Store Expansion And High-Margin Focus To Strengthen Future Outlook

Key Takeaways

• Expanding store network and strategic product mix shift towards general merchandise can drive revenue and enhance profit margins.
  
• Effective cost management amidst inflation and strong balance sheet support financial stability and potential shareholder value through dividends and buybacks.
  
• Rising costs, shrinkage, pricing uncertainties, and unstable freight rates threaten Reject Shop's profitability despite sales growth driven by higher average selling prices.

Catalysts

The Reject Shop Limited retails discount variety merchandise in Australia.

• The Reject Shop is expanding its store network, with 9 new stores opened in the first half of FY '25 and plans to open 7 more in the second half, alongside a pipeline of 15 new stores in FY '26 and beyond. This expansion is likely to drive revenue growth through increased market presence and customer reach.
  
• There is a strategic focus on general merchandise sales, which have higher margins compared to consumables. A shift in product mix towards general merchandise is expected to enhance gross profit margins over time, positively impacting earnings.
  
• Despite facing inflationary pressures, the company has managed costs effectively with a focus on maintaining a flat cost of doing business year-on-year, which could lead to higher net margins if these efforts succeed in offsetting rising expenses.
  
• Improved basket growth, driven primarily by average selling price (ASP) growth, indicates the potential for increased revenue without necessarily increasing the volume of sales transactions. This could support future earnings growth if the trend continues.
  
• The strong balance sheet with a cash position of $74.9 million and no drawn debt, combined with a commitment to maintain a dividend payout ratio of at least 60% of net profit after tax, provides financial stability that can support strategic initiatives and potentially enhance shareholder value through consistent dividends and buybacks.

Reject Shop Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Reject Shop's revenue will grow by 3.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 0.7% today to 1.8% in 3 years time.
• Analysts expect earnings to reach A$17.6 million (and earnings per share of A$0.48) by about April 2028, up from A$6.2 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as A$10.9 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.5x on those 2028 earnings, down from 39.3x today. This future PE is lower than the current PE for the AU Multiline Retail industry at 39.9x.
• Analysts expect the number of shares outstanding to decline by 0.06% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.69%, as per the Simply Wall St company report.

Reject Shop Future Earnings Per Share Growth

Risks

• The Reject Shop is facing inflationary cost pressures that could impact its cost of doing business, affecting net margins. Store expenses and admin expenses have increased, and store labor costs have risen, which could squeeze profitability if not managed effectively.
  
• Shrinkage, described as a deteriorating issue, has worsened beyond expectations, posing a risk to gross profit margins. Although mitigation initiatives are underway, continued shrinkage could impact earnings.
  
• There is uncertainty in pricing and pricing competitiveness in the discount retail market. Any failure to maintain competitive pricing while managing increased costs could impact revenue growth and margins.
  
• The business is dealing with potential instability in international freight rates. An unfavorable outcome in renegotiating freight contracts could increase costs, affecting the company's earnings.
  
• Although sales are growing, they are driven more by basket growth (average selling price increases) rather than transaction volume, suggesting that expanding customer base might be a challenge. Overreliance on price increases for revenue growth could risk profitability if consumer spending weakens.

Valuation

• The analysts have a consensus price target of A$5.96 for Reject Shop based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$6.68, and the most bearish reporting a price target of just A$3.8.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be A$970.4 million, earnings will come to A$17.6 million, and it would be trading on a PE ratio of 16.5x, assuming you use a discount rate of 9.7%.
• Given the current share price of A$6.51, the analyst price target of A$5.96 is 9.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.