(ASX: LOV) – Jewellery always fits

If your thinking of adding a small-cap to your portfolio, think Lovisa, a vertically integrated fast-fashion Jewellery specialist with 326 stores globally and arguably the most profitable small-cap retailer on the ASX. Brett Blundy, is the co-founder (recently appointed Chairman) and 41% owner via BB Retail Capital.

The last 6 months has been interesting for Lovisa as the company’s share price fell c.45% with its valuation peaking at a price-to-earnings of 30x that has since came down to earth at 20x. The p/e is still above average for a bricks & mortar retailer however does deserve our attention now.

The fall in share price was two-fold, firstly profit taking due to the high valuation. And second, the recent outlook that like-for-like sales is down -0.9% (target 3% – 5%) for the first quarter of FY19. Notable this is off the back of 4 years of growth with FY18 LFL sales +6.8%.

Excluding the flat same-store-sales in Australia, the company enjoys strong profitability, low debt, free cash flow generation and the benefits of a multi-year runway for growth with further store openings planned for Europe & North America.

Interestingly enough, over the last 12 months the group was able to open net 38 stores whilst maintaining existing store with capex totaling $15m, increased its dividend to $21m as well as increase its cash balance by $10m with no debt funding. A decent accomplishment for a year of 28% sales growth.

Key Stats (FY18)

  • Ebit: $51m ($27m in FY15)
  • Npat: $36m
  • Debt: $25m (undrawn)
  • Net Cash: $21m (+$10m)
  • Market Cap: $712m (18.01.2019)
  • P/E: 20x

The strategy of Lovisa is simple, new stores and geographies, reflective of most bricks & mortar businesses. but where Lovisa differs is its approach, thanks to its nimble business model; its new store costs are cheap and has some of the quickest payback periods I’ve seen. See below.

                                            Australia         South Africa       Singapore        Malaysia

New store fit out cost        124,000             57,000               122,000               65,000

Payback Period                      8.2                    2.3                    4.0                        3.1

Notes: Figures are in AUD

New store set up costs vary by country with Australia the most expensive at $125k (prospectus 2105) with a payback period of 9 months, leases are on average 2 – 5 years allowing for store network optimisation.

The low capital costs and relatively quick payback periods ensure new stores are funded by the cashflow of existing stores without any new debt or equity.

Additionally, its stores are small in size enabling lower lease costs and more profit per square meter. Furthermore, the stores don’t require much employees e.g. 1-3 employees. Overall the cost structure is straight forward with leases and salaries, and inventory.

Valuation

  • Operating Cash Flow: $46m
  • Capital Expenditure: $15m (current capex)
  • Free Cash Flow: $31m
  • Dividends Paid: $21m
  • Funds available for reinvestment: $10m

My arbitrary back of the envelope perpetuity calculation, a sanity check that deserves little attention.

  • CF / (r – g) = $31.3m / (11% – 7%) = $782m
  • CF / (r – g) = $31.3m / (11% – 6%) = $620m
  • CF / (r – g) = $31.3m / (11% – 5%) = $521m

Noting the above, today were paying 20x earnings for a company with the potential to double or triple its earnings in 5-7 years.

Outlook

For the future, I’m keen to see how the company responds to the change in LFL sales, and the actions the company takes to ensure transactions at existing stores continue to improve. Beyond this I will be watching the continued international rollout, in particular North America.

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