Offshore Markets Add Sparkle To Lovisa

This story features LOVISA HOLDINGS LIMITED. For more info SHARE ANALYSIS: LOV

Fashion jewellery retailer Lovisa Holdings has proved successful in rolling out stores offshore and brokers expect earnings will accelerate significantly once the upfront investment tapers off.

-Investment case hinges on size and speed of roll-out
-US the main target for growth in the short-medium term
-New growth opportunity in Malaysia and possible progression to Canada
 

By Eva Brocklehurst

Brokers are enthusiastic about the outlook for fashion jewellery retailer Lovisa Holdings ((LOV)) as it embarks on a large global roll-out of stores. While the stock is considered far from "cheap", Morgans points out exposure to a significant roll-out program globally is a rarity for the Australian retail sector.

The broker believes the earnings growth profile will accelerate meaningfully, once leverage returns on operating expenditure. Citi is also confident in the company's long-term growth, supported by the extensive plans to roll out stores. Like-for-like sales are expected to improve in the first half of FY20 amid better retail conditions and foot traffic in Australia, which represents 40% of the company's stores.

Like-for-like sales growth to date is within the company's target of 3-5%. There is also increasing brand awareness in new markets. Macquarie notes shopping centre traffic growth in Australia turned positive during the week ending August 11, after declining for 14 consecutive weeks and this is a big help to Lovisa, as it is dependent on shopping centre traffic to drive sales.

Citi suspects the online business has lowered profitability, overall. Online was launched in Australia in October 2018 and in the UK in July 2019 and as this business ramps up there may be pressure on margins. Macquarie points out physical site availability is a key issue in the UK.

Morgans suspects margin pressure is unavoidable, noting for some time the company has been highlighting the impact of a lower Australian dollar on gross margins. The broker expects a portion of the decline will be recovered via price increases but assumes gross margin drops to 78.5%.

The pressures on gross margin from currency are understandable, in Citi's view, as investments in new markets remain necessary. Citi expects FY20 operating earnings (EBITDA) margins to decline to 22.8% because of the ongoing investment, the ramp up of online business and costs of opening stores in the US and France.

Macquarie assesses Lovisa has a globally proven and scalable retail concept but the investment case will hinge on the size and speed of the roll-out. The US is the main growth driver in the short-medium term.

Morgan Stanley, while noting softer momentum in the business from the recent trading update, points out the exposure to offshore markets does come at a time when there are concerns about the impact of Amazon and a weak consumer setting in Australia. Still, the broker expects upside will ensue from success in Spain, France and the US as well as new markets.

New Markets

Citi expects 66 new stores in FY20, amid a new growth opportunity in Malaysia and further upside if Spain delivers. In Malaysia new stores so far have generated strong returns with the potential to roll out up to 50.

Attractive markets include Canada, Mexico and China, based on GDP per target customer and population. Citi has assessed these three countries are in the top costume jewellery markets and could represent a combined opportunity of at least 314 stores.

Progression to Canada is considered logical as Lovisa is currently rolling out stores in the US but the company has highlighted the different leasing methods, which could be a deterrent. Macquarie notes management has been diligent in terms of network optimisation and site choice, ensuring hurdle rates are achieved.

FY19 results were considered solid, given a challenging market. Strength in cash generation continued, with 107% conversion of operating earnings. This meant the company lifted its dividend by 22%, taking taking the full year payment to $0.33 which equates to a 94% pay-out ratio.

Morgans suspects Lovisa will lower the ratio in coming years, as expenditure in new large markets increases and lowers the pay-out ratio forecast to 80% for FY20. Bell Potter expects the cost versus sales ratio will remain at current levels before beginning to taper in FY21-22 as scale benefits flow.

Given reduced reliance on its mature Australian footprint and strong operating attributes the broker, not one of the seven monitored daily on the FNArena database, retains a Buy rating with a $15.00 target for Lovisa.

FNArena's database has three Buy ratings and one Hold (Morgan Stanley). The consensus target is $12.57, signalling 2.7% upside to the last share price. This compares with $10.98 ahead of the results. Targets range from $9.00 (Morgan Stanley) to $14.10 (Citi).

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