This week we’re looking at a small cap retail stock that is offering investors a concentrated bet on the reopening theme. In 2020 we saw a huge shift in sentiment towards stocks that were benefiting from a covid-19 environment. Companies such as Pushpay (PPH.ASX) and Redbubble (RBL.ASX), we bought both heading into the pandemic, were huge beneficiaries. Heading into Christmas, the covid winners and now the covid losers and retail stocks are starting to grab more attention. With Australia exiting lockdowns there is a lot of pent up demand for retail spending, what we like to call revenge spending.
The stock in question is the specialist jewelry retailer Michael Hill.
Michael Hill (MHJ.ASX)
Michael Hill International Limited is a global specialist retailer of jewellery with 285 stores operating in Australia, New Zealand, and Canada. The company was founded in 1979 by current group president Sir Michael Hill. Jewellery stores are a bit different from normal retail stores, people typically want to visit jewellery stores and talk to a diamond specialist when making big purchases, such as engagement rings. This sees them occupy a more stable position in the retail market place.
MHJ has slipped under the radar in the FY21 reporting season; they saw revenues increase 13% despite 10,447 lost store trading days as a result of Government mandated lockdowns and some permanent store closures. Their Canadian segment has done very well since reopening in June/July and we see the same happening in their Australian and New Zealand segments which are showing a lot of upside.
MHJ has been shifting the company toward a more digital footprint. Their digital sales increased by 53.4% and management expects to see digital sales accounting for north of 10% of total sales within the next few years. MHJ are also expanding through digital marketplaces, now offering their products through The Iconic, one of Australia's largest digital marketplaces. We expect to see MHJ find similar partners in Canada and New Zealand.
Michael Hill launched their loyalty program, Brilliance, and within eighteen months memberships have already grown to over 800,000. The program is clearly resonating with customers and is aiming to deliver increased frequency, larger baskets, and higher margins. The program will provide MHJ with valuable data and insights which should help increase personalisation and enable the use of artificial intelligence to deliver further growth in the business.
Valuation + Outlook
To value MHJ we are going to look at their assets and then their earnings power. After paying down debt, MHJ is now in a significant net cash position of $72m. To be conservative, and taking into account the required working capital for the business (i.e. cash for the registers), we will use a reduced net cash figure of $65m. MHJ recently conducted a strategic review of their Canadian in-house customer credit book. The asset is held for sale and is considered probable and expected to be completed within a year, the sale of the customer finance book should bring in around $13m. MHJ is also currently sitting on inventory of around $170m, if we add the $13m of assets held for sale then we get a net cash figure of $78m. This puts MHJ at an enterprise value of approximately $310m, giving MHJ an EV/EBIT of 4.3x. MHJ’s strong balance sheet gives us a huge margin of safety if things weren’t to go as expected, an important consideration we take into account in our investment process.
Looking to MHJ’s earnings power, we see MHJ starting to pick up up tailwinds on the back of a great FY21 result. They recently gave an FY22 Q1 update which saw same store sales up 15.5%, up from the corresponding quarter last year. Margins continue to rise on the back of their digital expansion and their additional omni-channel offerings - including Ship-from-store, Click & Reserve and Virtual Selling - all of which are higher margin channels. MHJ lost over 10,000 total trading days in FY21 and, while they lost 7,400 days in the September quarter heading out of lockdowns and into the Christmas spending season in Australia and New Zealand, they should see a surge in spending for retail across the board which should drive MHJ’s sales. There is a lot of pent up demand for consumer spending and we have already seen how it positively affected sales in Canada upon reopening. Management recently noting that “our Canadian business has been flying, delivering impressive sales and margin growth every week.” The play here isn’t like most retail store strategies, which is typically to open up new stores and expand their physical presence. The strategy here is to increase digital sales through marketplaces like The Iconic, thus driving margins and opening up their products to new customers. MHJ has also done a terrific job at growing their loyalty program to over 800k members in less than eighteen months; this will be essential to leverage their digital capabilities.
If MHJ sees the demand that we expect upon reopening and heading into Christmas, they should see $50m+ NPAT for FY22 which will put them at less than 8x earnings. All while paying a cool 4.5% dividend yield. If MHJ were to rerate to 10x FY22 earnings then this would put them at a share price of around $1.30.
MHJ is one of our favourite stocks to take advantage of the reopening theme
Disclaimer: MHJ is currently held in the TAMIM Fund: Australia Small Cap Income portfolio.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.