Small Caps | Jan 18 2016
-Buying opportunity arising in the stock?
-Accent sales growth may slow from high rate
-Accent synergy estimates very conservative
By Eva Brocklehurst
Footwear distributor and retailer, RCG Corp ((RCG)) is intent on unlocking the strategic benefits that will arise from its acquisition of the Accent group, with cross selling of brands and supply chain opportunities aplenty. Indeed, the current pull back in the stock presents a buying opportunity to Moelis, with RCG having reached a high of $1.80 in December before easing back at the start of 2016.
After a strong Christmas trading period the broker notes exceptional demand for apparel and footwear, which was underpinned by a falling Australian dollar that brought customers back to shopping precincts and away from online purchases.
This confirms Moelis' suspicions when initiating coverage on the stock last November: that consumers will increasingly return to the shops to try on items to obtain the level of service that exists above online offerings. Savings online now appear less important than consumers' desire to receive the goods immediately and, particularly in the case of shoes, have these fit properly, while also enjoying the shopping mall experience.
The Australian Retailers Association has reported an uplift in foot traffic and spending across the country over the holiday season, with higher-than-usual demand for soft goods post Christmas. The broker cites David Jones reports of like-for-like sales growth of 9.7% in the first half.
Moelis believes other factors, such as low interest rates and falling fuel prices, have also provided a positive boost to sentiment. RCG is likely to obtain a further boost from the “back to school” trade at the start of February, although the broker notes gross margins may be affected because of discounting.
Upside risks to forecasts at the first half result are considered highly likely, given the company's earnings sensitivity to higher sales growth, larger store footprints and margins. Assuming the Accent division’s margins are at 14.7%, for every 10% increase in like-for-like sales Moelis estimates this will increase FY16 group earnings by 3.4%.
While RCG has guided to 1-2% earnings margin compression in FY16 in the Accent division, the broker also understands that RCG is opening larger stores. As sales growth increases the broker expects margin compression will reduce and, with like-for-like sales growth above 20%, earnings margins are likely to expand. The company reported at its AGM the Accent division like-for-like sales rose 30% in the first 16 weeks of FY16.
The stock is a key way to play a growing active wear theme in Australia and Moelis retains a Buy rating and $1.75 target. Morgans, too, has an Add rating with a $1.67 target, suspecting the company's guidance at the AGM could prove quite conservative if the critical Christmas/New Year sales period is negotiated successfully.
Morgans believes it is highly unlikely Accent's like-for-like sale growth will slow dramatically and remains comfortable with the stock from a valuation versus growth perspective. The broker expects Accent sales growth of 20%, which implies sales growth slows to 15.6% over the balance of FY16.
Strong earnings upside is envisaged in FY16 with cost synergies evident in FY17. The broker observes management continues to assume no synergies from bringing the RCG and Accent businesses together and considers this a highly conservative assumption. Streamlining of the two supply chains should unlock meaningful cost efficiencies in time.
The company is nearing completion of a strategic review of The Athlete’s Foot and expects the changes being made will underpin growth in coming years. The first 16 weeks of FY16 revealed sales growth of 5.0% in this division. Momentum is expected to continue over the rest of the financial year. Morgans does note this remains the mature network among the company's outlets.
In contrast, management expects to open 28 Accent division outlets in FY16 and the broker expects these will largely involve the Platypus and Skechers brands. Meanwhile the Accent wholesale business, despite no specific numbers being provided at the AGM, is considered to be growing in the high single digits, primarily driven by the Skechers brand.
See also, RCG Corp Well Set To Run Higher on November 16, 2015
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