Why the market can't decide what Kogan is really worth
Readers who have followed me for a long time will have noticed that I am much more likely to write about a stock that has experienced a significant pullback than stocks that are hitting record highs. That is because I am looking for value opportunities. Situations where the market has punished a stock too harshly given the underlying economics of the business, and therefore at some point a rebound is likely.
The share price of online retail business Kogan (ASX:KGN) has retracted 50% from its highs in October last year. However, it is still more than double its level of 12 months ago. Clearly, the market is having trouble deciding what it is really worth.
When trying to ascertain the value of a business it pays to go back to first principles and put the noise of the market to one side. What are the revenues, profits, and cash flows of the business telling us? How secure is the balance sheet? And most importantly, what are the future prospects, and how much uncertainty is associated with those prospects.
Kogan is a profitable business and revenues and profits have been growing strongly. If consensus estimates are achieved in financial year 2021, revenue will have grown about 30% per year since listing in 2016 and earnings per share about 90% pa. The first half of financial year 2021 produced very strong results which lends a high degree of confidence to the full year forecasts being achieved.
Kogan is best known as an online retailer, but it actually has a wide array of business interests. Online retail includes exclusive brands as well as third-party brands. Exclusive brands account for 56% of gross profit. It also generates 12% of gross profits from the online marketplace where other sellers are able to market their wares. In this space it is competing with the likes of Catch (owned by Wesfarmers (ASX:WES), eBay, and Amazon. There are also mobile phone plans, energy retailing, insurance, credit cards and finance, travel and health.
In December Kogan acquired one of New Zealand's leading online retailers, Mighty Ape. Mighty Ape adds another 720,000 active customers to Kogan's 3 million. It is a profitable and growing business and the expectation is that combining the businesses will secure cost synergies and unlock additional revenue opportunities for each business. Of course, the success of any acquisition comes down to execution. The price paid, whilst not cheap, appears reasonable at 8.5 times forecast earnings before interest, taxes, depreciation and amortisation and about the same amount as the revenue earned in the last 12 months.
Sales growth for Kogan tapered off in January but was still around 30% when compared with the previous January. This was considered disappointing given the growth of 89% for the first half of the year. There were also some issues around warehousing and logistics as the business scrambles to cope with the rapid growth. This resulted in a resumption of the share price decline that had paused with the announcement of the Mighty Ape purchase.
Market analysts are forecasting that revenue will exceed $1 billion in 2023. If this is realised it will amount to growth of 28% pa. over the forecast period. At the same time earnings per share is forecast to grow by 36% pa. The business is in a strong position to capitalise on the trend towards online shopping, the strong growth in retail spending as international travel remains restricted, along with its strong brands and market leading positions in both Australia and New Zealand.
Given the history of strong growth and the forecast continuation along with the sector tailwinds, a strong growth premium might be expected in the valuation multiples. However whilst there is some premium, it is not actually that high. The PE ratio for FY21 is 27, falling to 18 for FY23. These levels are not cheap, but nor are they excessive given the track record of the business. At $25 the stock was priced for perfection, but around $13 the inherent risk of an investment is greatly reduced.