Equity research report on JD Sports plc PDF

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Equity research report on JD Sports plc. this includes strategic analysis, accounting analysis, ratio analysis, valuation forecasting and recommendations....

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Undergraduate Programme

Submitted by: Date Sent: 11/05/2021 Module Title: Financial Statement Analysis & Security Valuation Module Code: IB3960 Date/Year of Module: 2021 Submission Deadline: 11/05/2021 Word Count: 1499 Number of Pages: 14 Assignment Question: Equity research report on JD Sports Fashion plc

1/05/2021

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JD Sports Fashion plc (JD.L) London Stock Exchange

Currency in GBP

Equities United Kingdom Sector(s): C onsumer Cyclical Industry: Specialty Retail Recommendation: BUY Stock Rating Industry View Share price (21/02/20) Target price Upside/ (Downside) 28 71%2

BUY In-line 878.80p 1179.00p 34.28 %

Key Points: Opportunities: •

•

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Enter and exploit markets in developing counties through physical stores or online sales. Stable free cash flow to invest in new businesses to deliver long term sustainable earnings growth. Take advantage of the rise in the fitness and fashion trend and emerge as a market leader.

Sales Forecast 18000.00 16000.00 14000.00 12000.00 10000.00 8000.00 6000.00

4000.00

Risks:

2000.00 0.00

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• •

Uncertainty on future levels of footfall if “social distancing” measures continue. Possible external competition is anticipated over the growth years. Fluctuations in foreign exchange rate as the company operates worldwide.

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Contents: 1) 2) 3) 4) 5)

Strategic Analysis Accounting Analysis Ratio Analysis Valuation Forecasting Results, Recommendations and Sensitivity

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Strategic Analysis

1) International Expansion JD Sports sells its products through its physical and online stores in 19 countries across the world. Expanding internationally allows the company to diversify its business by spreading the risk of declining demand across various countries. Furthermore, it allows the retailers to maintain a link with suppliers in international markets and access resources that are not available in the domestic market, while also expanding its customer base. JD Sports Group has expanded to the Asia-Pacific Market, however most of the new stores were opened in Europe i.e. 52 new stores. The company is planning to further expand by opening a flagship store in Paris and New York.

2) Selling Multiple Brands using Multiple Channels

JD Sports is a multichannel retailer and, sells markets sports fashion and recreational products under various brand including JD, Scotts, Blacks, Millets, Sprinter, Tessuti, Go Outdoors etc. The company has 2,203 Sports fashion stores with 508 Company owned Finish Line stores. The international sports brands acquired by JD Sports is one factor that has contributed to its growth. Sale through multiple channels which includes in-store sales, online sales and sales using store devices, increases the company’s brand awareness, consumer business, store traffic and consumer satisfaction. Exclusive business with brands such as Nike, Adidas and Under Armour have also played a central role in the success of the company. JD Sports seek to build partnership with more brands and with exclusive products in near future.

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Accounting Analysis

Reformulated Income Statement (Appendix 1) Administrative expenses include one-off exceptional expenses that are related to impairment of goodwill and fascia names, movement in fair value of put and call options, and integration costs of outdoor systems, warehousing, sport zone and sprinter infrastructure of £90.3M. These charge is excluded from the operating profit as they are non-recurring and not a part of JD’s operations. NOPAT of 2020 is calculated as £306.85m, assuming effective tax rate of 28.10% (Appendix 2). Tax on finance expense is added back as tax relief which gives NIE after tax of £56.15m and Profit after tax of £250.70m.

Reformulated Balance Sheet (Appendix 3) For the calculation of NOA, we include intangibles that include brand licenses, brand names, software development and goodwill under operating assets (OA) as they are likely to provide competitive advantage to the company. Other assets were also included in OA as they are costs related to leased stores in some countries. There was a substantial increase in Property, plant and Equipment (PPE) which was due to the application of IFRS16 leases as from this year financial leases and similar hire purchases contracts are recognized in PPE. Cash and cash equivalents includes cash balances and short-term liquid investments, therefore classified as financial assets. Investment in associates are taken as financial assets as they are said to provide some return to the investee. Lease liabilities are now recognized separately in the balance sheet under the IFRS 16 leases due to which they are seen in FY 2020. The application of IFRS 16 leases resulted in net financial liabilities this year.

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Ratio Analysis

RNOA (Appendix 4)

A significant decline in RNOA can be explained by the continuous decline in ATO and NOPM. ATO (Appendix 5) and NOPM (Appendix 6) are the drivers of RNOA (RNOA=NOPM*ATO). Although sales have increased over the years, there is a decline in ATO because of increase in NOA. NOA has increased during the years due to the increased M&A activity by the company due to which PPE has increased substantially. NOPAT has also increased in the past years, however the proportionate increase is less than that of sales. This may be due to the rigorous promotional and discounting policies followed by the company.

ROE (Appendix 7)

The historical data of the past 4 years points out to the decline in ROE. This can be characterized by the diminishing RNOA as explained above and decreasing RNFA which is a negative value due to increase in NIE despite of owning financial assets. This means that finance expense is greater than that of financial income. FLEV is declining in the past few years, however the effect of FLEV on ROE is minor and is offset by decline of RNOA and increase in net finance expenses. There was a substantial increase in net finance expenses in 2020 because of addition of lease interest, due to the application of IFRS 16 Lease.

Figure 1- Ratio Analysis

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Valuation Forecasting Sales Forecast (Appendix 8)

Post-COVID 19 Recovery

Growth

Decline

Steady State

FY 2021

FY 2023-2026

FY 2027-2029

FY 2030+

FY 2022

Figure 2- Forecast Story

It is estimated that the industry-related revenue will contract in FY 2021 by 8.7% due to COVID-19 induced lockdowns that have resulted in closing physical stores all over the world (IBISWorld,2021). JD Sports being a key player in the industry is expected to face a greater decline in its sales growth i.e. by 9% as there still exists uncertainty due to COVID-19, furthermore even if stores open, social distancing measures will lead to decrease in footfall. Also, Brexit uncertainty would not have a great impact on the sales as the company has already opened a warehouse in Belgium to mitigate risks due to disruption of supply chain, in case of a no-deal Brexit. However, some risk related to tariff costs is taken into consideration while forecasting the decline in the sales growth. Signs of recovery are then forecasted in the financial year FY 2022 (15%), as economic conditions improve and inflation pressures decrease. Consumers are expected to increase their spending on health, fitness and outdoor products (Glassman,2021). Furthermore, JD Sports is investing in its principal warehouses at Kingsway and Rochdale to deal with online orders, in case there is a permanent shift from physical retail to online retail as a consequence of COVID-19. Also, sales are expected to grow in North America as sustained improvement in the performance of Finnish line stores is expected in the long-run. M&A activity during this period will further add to the recovery in this period. Moving on to the FY 2023-2026, JD Sports is anticipated to experience high growth in sales (18%-22%) which will be driven by growing world population, rise in standards of living,

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increase in disposable income, per capita spends and expanding base of middle class consumers. Acquisition of assets globally would further magnify the growth (KPMG,2021). A decline in the growth rate (11%-3%) is expected in the period between FY 2027-2029 as by then the company would have already benefitted from its expansionary strategy and would no longer engage itself in further M&A activities. Also, expected rise in competition during this period would add to this decline. Finally, we expect JD Sport’s sale to grow at the GDP growth rate 1.87% (Appendix 9) in FY 2030 and to remain steady after 2030. NOPM In the past years, there has been a decline in the NOPM despite the increase in the sales growth. We forecast that this historical trend will continue and NOPM will continue to decline in 2021. This decline is also due to fall in revenue in 2021 and then this profit margin is expected to increase gradually year after year. JD Sports has been looking to protect its profitability and increase its margin by avoiding short term reactive discounting. Also, it is forecasted that there will be a shift from physical retail to online retail, therefore this would help the company to reduce its operating costs. This would result in increase in NOPAT, therefore further increase in NOPM. ATO ATO is estimated to decrease substantially in 2021 and this is based on the assumption that the sales will decline in 2021 because of the impact of the pandemic and the increase in operating assets because of the application of IFRS 16 Leases. Later, we expect the ATO to increase year after year. This prediction is consistent with the rise in the revenue growth and recommencement of projects and new openings that were delayed due to COVID-19. Therefore, the assets acquired by the company in future would generate higher revenue. In steady state, we expect NOPM and ATO to remain constant. WACC WACC of 8.70% is assumed to be constant (Appendix 10).

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Recommendations, Results and Sensitivity The share price of JD Sports is forecasted to be 1179.00p (£11.79) using the AOPVM and FCFVM (Appendix 8). This is 34.28% higher than the current share price of 878.80p (£8.78). The AOP in 2021 is a significantly small number due to low sales and high cost of capital. However, both AOP and FCF increases in the future owing to the competitive advantage of the company and favourable macroeconomic policies. The sensitivity analysis shows the short-term and long-term judgement in the share price of the company if the market conditions change that would lead to a change in WACC, NOPM and ATO against the terminal growth rate. The results show that the target price would lie within the range £8.81- £18.73. The forecasted share price using the AOPVM and FCFVM is higher than the current share price, therefore we recommend a BUY.

Figure 3- Sensitivity Analysis

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Appendix

1) Reformulated Income Statement

2) Tax on Operations

Note- Calculation of tax rate= (Income tax expense/profit before tax= 97.8/348.5= 28.10%)

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3) Reformulated Balance Sheet

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4) Return on Net Operating Assets (RNOA)

5) Asset Turnover Ratio (ATO)

6) Net Operating Profit Margin (NOPM)

7) Return on Equity (ROE)

Note: For the calculation of ratios, balance sheet figures are taken at their opening book value.

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8) Valuation

9) Terminal Growth Rate

(Source-OECD, 2019) Terminal Growth Rate

2030

43%*2030 forecasted GDP Growth Rate in UK

2.04%

31%*2030 forecasted GDP Growth Rate in USA

1.86%

26%*2030 forecasted GDP Growth Rate in EU

1.59%

Weighted Average (Terminal Growth Rate 2030)

1.87%

Note: It is assumed that USA will account for 31% of revenue in 2030.

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10) WACC

(Source- FT,2021; Yahoo finance,2021)

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Reference List

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FT, 2021. UK 10 year Gilt Bond, chart, prices - FT.com. [online] Markets.ft.com. Available at: [Accessed 1 May 2021].

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Glassman, 2021. The Return of Consumer Spending | J.P. Morgan. [online] Jpmorgan.com. Available at: [Accessed 1 May 2021].

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IBISWorld, 2021. IBISWorld - Industry Market Research, Reports, and Statistics. [online] Ibisworld.com. Available at: [Accessed 1 May 2021].

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JDSports, 2020. [online] Files.jdplc.com. Available at: [Accessed 1 May 2021].

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KPMG, 2021. [online] Assets.kpmg. Available at: [Accessed 1 May 2021].

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OECD, 2019. European Union GDP Growth Forecast 2019-2024, Data and Charts - knoema.com. [online] Knoema. Available at: [Accessed 1 May 2021].

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Yahoo finance, 2021. JD Sports Fashion plc. [online] Uk.finance.yahoo.com. Available at: [Accessed 1 May 2021]....