By Dmitrijs Soha, Fund manager at Pinnacle Global Alpha
Market outlook
We believe some of the companies in the US omnichannel retail industry are currently trading at unsustainably low valuations, courtesy of overly pessimistic perception by the investor community and algorithmic traders preying on the weakness of their stocks. Short interests on these companies are currently well above 30%, even exceeding 70% in a number of cases, with short costs usually well over 30% p.a.
It should be noted that, despite declining or flattish revenues and margins, these companies are all cash flow positive, command strong balance sheets, and are in the process of executing on business turnaround plans, with some of them being led by new management or activist investors.
We believe these companies have a good chance of staying relevant and not going out of business within next couple of years, a scenario the shorts seem to betting on. A number of long positions in these companies take up a significant portion of our assets under management at firm level.
Summary
One of them, Signet Jewelers, is a good example of the above – a profitable business with a solid balance sheet, decent margins, diversified product portfolio, high market share, growing omnichannel presence, bloated costs, and top management with a defined plan of optimizing the business at the helm. The company is currently priced to a scenario of significant revenue reduction over the next 6 years, zero terminal growth, failure to execute on cost cutting initiatives, and barely positive free cash flows.
We believe the overall current market sentiment to be the key reason for Signet’s low valuation – nowadays, revenue growth is king, and a good number of traditional retailers transforming their business models and optimizing costs are implied to go bust within next 5 to 10 years.
The above, in our opinion, is a gross underestimation of the company’s current position and potential. It is true that retail is an industry undergoing major structural change, with the strongest players growing online presence, cutting redundancies, adjusting product lines and introducing various customer loyalty programs. We believe, however, that retailers with solid fundamentals and competent management have a good chance of not only surviving but thriving under the omnichannel paradigm, and Signet is definitely a horse to bet on.
We will show that the profitability and stability of the business remain strong, and, due to a number of clearly identifiable factors, the company enjoys an inherent multiplying effect on any positive news or actual changes to its operations.
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