Jewellery label Lovisa dreams of the US
If all goes well, this could be the best investment you make in 2019
‘I’m going to ask my mom if I can have this,” the tween-age girl standing beside me said to her friend. Something on the rack of lurid unicorn-themed accessories had evidently caught her eye. How did it come to this? A 40-something man standing in a kids’ accessories store in a shopping mall in Silicon Valley?
It started with trying to figure out whether there might be money to be made in the shares of Aussie fashion jewellery retail phenomenon Lovisa (ASX: LOV).
Lovisa was founded in 2010 by Shane Fallscheer, backed by his billionaire former boss Brett Blundy (founder of retail chains including Sanity Music and Bras N Things). The company opened almost one store per week in its first year and crossed the Tasman to open its first New Zealand store.
In 2011, Lovisa launched in South Africa and in 2012 it headed to Asia. By the time it floated on the ASX in late 2014, it had 220 stores. At June 30, 2018 there were 326 stores and more than 360 are expected by June 30 this year. The table shows how the store network developed between the float and the end of the 2018 financial year.
Rolling out successful stores internationally is a feat few Aussie retailers have managed. That’s why, for the most part, Australian investors are sceptical of home-grown retailers trying to export their concepts to the world. Their biases were recently reconfirmed by Wesfarmers’ loss of more than $1 billion in trying to crack the UK market with Bunnings.
As an investor, it’s important to understand the risks. And I’ve been buying Lovisa shares between $5.70 and $7.20 apiece, which is roughly half of their $12.53 record hit in June last year. So what’s caused the fall?
Mostly it’s the fear that the company’s Australian operations may see lower profits in 2019 than they did in 2018. And that didn’t go down well with investors who had previously priced Lovisa more like a hot technology stock than a retailer.
Christmas trading for Australian retailers was, reportedly, mixed. By the time you read this, you’ll have a clearer picture because several retailers (including Lovisa) will have delivered their half-year reports. But as I write (in early February), I’m still working off the numbers released at Lovisa’s annual meeting in October.
Lovisa’s sales for the first four months of the financial year were 0.9% below the previous year’s. But that modest fall was likely made up of a worse number in Australia offset by stronger growth from international stores. And the challenges don’t end there.
The company sources much of its product from China. And because the Chinese currency is closely linked to the US dollar, the lower Australian dollar (against the US dollar) this financial year will mean Lovisa’s inventory costs will rise and profit margins likely fall. A lower top line and lower margins could result in a meaningful fall in profit for the mature Australian part of the business.
In the UK, where Lovisa has been expanding quickly, retailers reported weak Christmas trading overall and confusion continues to reign over the implications of “Brexit”.
No rabbits in the hat
It’s undoubtedly a difficult time for this Aussie upstart. And I’m not counting on Lovisa to have pulled a rabbit out of the hat in the six months to December (though you will know by now whether it has managed to do so). In fact, I would view a result that disappointed investors as a potential buying opportunity. Here’s why.
While roughly half of Lovisa’s current stores are located in Australia, the company’s future is abroad. The Lovisa concept has shown an impressive ability to travel.
Run your eye down the table again. The potential is clear. And while Brexit may pose a few challenges, nothing will stop the Brits from shopping in the long term (I should know, I’m married to one). And a UK downturn may allow Lovisa to secure prime store locations at attractive rents over the next year or two. So it’s possible that good management will turn that challenge into an opportunity.
There are also opportunities elsewhere in Europe but the real prize lies across the Atlantic in the good ol’ US of A. Which brings us back to those girls in California and why I was standing among the sparkly tiaras and cat-ear headbands of a Claire’s Accessories store.
I was on a study tour, spending the better part of six days in American shopping malls educating myself about the nature of the competition that Lovisa is facing in the world’s largest retail market. What I found was encouraging.
Obvious competitor Claire’s is aimed at a younger audience (say, eight- to 17-yearolds). These customers often need parental permission (and funding) before purchases. And while Claire’s had tried a slightly more mature brand called Icing, it didn’t seem to have the formula right.
Meanwhile, Lovisa’s more stylish format and branding (which appeals to 15- to 50-yearolds), appears to be hitting the same sweet spot in California that it has in Australia, New Zealand, Asia, South Africa, the Middle East and the UK.
By and large, the eight Lovisa stores I visited were doing well and had enjoyed a busy Christmas. I was encouraged enough to put the chance of success in California at more than 65%. I estimate the potential for at least 150 Lovisa stores in California over the next six or seven years (the state’s economy is more than twice the size of Australia’s). And there’s every chance that these stores are even more profitable than Lovisa’s Australian network because wages and shopping centre rents tend to be lower in America.
And if we dare to dream that the Lovisa concept might work in several other large American markets, then it’s quite possible that in five years Lovisa might have more than
doubled its total store numbers and perhaps almost tripled its profit.
In financial terms, that could mean earnings per share approaching 90 cents in 2023. And given the stores’ fabulous profitability, most of that would come to shareholders as dividends.
If anything like those numbers were achieved, the stock could be trading above $20. That would provide a handsome annual return of around 30%, including dividends, for those who accepted the risks of a tough short-term outlook today.
Yet if the naysayers are proven right and Lovisa is just a fad, or competitors manage to drain away its profits, then look out below. The company has few assets to speak of, so there’s no protection in a disaster scenario.
This is not a stock to bet the farm on but a small investment in this Aussie success story taking on the world might just prove the best purchase you make in 2019. Disclosure: Greg Hoffman and private portfolios managed by him own Lovisa shares.