Consensus community valuation
Harli and Harpa (H&H) Competition
The H&H website is now live, presenting a clean and polished look. (FYI, it wasn't up when the first stores opened) It’s hard to find on Google due to name spelling variations, this should resolve as brand recognition grows. Their Instagram following is currently (2.3k), Lovisa's (461k), a metric worth tracking to gauge customer interest.
Product Range
The product range looks good, and I've changed my mind about the target age bracket (re my comments post LOV agm). After reviewing the website, I feel the product is more suited for an older customer base, 20-25+ and easily caters for a much older market too. To me, the product range appears more "mature" than Lovisa's offerings at this point.
Price points & SKUs
H&H's price points cover a broader range than Lovisa's, with products priced up to $200. Could this wide range potentially confuse customers about the store's target market positioning or is it a product fit test to see what works? Monitoring these price brackets going forward will help define where their market sits. For reference, Lovisa's highest price point is $75, with a total of 40 SKUs between $50-75 out of 6.4k+, so the bulk is well under $50. (ref: aust site)
Here's a breakdown of H&H's wristwear category, as per website 4/12/24
I've attached a comparison of a $200 bangle next to a $30 one, this is how it came up on the website. This price disparity might be confusing for customers, though the quality difference may be more apparent in-store. TBC
Product items by Major Categories as per websites, 4/12/24, (Note: This total doesn't capture all SKUs, especially for Lovisa, which has many subcategories.)
Bridal Category
The bridal category comparison was particularly interesting. H&H features it as a main menu item, with appealing product styling. Lovisa's bridal section, is hidden under "occasions," appears less attractive and to me looks "cheap" in comparison: no one wants to feel cheap when buying wedding jewellery. I think this could be a lucrative sub-category within the business.
Photography
A side-by-side product search for silver hoops revealed significant differences in image quality between Lovisa and H&H websites. Lovisa's product shots are arguably unacceptable for an online store. I suspect the images are being provided by manufacturers to accommodate their fast product turnover. While photographing small, reflective items on a tight budget is challenging (good jewellery photography is difficult and expensive), there's room for improvement in Lovisa's imagery. Enhancing photo quality could potentially boost online sales, maybe? This raises the question: what are the implications of trying to develop an online presence in China with subpar images? The flip side is it's perhaps this comment on product photos is misplaced, given that in-store sales remain the main driver of Lovisa's business. A focus on the important part of the business?
Store count
H&H currently has 11 stores open across VIC, NSW, and QLD.
Conclusion
My current thoughts, which are subject to change are that the H&H product is targeting an older customer than the Lovisa store. Side by side, the H&H website feels more luxurious and is easier to navigate and find items, although this is probably a reflection of the smaller number of SKUs available. Has Lovisa's ranging become too broad and less specific/targeted?
In contrast, Lovisa's site feels cheaper, this is partly due to the current Cyber Monday marketing, which is loud and in your face. At different times, the presentation has been "classier" so take this comment with a grain of salt.
Obviously, we need a lot more time to really see how H&H and LOV compete head-to-head, or if they are they actually targeting slightly different markets, with clear overlap in some areas but perhaps not all?
I'll revisit this after I have a chance to visit a store, (no idea when I’m next in Melb) and see if the online experience matches the in-store experience. I'm also v interested in accessing the quality of the product.
Store-Product Feedback
It would be great to get wider feedback on customer insights on Lovisa and H&H stores & product. So if you, your wives, daughters, or other family members have shopped there, I'd love to hear their thoughts on:
- Product, store layout & atmosphere
- Customer service
- Anything really, all feedback is valuable, esp from real consumers
Thanks
held
Store opening: Harli + Harpa
Woah, I totally missed this! I've been away a lot in the last couple of months, but I just found out about this via the Intelligent Investor weekly report. (It was a 1-liner in the II report to explain the recent SP drop)
Thought I'd share it in case others missed it too.
Lovisa's ex-CEO Shane Fallscheer has opened a new jewellery store called Harli + Harpa. They launched their first store on the Sunshine Plaza last week, with a second one in Westfield, Doncaster.
Interestingly, I couldn't find a website for them, and their Instagram only has six images so far. Looks like a soft opening.
Their message: Harli + Harpa is positioning itself as ‘Your walk-in jewellery box’, focusing on fashion-forward, long-lasting pieces for every occasion, good tagline.
Fallscheer at the helm is a huge advantage for this new chain. With his Lovisa background, he knows the prime locations with the biggest ROI and will target those first. I reckon they could easily ramp up to 20+ stores quickly - he's probably got the funds to make it happen.
Excerpts from AFR, link below
"Mr Fallscheer has deep retail connections after working with billionaire Mr Blundy for three decades, and is aiming to shake up a sector that Lovisa has dominated with its affordable earrings and friendship bracelets."
"The retail executive surprised the market in October 2021 when he flagged his departure from Lovisa after 12 years leading the fashion jewellery company, which at the time of his exit spanned more than 550 stores in 20 countries."
"Mr Blundy, who is the chairman of Lovisa, said at the time that Mr Fallscheer was the driving force behind its creation."
A major threat is the potential migration of key Lovisa staff, which may have already happened. SF has working relationships with important players at Lovisa, making poaching or offering new opportunities very tempting. My thought has always been: if you wanted to compete with Lovisa, poach their product development staff first, followed by other key operational positions. So, this could be exactly what's happened here.
Another reason for Herrero’s departure?
Store layout looks familiar
Same goes for the Insta styling
It's worth noting that Claire's in the US recognized the threat of Lovisa and established a new chain called Icing to go head-to-head with them. However, in my opinion, they aren't in the same league as Lovisa, so I never really considered this a real threat. On the other hand, Harli + Harpa, with Fallscheer at the helm, is potentially a long-term real threat to Lovisa's business.
Where to from here:
I'll be tuning into the AGM on Friday, keeping a close eye on developments, and reassessing my options. It’s probably time to reduce my position size, which is quite large IRL due to cap growth. While the long-term impact on Lovisa will take time to materialize, there could be a quick hit to individual Aussie store profitability if they are head to head in a shopping centre.
For example, if jewellery spend in a shopping centre gets split between two stores, it immediately impacts Lovisa's profitability at a store level and, by extension, their bottom line.
held
16/11/2024
It looks like it’s been over 12 months since my last valuation (I didn’t date it). There’s been a 59% jump in the share price in the last year and I suspect the valuation has jumped also.
Let’s take a look!
@Slew has done some work on store roll outs so far this year (36) which seems to be not as good compared to last year at this stage (99 total rollout last year).
What do the analysts think will happen with earnings? There quite a few that follow Lovisa (a consensus of 14 on Simply Wall Street for forecast earnings data)
Source: Simply Wall Street
For FY25 the consensus NPAT is 95 cps and heading up steadily over the next few years. If this turns out to be close that’s a massive 125% ROE based on shareholder equity of 73 cps at the end of FY24. That’s the highest forecast ROE of all the businesses I hold IRL.
If I use McNiven’s Formula and assume ROE can be maintained at 125% (unlikely I believe), shareholder equity of 73 cps, 15% of earnings reinvested, 85% earnings paid as unfranked dividends (approx 2.8%), I get a valuation of $25 for a 10% required annual return. So even though the share price is well down from its 12 month high of $37.48, it doesn’t look cheap to me.
Source: Simply Wall Street
The other thing to note is that over the last 4 years Lovisa has paid out more in dividends than it had in NPAT! The dividends are well covered by cash flow, but over the same time debt has risen and cash reserves have fallen. Four years ago Lovisa had no debt and $38 million in cash. Now it has $54 million in debt and $35 million in cash. Still very conservative, however, I’m not sure if Lovisa can continue to pay out more dividends than NPAT continually. It’s not something you see a lot. Perhaps Brett Blundy can see the business spewing more cash into the future? He generally sees high ROE as KING, and debt as the enemy!
Source: Simply Wall Street
Looking at my current valuation I probably should have been selling Lovisa last month. For me it’s a hold for now. I don’t think it’s cheap enough at $29 per share.
Held IRL (0.8%)
11/2023?
FY23 NPAT $68.2M up 20.1% on last year, but was 7.5% below analysts consensus of $73.7M.
FY23 EPS 63.3cps up 16.6% on last year.
Final Dividend 16% lower at 31cps compared to 37 cps last year. Total FY23 dividends of 69cps representing a 109% payout ratio. This is a worrying trend. For high ROE businesses I would prefer to see more earnings reinvested into growth.
Franking reduced to 70% compared to 100% previously. With a higher proportion of overseas earnings this might be the norm from here on.
Total shareholder equity of $80M, with 110M shares outstanding at 30 June 2023. Equity per share of 72.7cps.
Return on Equity (ROE) at 85.3%. While this is likely the best in the ASX retail sector, it’s not as high as I was expecting (+90%).
Using McNiven’s StockVal formula assuming forward ROE of 85%, equity of 73cps, 10% of earnings reinvested, and a required annual return of 10%, I get a valuation of
“Join the Lovisa America Team! Exciting times are ahead at Lovisa with many new stores opening across America. We are looking for our next amazing Lovisa Sales Super Stars to join our growing team.” Ref: Lovisa US website, job openings
I’ve been exploring job openings at Lovisa worldwide to get a sense of new store openings. My hunch is that the focus is on the Americas region, given the new logistics/warehouse facility that opened, which should allow the store count to ramp up. In FY24, there were only 17 new stores in the US compared to 72 the previous year. Did they hit operating/logistics capacity in FY24 and were unable to effectively open more stores?
The American website combines job searches for the US, Canada, and Mexico, reinforcing the comment at the last meeting that they look at geographic regions rather than country borders.
Based purely on job availability locations, there has been an increase in store numbers in the region:
- US: 23 new locations
- Canada: 5
- Mexico: 1
As shown below, there are also a few additional store locations in other countries.
This brings my estimate of new stores opened since FY24 to 36 plus. My rough analysis only captures stores needing staff, so it is far from perfect data, just an indication.
I’m in two minds about this. In around half a year, there have been less than half the store openings compared to the 99 from last year. Ideally, I would have expected to see a greater number of stores opening by now to capitalize on the Christmas trade.
However, I have no idea about the number of stores in the pipeline waiting on lease negotiations, etc. The US is far from saturated in terms of store numbers and locations.
I was unable to count the stores on the store locator map of the US, as they are not shown in list form only as a map. I don’t have the time/patience to count them now. Does anyone know a way to count the stores from a map easily? https://www.lovisa.com/pages/store-locator This would be a better data point.
Regarding China store openings, I found nothing on any new stores in China. I did come across Lovisa on numerous online platforms in the region, so it appears that China stores has been put on the back burner, opting for an online-only presence.
disc: held
This straw examines the performance of $LOV over recent years and considers how the business might evolve over the next decade, to form a basis for my valuation.
I’ve not been very reader-focused in writing it up, as it is more a download of the thought process I went through. So for those for whom life is too short, I’ll summarise the key messages below, and then for those who have developed their own valuations of $LOV and want to get into the details, I’ll leave it to you to wade through my brain dump (good luck!).
Key Messages
- $LOV along with most of the retail sector has rallied strongly over the last 6-months
- This has been driven by excessive market pessimism combined with operational outperformance by many, including $LOV
- $LOV is still early in its global rollout, having established clear and compelling unit economics
- The rate of the future rollout is a key unknown which drives uncertainty in the valuation
- $LOV has significant optionality in capital management including i) new store openings, ii) dividend policy and iii) capital structure.
Valuation
- $24.80 ($19.50 - $30.50) – at constant FY23 LT Debt of $65m
- $30 ($23 - $37) – capital structure with LT Debt of 0.5x EBITDA (“Levered Case”)
- To achieve a 10% Return in the Levered Case requires a SP of $18.50 ($14 - $23)
Conclusions:
- At the current SP of $31.65, I’m a HOLD on $LOV. While at the top end of the valuation range with the current capital structure, it represents reasonably fair value considering the balance sheet and growth optionality.
- I'm a Buy around $19 and a Sell above $36.
DETAILED NOTES and ANALYSIS
1. Retail Context
$LOV broadly reflects what has happened to the retail sector over the last 12 months. We saw a low point in market expectations around 6 months ago – when many were predicting a 2024 recession in US, EU and Australia, which would necessarily result in serious belt-tightening in discretionary categories.
While the results have indeed shown some slowdown, like-for-like (LFL) comparisons between the last quarter of calendar 2023 and trading updates in January and February have indicated the resilience of the consumer. With interest rate cuts anticipated in CY24, and job markets generally strong (albeit weakening), consumer confidence in US and Australia has picked up more recently. The EU area and UK – both in recession – remain in the doldrums. While global economies are not yet out of the woods, it appears increasingly likely that many areas will avoid recession and recessions, where they occur, will likely be shallow and short-lived.
So, with this macro backdrop, retailers headed through 2023 preparing for the worst. Many managed inventories tightly, continued to benefit from normalised supply chains, and managed costs of doing business as well as they could in an effort to minimise the negative operating leverage of their high fixed cost bases. Certainly, there were significant profit falls, but generally retailers performed better than expected. SP's have rebounded accordingly.
$LOV reflects this broad trend. Compared with FY23, when the P/E was 30.5x, after 1H, the forecast P/E for the FY24 has rocketed back up to 41 – near its highs in the last 24 months.
So, I am keen to understand what a reasonable range of valuations is for $LOV, at this point.
Lovisa is still at the early stages of a global roll-out. It now has a significant presence in ANZ, US and the EU/UK, but is in fact now present and growing on every continent and it in 40 countries.
It has proven compelling economics at the store level, and with strong free cash generation, a key question is at what rate will it continue to roll out new stores. This is clearly a perpetual question on the analysts’ minds – rightly so – and one which CEO Victor Herrero steadfastly refuses to give guidance on, sticking to the key message that they will open stores when they get good deals. Personally, I like this approach, as it has capital discipline written all over it. However, as my analysis shows, the uncertainty creates a wide range of potential outcomes for valuations.
2. The$LOV Global Rollout Under Way
I like to invest in companies that are building leadership in global markets (think $ALU(sniff), $RMD, $WTC, $PNV,…and yes $AD8 and $PME). So, part of my thesis is that $LOV is building a global brand and footprint in fashion jewellery and, provided it continues to execute, it has a very long runway ahead, even if the business is now relatively mature in ANZ. (Even my small home town in NZ with a population of <100,000 has a $LOV store!)
Table 1 below shows the evolution of the store footprint. The bottom row of the table shows the net annual change in stores. What this table doesn’t show is how actively the network is managed. Underperforming stores or even entire franchise agreements will be exited where necessary.
Considering the ANZ store footprint as indicative of a relatively mature market gives an indication of the potential ahead. For example, with 207 stores in the US today, the potential here could be 1500-2000 stores, double the size of all $LOV today. The same is true for the EU/UK region.
Table 1: Store Footprint
3. Revenue Growth Tells the Story of the Recent Retail Cycle
Next, I want to understand the historical story of revenue growth.
Figure 1 (below) shows annual sales growth by half-year increment, on both a like-for-like (LFL or comparable stores) basis and total revenue growth. The latter benefits from the significant new store opening programme of the company's global roll-out.
Figure 1: $LOV Annual Revenue Growth (%, Total and LFL)
Source: Annual Reports
Consider first the LFL sales growth. Pre-pandemic, $LOV experienced a slowdown from 2017 into 2019. At that time, $LOV was dominated by ANZ, and I can’t see anything in the macro for clothing and accessories retail segment to support the companies claim at the time that macro factors could justify their claims of “cycling strong prior periods” and “tougher trading conditions”. In any event, strong new store grow meant that overall revenue growth was strong.
The pandemic dip in 2020 and sharp rebound in 2021 requires no explanation.
And the graph clearly shows the retail cyclical slowdown from 2023 into 2024, with modest single digit LFL growth falling into negative territory. On a volume basis, given inflation and pricing icnreases, the down turn is probably deeper. 2023 was probably flat, and 1H FY24 was probably closer to a LFL contraction of 6-8%.
So, in terms of future, long term modelling, I will consider LFL sales growth scenarios (in nominal $) of 2%, 3% and 4%.
At the low end (assuming long run inflation of 2.5%), this actually represents a scenario where same store sales decline in real terms, with the 3% representing broadly flat, real sales, and 4% a modest increase. Given the competition that will exist in this segment, I don’t consider it reasonable to consider higher growth scenarios, even though these have been achieved in the past, as I don’t see a case where strong brand value creates pricing power in this market. (I’m not a branding expert,… so I’d rather be conservative).
Now turning to total revenue growth, the difference between the orange bars and the blue line in Figure 1 is the global rollout of new stores.
4. Global Store Rollout
Key to understanding the value of $LOV is knowing the future pace and economics of the store rollout program. On the last two investor calls Victor Herrero was clear that the rollout trajectory is “not linear”, that they open stores when they can get a deal that works, and that each time they open a new market, a new set of “blue sky” awaits them.
So, what does history look like? Consider Figure 2, below.
Figure 2: $LOV Store Roll-Out (Annual Net Change in # Stores; and % Change from PCP)
Source: Annual Reports
$LOV appears to not be driven by a pre-determined target of number of new store openings.
The drop in 2020 is easily understood due to the pandemic restrictions impacting 2020. In fact, the net store increase masks a larger number of closures, no doubt due to the pandemic.
2021 can be explained by the pent-up demand following re-opening, as well as (potentially) a brief window when good deals could be struck with shopping mall owners seeking to repair their balance sheets and attract quality tennants.
So, with the backlog of 2021 out of the way, 2022 probably reflects a return to something like BAU, which then makes 2023 a surprise with a massive step up in new stores, which drove revenue and SP.
So, what of 2024?
Well, 1H has seen only 54 net store openings, with an even slower start to 2H. It seems likely that FY24 will end up with somewhere between 80 and 100 new stores – back around 2022 levels. There were no capital constraints to store opening in 1H FY24, because $LOV paid down $22m of its $65m long term debt, finishing the year with $58m cash, up from $50m 6 months earlier.
Perhaps the conservative approach is prudent given high interest rates and continuing marco-uncertainty, with the EU and other markets in now squarely in recession, Australia in a per capita recession, and the US being somewhat the exception in the OECD group.
Based on the current operating economics, $LOV has the capacity to take on more debt, increase the rate of store buildout AND modestly increase the dividend. So, Victor has a lot of levers at his disposal. (The fact that Victor won’t provide forward indications as to the rate of store openings is clearly driving some of the analysts nuts.)
Next, we have to understand store level economics.
On the recent 1H call, Victor said in Q&A that the best way to figure out the cost of opening a store is to get it from the capex and number of stores, recognising the following:
· Australia or South Africa about $0.15m per store
· US “about double that”, so $0.30m
· Cheaper markets “a bit less”, so assume $0.1m per store
Having looked at the accounts for 2022 and 2023, I get higher numbers of around $0.4m per store. So, what is driving the difference? In calculating a Net Change in Stores, I am blending several factors which all impact the investing cashflow (capex) line:
· New store openings;
· Store closures (there were 31 in FY23 and 19 in FY22);
· Acquired stores; and
· A reduction to capex from contributions from Owners to fitouts. When Lovisa takes on a lease and fits out a shop, some of the investment improves the store beyond the life of the lease, so the landlord makes a contribution to the fitout.
So, this explains why a simplified Capex per net new store results in a higher figure than those indicated by management, and it allows me to keep the model simple.
Because the market potential is large, and we cannot know the rollout rate, I’ll run three scenarios:
· Low Case: 100 net new store per year
· Mid Case: 135 net new stores per year
· High Case: 165 net new stores per year
I’ve chosen a fixed number per year rather than a % number to reflect that as the rollout continues, while the company will have progressively higher financial capacity to open more stores, countering this it will become progressively harder to find good deals in each market (law of diminishing returns).
The analysis is conservative because, in the high case, we are simply repeating a level of store openings already experienced in 2023. Total stores across the three scenarios considered are shown in Figure 3.
Figure 3: Number of Stores – 3 modelling Scenarios
In the scenarios contemplated, the 2033 store counts are 1804, 2108, and 2412, given a 1H FY24 count of 854, so a two to three-fold increase.
This is in the context of a global roll-out already underway where the US at 207 stores is arguably 10%-20% penetrated, and the EU/UK at 249 is at a similar level. Based on these scenarios, there will plenty of growth potential beyond 2033 (if the brand remains relevant and if the competitive landscape allows!)
These projections Also seem reasonable for global retail brands. Retailer H&M grew its global physical store network from 550 in 1998 to a peak of 4,500 in 2019. If anything, subject to financial capacity constraints, my Scenario 3 could be considered modest, because opening what is a relatively small Lovisa boutique is arguably a less ambitious undertaking than an entire H&M store.
4. Margin Evolution
Gross Margin
Pre-COVID, $LOV achieved gross margins of 80%. (That’s pretty impressive, when compared with $SUL at 47% and $NCK at 63%.) While gross margins dipped through COVID, they have most recently been restored to 79.9% at FY23, and even 80.7% in FY24. To keep things simple, I assume %GM is maintained at 80% in all scenarios.
I’ve done this partly because I don’t understand the potential impact of i) increasing scale, driving future economics of scale in manufacturing, offset by ii) a potential increasing proportion of stores in locations where prices may be lower (e.g., middle income countries). Having said that, my modest store growth scenarios could be achieved in the high value markets of the US and EU/UK alone, however, it is clear that $LOV are truly going global!
Cost of Doing Business
While the store level expenses are directly scalable, as the network of stores scales in any country or region, there will be efficiencies in a) distribution, b) regional overheads and c) e-commerce.
On e-ecommerce, I have not modelled this separately. $LOV has an online offering in each of it’s markets, however, it has not been particularly transparent in breaking out the key value drivers. This is a limitation in the model. If $LOV achieves increased brand recognition and ability to move loyal customers online, this will result in the lower cost of doing business and increased margin potential.
Figure 4 shows the Cost of Doing Business, which I have calculated as:
= Salaries and employee benefits expense + Property Expense + Distribution Costs + Other Expenses.
Figure 4: Cost of Doing Business
CODB as a % of revenue increased significantly during 2022 and 2023. However, judging by the comparison of 1H FY24 to 1H FY23, the result for FY24 appears to be stabilising.
What can explain this trend? There are three factors:
- First, we should ignore the results for FY20 and FY21, as these will have been impacted by various closures, restrictions, and subsidies during the pandemic.
- FY23 also saw a record number of new store openings. So, this is likely to result in a period where stores incur their full operating cost during a period when store sales are ramping up. As the network scales, this effect will become proportionately less important over time.
- FY22 saw higher distribution costs and FY23 was a period of peak inflation.
For future periods, I therefore assume that CODB/Revenue is maintained at FY22 levels. The modelling assumption is described fully in the next section on Operating Margins.
Operating Margins (OM)
%OM was 18.0% in FY22 and 17.7% in FY23. Margins appear to have stabilised in FY24, with 1H FY24 at 21.9% compared with 1H FY23 at 22.2%. (Note: 1H %OM is significantly higher than 2H due to the stronger 1H revenues)
Over time, as the store network continues to expand there should be economies of scale in the distribution network. For example, the distribution infrastructure for US, EU/UK and ANZ is now largely in place. Further buildout of the stores within these regions should enjoy lower incremental distribution costs.
What is less clear is how the CODB and margins scales as the mix of stores across regions evolves. For now, it is assumed that US, EU/UK and ANZ will continue to contribute the large majority of stores. This assumption could be changes in future, for example, if there was a major build-out of the network in China. However, this seems unlikely to change the overall assumption given the prior progress of Western retailers in China, who generally have not built out networks beyond about 200 stores (e.g. Carrefour).
Model Scenarios - Operating Margins
Going forward, my model assumes FY24 %OM will be 17.5%, with scenarios as follows:
- Flat %OM = 17.5% from 2024-2033;
- 0.1% p.a. margin improvement reaching 18.4% in 2033;
- 0.2% and 0.25% p.a. margin improvement in the high-store buildout scenarios, reaching a %OM of 19.8% in 2033, in the highest case.
5. Capital Structure
In running the valuations, I have run all 9 scenarios across three cases:
- WACC = 7.9% with constant LT debt at $65 million (calculated off the current balance sheet with cost of equity of 9.5% and cost of debt of 6.0% - applied to both debt and leases)
- Increase LT debt to maintain a constant leverage of 0.5 x EBITDA (this drives significant FCF generation while still maintaining a conservative balance sheet. For example, this is approximately the level of debt at $JBH)
- I’ve also modelled a 10% discount rate, to show the SP required to deliver that investment return.
6. Continuing Value
Across the scenarios modelled, by 2033 $LOV will have established a global network of between 1804 and 2412 stores, compared with the 854 at the end of 1H FY24.
2033 need by no means represent “Peak Lovisa”. For example, Zara reportedly has around 3,000 stores worldwide, and H&M has between 4000 and 5000.
Therefore, assuming annual market growth of 2.5%, I assume ongoing growth in Free Cash Flow in the continuing value period of 4.0% p.a. achieved through any combination of i) network growth, ii) brand value improvement, iii) operating efficiencies, and iv) increasing contribution over time from stores in middle income countries.
7. Key Risks
Some key risks are not considered in my valuation model:
- “Peak Lovisa” is reached beore 2033 or shortly thereafter, due to a global shift away from fast-fashion, costume jewellery.
- Growing competition – others seek to replicate Lovisa’s model. (We have seen this before in fashion as Zara’s disruptive business model was replicated over time.)
Either risk materialising would see a slowing of network expansion, followed by pressure on margins, over time. Emergence of these risk would likely see a rapid contraction in the earnings multiple, back into the pack of retail more generally. (P/E of 12%-15%).
Note that in the current model, the implied P/E at 2033 ranges from 17.6x to 19.3x – so my valuation assumes that $LOV retains its growth premium over the retail sector for the next decade.
8. Valuation
Figure 5 shows the NPAT over the 10-year period across the 9 scenarios. The scenarios spanned the ranges of the parameters shown in the blue box.
Figure 5: NPAT Evolution Across Scenarios
Figure 6 shows the resulting valuations, with the red lines reading off the mean, p10%, and p90% valuations for the valuations run at constant LT debt ($65m) and WACC of 7.9%.
The light grey line shows the valuations run with LT debt increased each year to a level of 0.5 x EBITDA.
The orange dotted line shows the SP required to achieve a Rate of Return of 10% in the Levered case.
Figure 6: Valuation Results
Table 2 below provides some more of the modelling puts, including earning growth rate, margins and implied P/Es over time.
Disclaimer: The analysis has been performed for my personal use and should not be used as the basis for investment decisions. Model calculations and outputs are not validated to be free from error.
Disc, Held in RL and SM
I have a few companies reporting today. At a quick glance the Lovisa results look good, and ahead of FY24 analyst consensus. ROE, based on doubling 1H24 NPAT (ie. $107 million) and 1H24 equity reported ($104 million) is approx 100%. This assumes next half will be as good as 1H24. Does this look right Strawpeople?
I’ve been working on ROE of 90% for my valuation. I think the market will like it. I hope I haven’t made any huge errors here. I’ll have a more accurate look later.
Summary:
• Revenue up 18.2% to $373m with improving trend through Q2
• Comparable store sales down 4.4% on HY23
• Gross Margin 80.7%, up 40bps
• 74 new stores opened during the period, 854 at period end
• China and Vietnam markets opened during the half year
• EBIT $81.6m up 16.3%
• Net Profit After Tax up 12.0% to $53.5m
• Operating cash flow of $150m up 29.1% on prior period
• Net Cash of $15.5m at period end, with $120m of available cash facilities in place
• Interim Dividend of 50.0 cents per share, 30% franked
Lovisa shared their Macquarie Conference Presentation back on the 5 March 2022. This has been the most recent ASX news out of Lovisa…albeit old news now. What else has been going on?
Friday’s episode of ‘the Call’ with Luke Winchester (@Wini) and Claude Walker prompted me to review my IRL holding in Lovisa, which is currently sitting at about 2.5% of my portfolio.
I first became interested in Lovisa in July 2019 after hearing Owen Rask talking to Angie Ellis from ‘8020 Invest’ about Lovisa in this podcast. Lovisa sounded like a very promising high performance business, so I put it on my watch list.
In July 2019 Lovisa was trading around $11 per share. Then in Feb 2020 comes the onset of COVID19 and the Lovisa share price plunged as low as $2.45 before beginning it’s recovery to an all time high of $22.82 in November last year.
I started buying Lovisa in March 2020 (too early as usual) at an average cost of about $7 per share. Nervous about the market and economy I lightened off half of my holdings between March and November last year. I still hold 2.5% of my portfolio in Lovisa now. What should I do…Buy, Hold or Sell?
On the Call, Luke said if you look at Lovisa’s economics, it has the perfect recipe for a retailer:
- Very high gross margins
- Very high inventory turnover, and
- Very low store footprint
Luke said the growth was all in the US and if over the next 5 years Lovisa could grow US stores from 100 to 1000 or 1500, the shares sound cheap. But when Nadeem Blayne pressured Luke for a call, Luke went weak at the knees and said it was a ‘Genuine Hold’ (…not even a nibble)! :D
Claude had a different view saying Lovisa would be a company you would buy for the yield and that there is a real threat of competition.Claude said What is to stop ‘Lovisa 2’ coming along and reducing those nice margins? Claude thought Lovisa was closer to a Sell than a Buy!
Nadeem even threw in her thoughts saying that even though Lovisa has competition now, she has taken both her children to Lovisa to have their ears pierced…not really knowing why!
My view
Lovisa has been in the ‘too hard basket’ for me lately, so I’ve just Held. There is so much going on in Lovisa’s geographical footprint that it is hard to get a clear picture of what might happen to the businesses going forward. There’s also the relentless down selling of retailers lately (could be a good reason to buy??).
Luke talked about the growth in the US. However, there is also huge potential for growth in Europe.
I think Europe could be a wild card. Lovisa has added 168 stores since June 2020, 87 we’re acquired in Europe as a result of the beeline acquisition in FY21 and 163 stores now trading in Europe. This compares to 53 new stores in US.
What I like about the European Beeline acquisition is the price Lovisa paid for it, a total of 60 Euros from memory. Lovisa almost stole the distressed business when European retail businesses were being hit the hardest.
Headwinds
There are some real headwinds to consider, and the impact could last for a while:
- labour shortages and logistics challenges, in particular in the USA, which has also impacted store build costs
- Logistics challenges have continued in the second half in particular impacted by recent lockdowns in China
- The impact of a recession (if we have one) on discretionary consumer products.
- continuing COVID lockdowns?
Lovisa seems to be impacted more by COVID than many other retailers. Easy to understand when you think about it, people are staying at home so there’s no need for jewellery. Who wants to get up close and personal and have their ears pierced when COVID is spreading? Who wants to jam up in a tiny Lovisa store and try on jewellery others might have also tried on?
How well can this business perform if the headwinds disappear?
We only need to go back prior to COVID to see how well this business can perform in the absence of headwinds.
ROE has been gradually declining over several years from over 100% in 2016 to 29% in 2020. Declining ROE is something I really don’t like to see in a business and is usually a signal for me to get out, but hey…when you start out with ROE of over 400% (2015), something has to give!
in 2021 the ROE lifted back up to a respectable 55% and according to 10 analysts from S&P Global (Simply Wall Street data) Lovisa could return to ROE upwards of 90% and earnings growth of 18% over the next 3 years.
If we use McNiven’s StockVal formula and apply a 90% ROE as the APC, 28% reinvested earnings (RI), and shareholder equity of 58 cents (E), the valuation for a 10% required return is $17.20. That makes Lovisa good value if you want to take the risk!
A lot is hinging on a quick turn around over the next 12 months. It’s still a bit of a gamble for me, so I’m going with Wini on this one…it’s a ‘Genuine Hold’!
Disc: Held IRL