Early signs bode well for Super Retail Group turnaround story

The 25% selloff in Super Retail Group Ltd (ASX:SUL) since the beginning of the year seems excessive given the discretionary retailer’s revenue growth for the six-month period ended 31 December 2015 of 6% to $1,215.5 million and profit of $44.9 million, up 33.6% on the previous corresponding period.

Despite strong performance by its auto and sports divisions, what’s letting the company down is the group’s leisure business, including BCF and Ray’s Outdoors, which due to investment in competitive pricing, stock clearance and higher sourcing costs, reported a whopping 40% fall in operating profit.

However, significant efforts are now being made to turnaround the fortunes of underperformance of BCF and Ray’s Outdoors after the company incurred a $20 million impairment against its brand value.

The company is now focused on sustaining the sales momentum of the BCF business – while also improving gross margin through optimising product range and pricing – and has extended the trial of the new format Rays stores.

If the first eight weeks of the second half is any proxy, the challenge of lifting sales and profit margins within the leisure division seems to be working, with like-for-like sales growth around 12% in the leisure division, 4% in the auto division, with the sports division up around 5.5%.

While Super Retail Group may not have met analysts’ expectations at half year, the stock does appear to be mispriced, especially given the strong performance of the auto and sports divisions – due to store refurbishment, improved service offerings, growing on-line channels and a refocus on more tailored marketing – plus the promise of a turnaround with the leisure division.

Other strategic initiatives the Super Retail Group is working on include, a $3.9 million investment in a start-up digital businesses – including Fixed Price Car Service and Youcamp – $53 million cash invested in future growth in new and refurbished stores, and has strong working capital management, with operating cash flow of $177 million, 26% higher than the previous comparative period.

Lower freight costs from new supply chain facilities and systems are also expected to help improve margins.

While the leisure business has been successful in growing dollar market share, the focus is now on optimising product range and pricing to further increase gross margins.

The performance of the three converted Rays stores has been encouraging with like- for-like growth collectively outstripping the rest of the Rays network by more than the targeted 12%.

The business plans to trial a further five stores in the next six months, and will closely monitor the performance of the trial over the next 12 months before making a decision on a wider rollout.

Given the quality of Super Retail Group’s investment grade balance sheet, and the early stage turnaround for its leisure division, the stock shouldn’t be overlooked.

Despite having a funding gap of $703 million and a net-debt to equity of 49.32%, earnings per share (EPS) growth has been good over the last five years is forecast to be excellent going forward; with EPS of $0.49 in 2015 forecast to grow to $0.72 by 2018.

Based on the amount of capital that Super Retail Group is deploying, the market clearly wants greater clarity on its long term growth outlook.

While there is clearly a lot riding on the repositioning of Ray’s Outdoor and BCF, the early signs are encouraging, and there’s no doubt the company will emerge as a stronger and more competitive business.

Further consolidation of its leading retail platform and ongoing forays into online ventures will positions the company well to grow future earnings.

Equally attractive to investors is the (fully franked) 2016 dividend yield of 4.76%.

Based on these dynamics and 12 months price targets as high as $11.30, the current share price ($8.60) does make for an attractive entry point.