Cash is still king for UK retail shares

<p>There are a few clear differentiators for investors eyeing the UK retail sector with a view to long-term value.</p>

UK investor focus returned to retailers this week after shares in Britain’s biggest,Tesco, fell sharply, despite solid earnings.

The slide contrasted with a big jump in shares of JD Sports to a record high earlier in the week, extending their rise over a year to almost 100%.

Poor prospects for growth over the short term and the protracted wait for dividends are making Tesco investors restive. Restive enough to sell the stock harder than those of its main rivals so far this year, including a near-6% slide on Wednesday.

It comes despite the group’s successful efforts to put right a host of missteps and legal misdemeanours, boosting the stock by 38% in 2016.

 

Suffice to say that pressures in Britain’s fiercely competitive grocery sector and the re-emergence of inflation, have made investors wary.

The wider takeaway for investors brave enough to maintain exposure to British retailers, is that the grocery industry may not be the optimal segment, right now.

It’s quite bewildering that some yield hunters settled for negative total returns over one year of -10% from Sainsbury’s and -3.1% in Tesco, when returns as high as 300% were available elsewhere in the sector—see boohoo.com.

Granted, its questionable whether probable gainers can be forecast with any degree of consistent accuracy, whilst small-to-mid-cap shares like Boohoo add a large dollop of risk.

Still, long-term value differentiators are no mystery, and those that apply to the UK retail sector are pretty much identical to those applicable to the wider equity market. Think well-established dividend (preferably progressive), moderate debt, and favourable assets-to-liabilities balance (including pensions).

 

Among retailers though, long-standing challenges often make those standards difficult to sustain. Plus, with Brexit-linked inflationary pressures emerging, now more than ever, it is companies with the strongest cash positions that are likeliest to survive and thrive.

 

On that basis, it is no surprise that five of the top 6 British retail shares over a year also have the best long-term cash flow growth, as shown in the table below.

UK RETAIL SHARES SCREEN: LONG-TERM CASH FLOW GROWTH / 1-YEAR PRICE PERFORMANCE

UK RETAIL AND CASH FLOW SCREEN_AMEND2

Source: Thomson Reuters / City Index

Here we should explain our cash flow gauge.

 

  • We opted for operating cash flow because we’re filtering capacity to ‘invest in price’
  • To capture companies with a proven ability to put away hard cash, we tracked ‘interim trend growth’ (year-to-year) over five-years
  • At least 11 interims were required. If not available, there was no output
  • Moderate leverage often makes sense, so we measured levered free operating cash flow which takes borrowing into account

 

As can be seen, JD Sports, is the winner by cash and share gains. And the fact that five good cash generators were among the best stock performers (out of a list of 30) is also a reminder of a simple truth.

 

 

 

 

 

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