Out of love with Lovisa?

For a while there Lovisa (LOV) was a bright spot in Australian retailing. A domestic success story conquering the world. But that was a few months ago. In October the company’s share price is down 26% after a poor sales update. Investors’ love affair with Lovisa seems to be falling apart.

Lovisa has infiltrated your local shopping centre with its low cost fast fashion jewellery. This just in: gold diamond (shaped!) pearl earrings for the low price of $18. Or yours for four interest-free payments of $4.49 fortnightly with everybody’s favourite budget management tool AfterPay (APT).

In August Lovisa delivered a stellar result for the prior year. Revenue was up 21%. That was mostly driven by opening 52 new stores (and closing 14). But the real standout was sales in stores opened for longer than a year, called comparable store sales. Those improved by 6.8%. That’s a heck of a year. And it came on the back of 10.3% growth the year before.

And profits didn’t disappoint. Earnings before interest and tax rose 26% with a margin to sales of an almost unheard of 23.5%. Net profit after tax rose 24% to $36m.

With a long runway of growth from new stores and excellent performance from old stores, what was not to love?

Trees don’t grow to the sky

Well, as the old German proverb goes, trees don’t grow to the sky. And neither do high growth retailers.

Those amazing sales numbers from existing stores seem to be falling victim to their own success. When announcing their annual results Lovisa warned that sales for comparable stores were below their 3% to 5% targeted range after being above it for years. An update given at the annual general meeting this week showed comparable store sales were down 0.9%. Lovisa fell 18% on the day it was announced (though it has recovered a little since).

Growth in the established stores is one part of the puzzle. But it’s the offshore expansions that has investors excited. Lovisa has been successful in going global so far. It has successfully exported the concept to New Zealand, Singapore, Malaysia and South Africa. But those regions can’t support any more stores. Growth will need to come from new regions like the UK, Spain, France and importantly the US. The UK already has 24 stores and can scale up to 100. Other geographies are still unproven.

And the Australian dollar is not helping either. Lovisa imports most of its trinkets from overseas, so a stronger Aussie dollar helped Lovisa improve earnings by $2m last year. Despite having some hedging in place, a slide to $0.71 per US dollar won’t help this year or next.

Paying the big price

But all of this wasn’t so much a problem. The business has performed well and may continue to perform domestically and expand globally. The issue was the multiple being paid for those earnings and how little margin of safety investors were prepared to accept. Just before the annual results were released, Lovisa was trading at a hefty 29 times the following year’s consensus earnings.

Paying that multiple meant that Lovisa would have to succeed in getting at least a few of those new regions right. That’s possible and Lovisa has form. But it’s not as certain as investors had assumed.

And it meant that the current crop of stores would need to be as profitable as they have been. At those stellar margins Lovisa is in a rarefied group of Australian retailers. Nick Scali (NCK) has similar margins but for a very different product.

Would it be a surprise to see Lovisa’s margins fall? With an unfavourable foreign exchange rate and a consumer squeezed by lower spending power and tempted by more online sales? It shouldn’t be.

Founder and 41% shareholder Brett Blundy will come onto the retailer’s Board as chairman next month. He has his work cut out for him convincing investors that the business can keep a wonderfully performing Australian business on track while conquering the world. The ending to the Lovisa love story is unlikely to be a happy one.

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