The Reject Shop Set For Solid Earnings Growth

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

By Chris Shaw

The end of last week was a busy period for discount retail group The Reject Shop ((TRS)), as the company announced the retirement of its chairman Brian Beattie and reaffirmed earnings guidance for FY10.

Mr Beattie has been chairman of The Reject Shop since 2004, a period in which he saw the company through listing and a doubling in store numbers. Macquarie notes he will be replaced by Bill Stevens, who has been a director of the group for the past two years. A new director with strong retailing credentials is now a target for management.

Of more importance from an immediate investor perspective was the confirmation of earnings guidance for FY10, this guidance indicating a full year net profit of $22.5 million. Macquarie notes this compares to previous guidance of a profit of $22-$22.5 million.

According to Macquarie the earnings guidance from The Reject Shop implies a strong second half performance, particularly as the period has coincided with difficult retail conditions. The other positive is the result will be achieved despite the company dealing with possible distractions and disruptions from the opening of a new distribution centre in Queensland earlier this month.

The centre will supply 90 stores in Sydney's north initially, but more importantly in Macquarie's view will also open up the central and north Queensland markets for The Reject Shop going forward. Significant freight savings are also possible as a result of the new centre in the broker' view.

The centre will be important in helping The Reject Shop meet its growth aspirations, Macquarie noting the plan is for the store network to increase to around 400 shops in total against 198 stores at present. Current plans are for 20 stores to be opened in FY11 following 27 openings in FY10.

As Macquarie points out, this continuous store roll-out is helping offset the current weakness in retail conditions. This weakness is evidenced by like-for-like sales growth being forecast to fall by around 3% this year on the broker's estimates.

While the store opening plans are important, GSJB Were suggests earnings growth is likely to also come from the good business model The Reject Shop has in place. This model allows the group to leverage its investments in both IT and the supply chain. As well, a higher Australian dollar would be a positive given that would imply lower import product costs.

Even allowing for current conditions The Reject Shop is expected to deliver solid earnings growth, Macquarie forecasting earnings per share (EPS) of 86.4c in FY10 and then 104.4c in FY11. GSJB Were's EPS forecasts are similar at 86.9c and 101.0c respectively. Consensus EPS forecasts according to the FNArena database stand at 86.8c for FY10 and 101.1c for FY11.

Applying these forecasts suggests an earnings multiple in FY11 of 16.4 times according to GSJB Were. This is a 33% premium to the average Small Industrials earnings multiple  but the broker sees this as reasonable given the expectation of above market earnings growth.

For FY09 to FY12 GSJB Were is forecasting capitalised annual EPS growth of 17.5%, which along with management's solid track record of operations justifies a higher multiple in the broker's view. Macquarie agrees, pointing out the plan to potentially double The Reject Shop's store footprint offers a high level of visibility for earnings growth and so justifies a premium multiple.

Post the update by management Macquarie has lifted its price target for The Reject Shop to $18.00 from $16.30, the change reflecting a rolling forward of its model. This equals GSJB Were's target and compares to an average price target according to the FNArena database of $17.37. The database shows The Reject Shop is rated as Buy and Hold three times each.

Shares in The Reject Shop today are weaker and as at 1.55pm the stock was down 47c or 2.9% at $15.95. This compares to a range over the past year of $11.39 to $17.39 and implies upside of around 8% relative to the average price target in the database.

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