Following our Breaking down the online retailers blog written by Luke Winchester. He discussed the possible reduction in tailwinds that the e-commerce sector had experienced due to COVID. Plus, a headwind of increasing costs.
The pure online retailers such as Kogan, Temple & Webster and Redbubble provided market updates around possible weakness post-COVID lockdowns. The main headlines out of these company numbers were the slowdown in top line growth when compared to the beginning of the pandemic. Considering the high multiples these companies were trading at the time, the slowdown of growth was a concern for investors. That said, we believe the market may have overlooked the increasing costs required for the online players to produce revenue growth, which could become an increasing concern.
Our Investment Philosophy
Part of our investment philosophy at Oracle is to invest in businesses that are increasing their margins, or at least sustaining them as they grow their top line.
In the Oracle Emerging Companies portfolio, we have avoided pure online retailers and invested in omni-channel retailers who are able to serve their customers both online and in-store. We have found that these businesses are able to grow revenue at a reasonable rate while maintaining their margins. Our two notable holdings of this type are Premier Investments and Lovisa. Premier is the owner of Just Group, which includes well-known brands Smiggle, Peter Alexander and Just Jeans. While Lovisa is a fast-fashion jewelry chain, according to their website, they are bringing brilliantly “affordable, on-trend jewelry to the world”.
We are expecting a strong full year result from Premier Investments after a positive update at their half year report. Being an omni-channel provider Premier was able to shift their focus online when COVID first hit. They were able close underperforming stores and negotiate large rental reductions with landlords. Below is the gross margin chart from Premier’s half year 2021 update, detailing how they were able to expand their margins during a difficult trading period. You can see by this chart that Premier is a very well-run business led by retail veteran Solomon Lew.
Lovisa’s half year 2021 investor presentation showed the company maintained their margin during the heights of lockdown even with impacted supply chain constraints. The beauty of Lovisa’s business model is their small store format and high inventory turnover. This leads to a high return on invested capital for investors as they roll out new stores.
When it comes to pure online retailers and their increasing costs to operate online, Redbubble’s latest financial update is a good example to use. During the 3rd quarter of last financial year, revenue increased by 55% while marketing costs (the bottom row) increased by 71%. For the year-to-date, revenue increase 85% but marketing increased 107%.
You can see that Redbubble have labelled marketing costs as paid acquisition because they are paying Google, Facebook etc. to acquire their customers. As pointed out in the previous blog, the pure online retailers have a heavy reliance on the big US technology companies to bring customers to their website. The cost of advertising on these platforms is now increasing as competitors outbid each other for clicks.
From a valuation perspective and sticking with the FY22 earnings multiples used in the previous blog, Premier trades at 22x, Lovisa is currently trading at 37x and Redbubble 34x. However, looking back to when the half yearly reports were released for each company, Redbubble was trading at a whopping 61x FY22 earnings and Lovisa was at 24x. The markets were quick to bid down Redbubble as costs were increasing faster than revenue and bid up Lovisa, which managed to maintain their growth and constrain their margins.
A commonly used term in investing now is GARP, which stands for “growth at a reasonable price.” When researching companies for our Oracle Emerging Companies portfolio, we place a strong emphasis on valuation, as we are acutely aware that the price paid for a business will ultimately determine our expected future returns. Valuation is something all investors should keep at the forefront of their mind when looking for the next growth opportunity. This is the reason we prefer the omni-channel retailers, as they can produce growth while also expanding their margin.
Pure online retailers have recently come under pressure due to increasing marketing costs. This is due to a reliance on the large tech companies, Facebook, and Google for example. On the other hand, the omni channel retailers have either decreased or maintained their margins. COVID-19 has played into the hand of the brick-and-mortar retailers as they were able to renegotiate to lower rental prices. From an earnings valuation perspective the omni channel retailers are at a more reasonable price than the online retailers, with the former expanding their margins and the latter’s contracting. Therefore, we like the omni channel retailers for the Oracle Emerging Companies portfolio.
Written by Jack Magann
Oracle Emerging Companies Portfolio Manager
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