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Frasers Group - coronavirus exit strategy could cost GBP100m

Nicholas Hyett, Equity Analyst | 23 February 2021 | A A A
Frasers Group - coronavirus exit strategy could cost GBP100m

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Frasers Group plc ORD GBP0.10

Sell: 464.80 | Buy: 465.20 | Change 13.60 (3.01%)
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The Government's roadmap to exit lockdowns has non-essential stores like Frasers reopening on 12 April 2021 at the earliest. In light of this new timeline, Frasers warned that it expects to have to write down the value of its properties by £100m.

Management noted that "the length of this current lockdown, potential systemic changes to consumer behaviour and the risk of further restrictions in the future" were all considered when calculating the damage.

The shares were up 1.1% following the announcement.

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Our View

There's a light at the end of the tunnel with an exit plan for lockdowns agreed. But, as Frasers pointed out, the pain for non-essential retailers is far from over.

The government's reopening plans suggest there's a long way to go before social gatherings resume and employees return to the workplace. Even then, these events might look very different after over a year's worth of disruption. Frasers' brands like House of Fraser and Jack Wills depend on those markets, and could be under pressure well beyond the end of lockdown.

On the plus side the second round of lockdowns in November didn't hurt the group as much as we feared, and crucially, trading when stores reopened was strong. The core Sports Direct business in particular has benefited from increased interest in exercise and lounge wear.

More impressive than the resilient revenue performance is the uptick in underlying cash profits - that's certainly not something every retailer can boast at the moment. As well as cost savings, this is coming from growth in the online business, and the protection of all-important gross margins.

Prior to the pandemic, Frasers was working to turn around its eclectic mix of acquired retailers. Among them are large UK high street names, like House of Fraser, GAME and Jack Wills, as well as stakes in Hugo Boss, Mulberry, Dave Whelan fitness and gym assets.

The plan is to become a "multi-brand, multi-category" retail powerhouse. The problem is, it's not immediately clear how all the pieces fit into the puzzle. Making a coherent, and lucrative, whole out of them is going to take time and money. Investors shouldn't hold their breath when it comes to dividends and given Ashley owns over 63% of the shares, what he says goes.

In Sports Direct itself, the group's "elevation strategy" calls for new freehold flagship stores, displaying products in a more flattering, and digitally integrated, environment. That should allow the group to improve its relationship with key brands like Nike and Adidas, securing the newest products.

These new format stores seem to be resonating well, but as yet they don't contribute enough to group performance to move the dial. Lots of stores still need upgrading if the format is going to contribute more meaningfully.

The group has headroom in the financial terms set by its lenders, so we don't have concerns over liquidity. However, executing Mike Ashley's grandiose vision for Frasers' is a big ask in the current conditions.

Frasers key facts

  • Price/earnings ratio: 17.5
  • 10 year average Price/earnings ratio: 15.5
  • Prospective dividend yield (next 12 months): 0.0%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results (figures exclude the impact of exchange rates and acquisitions unless otherwise stated)

Revenue fell 11.2%, excluding the impact of exchange rates and acquisitions, to £1.9bn in the first half. That was largely driven by declines in Sports Retail revenue, following temporary store closures.

Despite the revenue declines, underlying cash profits (underlying EBITDA) rose 18.8% to £226.3m. That reflects strong trading since stores reopened, growth online and operating cost savings.

The core UK Sports Retail (57% of group revenue) division saw revenue fall 12.6% to £1.1bn, because of store closures. All stores in England have been open since 2 December, and there has been a good performance from the online business. Gross margins rose, from 43.2% to 44.4%, which together with operating efficiencies meant underlying EBITDA rose 7.5% to £156.8m.

The Premium Lifestyle division posted a 0.7% fall in revenue, but including the acquisitions of Jack Wills and, revenue was up 4.8% to £320.4m. A lower volume of concession sales in House of Fraser meant gross margins fell to 47.0%, compared to 51.5% in 2019. Underlying EBITDA rose from a loss of £5.5m, to +£18.9m. This was helped by new Flannels store openings, cost savings and business rate relief from the government.

European retail revenues fell 12.3% to £352.0m, again this was driven by store closures. The group was unable to recoup enough costs to stop profits falling faster than revenue, and underlying EBITDA fell 24.1% to £24.9m. Rest of World retail revenue fell 14.5% to £77.1m, and underlying EBITDA was £10.4m, compared to a loss of £2.5m last year.

Wholesale & Licensing saw underlying EBITDA fall to £11.0m from £16.3m.

The group continues to invest in its Elevation strategy, and says its relationship with key brands is improving, including: "Nike for Sports Direct, Burberry for Flannels, and Hugo Boss for House of Fraser".

The group stated it has around a 10% holding in Hugo Boss shares, and 37% of Mulberry.

Underlying free cash flow was £252.6m, compared to £162.3m last year. Net debt fell almost £116m to £250.1m during the half.

Frasers group no longer expects underlying cash profits (EBITDA) to rise 20% - 30% in 2021. The group has withdrawn all financial guidance, following the closure of its stores in London, the South East and East of England from 20 December, as a result of new lockdown measures.

The closures come during a key trading period, with a "high likelihood of further rolling lockdowns nationwide over the following months at least".

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.