed a net increase of 54 stores in the last financial year, up from 38 in 2015/16. If the EU determines British exporters should be less well-off outside the single market, why should firms operating there be unscathed? Thus, it was quite rational how JD shares felt a jolt after the Brexit vote - dropping from 265p to 205p (adjusted for November's 5 for 1 share split) - although it is impossible to quantify what risk may be involved.

The market brushed aside any worry, however, as bullish trading updates from end-July attracted momentum buyers. Management's PR line is to politely cite "some uncertainties for the immediate foreseeable future" while offering a carrot how the group is strengthening for "expansion over a wider geography" as if it knows not to rest growth on Europe. Three more stores have opened in Malaysia and a first in Australia is due shortly. If the JD brand gains global momentum then it can offset Brexit risks, but the market isn't paying attention to them.

Blacks and Millets turn it around

A rational reason why JD was rated modestly around 2012 was its £20 million January "rescue" of the "failing" Blacks Leisure, as the media portrayed it. Promoting its own brands of Eurohike and Peter Storm (vertical integration quite like Sports Direct) Blacks Leisure Group had been unable to negotiate a fresh loan from its banks. JD beat off other bidders, including Sports Direct, to buy Blacks from the administrators.

To any investor who had followed Blacks, this was potentially owning a chronic liability, but the five-year turnaround did not prove much constraint on JD and a £4 million loss has become a £1.2 million operating profit in the last financial year. The own-brands appear to have decent customer following compared to Sports Direct buying Karrimor and re-locating manufacturing abroad, only for quality to suffer.

JD's £112 million purchase of Go Outdoors last November (being reviewed by the Competition and Markets Authority) also introduced 58 stores in out-of-town retail parks and further online sales. But I recall from following Blacks/Millets in the wake of the 2009 recession, "more people enjoying the outdoors" is not a reliable theme when consumer spending tightens. There have been real improvements albeit recent sales have probably benefited from credit growth.

Justified premium to rivals

As a circa £4.4 billion retailer JD trades on about 2.3 times sales versus Sports Direct at £1.8 billion on 0.6 times sales and Supergroup at £1.3 billion on 2 times sales. A desirable brand and strong relationships with suppliers justify this versus Sports Direct's woes and Supergroup seeing a temporary drop in profit/earnings in its last financial year.

That's so long as UK inflation/credit trends don't undermine consumer spending to alter the now strong expectations around JD, and Brexit issues also don't unsettle momentum traders to sell. It's also possible a proportion of JD's customer base involves younger people living with parents than being financially constrained by high property prices/rents.

So JD merits retaining for its long-term international potential, but keep an eye on what can take some shine off its story in the medium-term.

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.