The big slow hits fast fashion for jewellery chain
Lovisa is one of the best retailers we have ever seen. Astounding gross margins of 80% translate into operating margins of 25% and net profit margins of 15%. This is about as good as retailing profit metrics get.
They are so good that for a long time we thought the business was a fad or would be challenged by competition. Continued sales growth and high margins have changed our minds, and Lovisa has sat on our Buy list since last year.
The secret to its success is a vertically integrated model that turns over new styles quickly. This is fast fashion for jewellery.
- One of the best retailers
- Competitive advantages in tact
- Slower store rollout likely
Lovisa captures additional margin because it designs and manufactures its own products and sells them in its own stores.
A dense store network of over 400 stores worldwide - 150 of those in Australia - mean that it can access sales data to influence new designs. If a new trend is emerging, Lovisa is among the first to know and can use its design and manufacturing nous to get product out quick.
It's a formula that has worked wonderfully in other product lines for the likes of Zara, and its one we've been prepared to pay up for because the potential for new store openings is enormous.
The big slow
In the US, Lovisa currently operates about 20 stores. We think there is room for perhaps 800. Hundreds of additional stores are also possible in Europe and nascent rollouts have begun in France, Spain and the UK.
The economics of a single Lovisa store are stunning. New stores earn their cost back within months and the uncommon combination of high margins and high turnover result in return on equity in triple figures. Read that last sentence again; it is no mistake.
That store rollout, supported by those economics, is why we've been prepared to pay seemingly silly multiples for the stock - it has typically traded at four to five times revenues and about 30 times earnings.
With 2020 earnings likely to fall savagely, the market is already looking forward. Consensus numbers assume 40 cps in profits by 2022, so Lovisa trades at 20 times 2022 earnings. That doesn't sound dear but it does suggest a recovery has been priced in.
Not so fast
It's hard to be sure of that. Lovisa's typical customers are young people buying jewellery to wear out at parties, concerts, nightclub and restaurants, and those activities won't return to normal for some time.
In the US and Europe, where the virus has raged worse than in Australia, further delays to normality are likely. It's hard to see store openings following their old path.
Even if the profitability of the current network is restored, slower growth will result in lower value.
It's hard to quantify the impact of that but the risk of slower growth has risen and the share price appears to ignore that risk.
Lovisa remains an outstanding retailer with strong management, a decent balance sheet and excellent store economics. The ability to utilise sales data to inform design decisions, and move product fast, is an advantage that is hard to challenge.
We are, however, lowering our Buy price from $8 to $6 and our Sell price from $17 to $15. Those prices might change again as new information emerges but it is prudent to show some caution, especially as the stock has risen so far from its low (about 200% for those counting). Lovisa moves to HOLD.
Note: Our Model Growth and Model Income portfolios own shares in Lovisa, as do the Intelligent Investor Equity Growth Fund, and the Intelligent Investor Equity Income Fund.
Disclosure: The author owns shares in Lovisa.
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