The Reject Shop’s Upside Potential

This story features REJECT SHOP LIMITED. For more info SHARE ANALYSIS: TRS

By Chris Shaw

Shares in retailer The Reject Shop ((TRS)) have risen 14% since the group's full year earnings release in August and are up 50% over the past year, increasing the risk of some near-time price consolidation, according to stockbroker Moelis and Company.

But taking a medium-term view Moelis continues to rate the stock as one of its preferred Small Industrial exposures, as there remains growth potential from a continuation of the current store rollout policy.

The rollout remains immature at present, Moelis noting The Reject Shop at the end of FY10 had 196 stores against a target of around 400 locations. Previous indications were for 17 store openings in FY11 but Moelis now expects 19 openings should occur in the period, 12 of them by Christmas.

What should also provide a boost for The Reject Shop, according to Moelis, are ongoing benefits from the opening of a second distribution centre in FY10, as this will create some scale benefits the company could not previously access.

These scale benefits are possibly being underestimated by the market at present, as Moelis points out the new centre in Queensland is already generating greater efficiencies than the existing centre in Melbourne. This is being achieved despite at present less than 30 stores in Queensland and the Northern Territory being supported by the new distribution centre.

For FY11 specifically Moelis suggests earnings risk is to the upside relative to profit guidance of a result between $26.0-$26.5 million, as like-for-like sales growth appears to be tracking at 3-4%. This compares to like-for-like growth of around 1.0% in FY10, when earnings per share (EPS) grew by 22%.

This improved like-for-like growth is coming despite some currency driven product deflation stemming from ongoing strength in the Australian dollar. While currency movements should impact, in the view of Moelis FY11 trading will still be very dependent on Christmas trading as this period accounts for around 60% of annual earnings.

Moelis expects a continuation of solid earnings growth, forecasting EPS will increase by 15-20% annually through FY13. The broker's forecasts reflect this as its EPS estimates stand at 102.1c in FY11, 121.1c in FY12 and 143c in FY13.

By way of comparison, consensus EPS estimates for The Reject Shop according to the FNArena database stand at 101.8c in FY11 and 121c in FY12. The FNArena database shows The Reject Shop is rated as Buy twice and Hold twice, while Goldman Sachs also has a Buy rating on the stock.

RBS Australia rates the stock as a Hold on valuation grounds, while Macquarie is closer to the Moelis view in that new store openings and the potential for these to drive earnings mean the current multiple premium on which The Reject Shop is trading is justified.

Moelis also rates The Reject Shop as a Buy with a price target of $22.00, which compares to the average price target according to the FNArena database of $17.74. Credit Suisse is closest to Moelis with a target of $19.40, while RBS Australia is less bullish with a target of $16.56.

Shares in The Reject Shop today are down slightly and as at 10.50am the stock was 2c lower at $18.24. This compares to a trading range over the past year of $12.29 to $18.40 and implies downside of around 3% to the average price target in the database.

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