Lovisa (LOV) produced a strong set of numbers with its 2018 result and a nice dividend surprise. EBIT was up 26% on the back of continued strong store growth, 6.8% like for like sales growth and expanding gross margins. The only negative in the result was that for the first 7 weeks of FY19 like for like sales growth is tracking below management’s long-term target of 3-5%, although it is still positive. Given the strong growth experienced over the last 12-18mths, this is hardly surprising.
The LOV investment case revolves around the store rollout opportunity. Notwithstanding the slow start to like for like sales in the first 7 weeks, LOV starts the year with 38 more stores than last year, an increase of 13%. These stores will still be maturing, and then further new stores will open. Management has stated that the pace of store rollout will accelerate in FY19. This will drive earnings growth in FY19 and beyond.
Success will depend on two main questions...
- What will the pace of rollout be over the next few years?
- How large will the store rollout eventually become?
Answering either of these questions is problematic but directionally it is obvious how things are likely to play out. Management has indicated that the pace of store rollout will accelerate into FY19.
We believe this confidence comes from two sources. In FY18, LOV was only really expanding into one market the UK, while in its other markets it was “business as usual”. In FY19, they are looking to expand into the UK, USA, France and Spain. While management did not say that they are in full rollout mode yet, in the trial markets of USA, France and Spain, they expect to have 7 stores operating in each of these countries by Christmas. We know from our monitoring of job ads that LOV already has 7 stores in both Spain and France and 4 in the USA (3 in Los Angeles and 1 in Orange County). We think it is safe to assume that each of these markets will move into full rollout mode.
In short, the opportunity set has increased significantly and the scale of these market opportunities is vastly larger than the geographic footprint LOV had been operating.
The second reason we believe that LOV is confident of accelerating its growth is that in FY18 they actually opened 52 new stores, but this was offset by 14 closures. While LOV will always optimise its network, we believe that this process is now largely complete and closures will reduce.
On the question of how large will store roll out eventually become, we can look at Australia, LOV’s most mature market for guidance. LOV has 151 stores in Australia, a country with a population of 25 million people. Breaking this down a little further there are 25 stores in Sydney, and 2 of these are in 1 shopping centre (Queen Victoria Building). These metrics highlight the conservative nature of management’s guidance of 100-store capacity in the UK.
While LOV has specific store requirements, it needs to be remembered that these requirements are not that unusual. In fact, they are the requirements that most “small store format” retailers look for. Instead, the limiting factor is store availability, that is, the physical store locations already exist. We believe that in developed markets population provides a useful guide. The USA has 327m people, UK 67m, France 65m, and Spain 46m, so the question is how many stores will eventually be opened in each of these markets. The answer is lots, particularly if the Australian penetration rate is taken as a guide or for that matter any other ratio of stores to the population. In addition, while LOV management is not currently looking at any other markets, there is no doubt that eventually they will.
The point is that with the cultural and social/economic diversity of LOV’s existing international network there is no doubt that LOV’s store format will succeed in whatever country they operate.
So what does all of this mean?
LOV trades on a high valuation multiple and this, in turn, raises questions over whether this can be justified. Ultimately, this will all come down to the earnings growth that LOV can deliver. With a network of 326 stores right now and with a vast store rollout ahead of it,
LOV will continue to grow rapidly over the foreseeable future and therefore justify its premium rating with earnings growth driving the share price higher.
If we assume that LOV sustains its historical 30 store openings out into the future, its valuation would be around the current share price. However, with the growth in the geographic markets LOV is now looking to expand into and the massive size of each of these markets, an acceleration in the pace of store rollout it is inevitable. As with all store rollout stories eventually, the law of large numbers will come into play and the incremental growth from store rollouts will become increasingly marginal and then the valuation premium will come under pressure. However, LOV is in the very early stages of its global rollout and this dynamic is many years away.
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