This week, Next warned investors that it may tweak guidance as warmer weather in the UK may have an impact on sales. Next stock was hammered, as everybody noticed. Not so many observers were quick to pick up the performance of Associated British Foods, however. In fact, the shares of the Primark owner rose more than 4% on Tuesday. Why so?
Well, Credit Suisse upgraded the stock to outperform, and thats one reason. Another possible reading is that pressure on margins will become more evident into 2015 as the consumer will continue to buy cheaper goods. If so, the Primark owner may be in a sweet spot, but trends should also favour ASOS, SuperGroup and Boohoo, all of which sell fashion clothing and apparel at convenient prices.
Its not so easy, though. The real problem at ASOS? A steep growth in revenue is necessary in order to preserve thin operating margins. As such, heavy investment and price investment are needed.
I Was Wrong
When I wrote about ASOS in early June the retailers shares traded above 40, but they have since plunged to 20. Back then, I noted that it would have made a lot of sense to add ASOS stock to a properly diversified portfolio. It was never meant to be a swift exit, but ASOS stocks performance has been dreadful so far. Fair enough.
Still, will the shares return to trade around 30? Very ppossibly
And will they hit 40 again in the next twelve months? I wouldnt rule that out, either, although it looks much more challenging now. ASOS is down 67% year-to-date, and it has been outperformed by SuperGroup and Boohoo.
My call hasnt yielded dividends so far well, in fact its a 50% paper loss! but I believe ASOS is still a bet worth taking over the medium/long term, and even more so at 20-24 a share. Its not just a speculative bet on a stock whose valuation has been battered for a couple of quarters now. Read on
Trading Multiples/Balance Sheet/P&L
ASOS is not Next and is not Ted Baker, the two top names in the sector. Admittedly, these two belong to a different league. Their shares are a tad expensive, but their management teams have proved they can deliver in tough trading conditions. Management at ASOS must prove they can do the same right now.
ASOS is certainly overvalued based on the value of its assets, but its balance sheet is strong. Management has shown financial discipline in managing cash flow and working capital, and these are elements to like. Of course, its the income statement that will make the difference to ASOSs equity valuation in years to come.
If ASOS continues to invest in capex which is forecast at 6% of sales its top-line growth will not disappoint investors, who should carefully monitor the companys underlying level of profitability, but should also consider that estimates are for revenue growth above 20% over the medium term. ASOS is tapping new markets, too.
Operating profit and net income may turn out to be volatile, and will come under pressure at times, but ASOS will just have to continue to grow its business to shore up its equity valuation. ASOS will likely be in the black even if price investment policies may lead to a 15% annual growth in sales, i.e. more than five full percentage points below projections.
Its stock trades at 27x and 22x adjusted operating cash flow for 2014 and 2015, respectively. These trading multiples dont reflect its growth potential, in my view. The key question now is whether the interest of shareholders would be better preserved if ASOS were part of a larger conglomerate, just like Primark. A takeover would easily value ASOS stock at 35, and would also boost the valuation of its rivals. This is a very possible outcome if pressure on profitability persists, in my view.
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK owns shares of ASOS. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.