Equities

Lovisa's (LOV) result has been very well received by the market, due to a number of factors. Firstly, leading into the result there were concerns due to the tough retailing environment in Australia that like for like sales would deteriorate – the actual result shows a deterioration of just 1.8% (off a very strong pcp) and for the first 6 weeks of the new year it has turned positive (sub +3%). 

Secondly, there were concerns about the impact of currency on gross margins – the result shows that a 1 cent move in the currency impacts gross margin by just 0.25%. 

Finally, management gave a green light to the store rollout in the USA and France. In the USA there are over 1,100 enclosed shopping malls.  We know that initially, LOV plans to target 200 of these malls.  Critically, they may not end up in all of these malls, as management simply will not enter into any lease agreement that does not meet their criteria. 

Of course, this is only the initial target market and there are the other 900 malls to go. There is no way to know precisely how many stores LOV will have in USA, France, UK etc. All we do know is that Australia supports 155, so given the relative population sizes of these countries the answer is many hundreds.     

We continue to believe that the market is underestimating the significance of the global store rollout, and critically how this will underwrite the confidence in the earnings outlook for LOV.  In the first half of 2019 LOV opened 51 new stores and closed 11 as part of its network optimisation program, for a net increase of 40.  While we would always expect some store closures from LOV, the quantum is likely to decline from here. 

Critically this level of store openings occurred before management committed to a full store rollout in the USA and France.  Management is in the process of building out its teams in USA and France to manage the rollout and have said operationally there are no real limits to the number of stores it could rollout in any given year.  Rather, it will be determined by the availability of appropriate sites. 

If LOV could find 51 “appropriate sites” during 1H19 and is now actively looking in the much large markets of the USA and France, it is almost certain that they will be able to open an increasing number of stores.  Assuming 60 net store openings per annum over the next 3yrs this will produce compound growth of 14%pa with every additional 10 stores adding an extra 2%.  When combined with like for like sales growth, the maturing of the performance of newly opened stores and operating leverage, we can bank on LOV achieving around 20% earnings growth. Importantly, the risk surrounding this growth is low.

The share price has rallied strongly over the last few months, and we suspect that it will do some consolidation around these levels. However, with the stock trading on a PE in the 22-23x range given the strength of its earnings outlook, it remains an attractive investment.

 

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