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Poundland Plc – 05th May 2014

Company Overview:

Poundland Group PLC operates as a single price value general merchandise chain in the UK and more recently in Europe. The group currently trades from a network of 517 high street and out of town stores (31 December 2013) and has plans to increase the total number to over 1,000. The group also own 31 stores in the Republic of Ireland where it trades under the Dealz brand. In addition to the expansion within the UK and Ireland, PLND management also plans to expand internationally with the first destination being Spain.

Until its IPO in Q1 2014, Poundland Plc was majority owned by Warburg Pincus Private Equity (76%), while management held the remainder of the shares following an earlier MBO (Management Buyout). Although Warburg Pincus has, since IPO, reduced its stake in the firm, members of management have retained their stakes.  The Chief Executive, Jim McCarthy, remains the fourth largest shareholder with a 3.87% ownership claim.

PLND stands apart from the crowd in the UK Single Price Value Merchandise arena given that it is the only such retailer to have professional ownership and management, which is in contrast to the family owned and managed structure of most competitor business.

The industry is forecast to grow rapidly over the coming years, with PWC anticipating an annual CAGR of 9.3% between 2012 and 2017. At present, the listed single price general value merchandise sector in the UK has a market cap which is below £1 billion. This compares meekly to the listed market cap of US single price retailers which exceeds $50 billion, and could be said to support expectations by PWC if the similar socioeconomic demographics of the UK and the US are anything to go by.

Index  FTSE 250 Ticker  PNDL.L Latest Close  349.00
52 Week High  401.00 52 Week Low  300.00 P/E  31.11
Dividend Yield %  N/A Dividend Cover  N/A CEO:  Jim McCarthy
CFO:  Nick Hateley

Declining incomes among the poorest and persistently low wages set to drive expansion in value merchandise retailers

While talk of the UK economic recovery has graced the pages of both mainstream news media and the financial press for the last 18 months, unbeknownst to many of us there is a significant portion of the general population that wouldn’t have known a recovery was underway otherwise.

While some of us have been fortunate enough to enjoy some form of improvement in financial circumstances since the crisis, recent Department for Work and Pensions data has highlighted what will be a more alarming trend for policy makers and politicians ahead of the 2015 elections.

The data revealed that while most of us have seen our overall compensation increase over the last decade, the average incomes among the poorest of workers in the UK have actually declined by 10% over the same period.

Although there are many theories available (skill gap/mismatch, oversupply of low or unskilled workers etc etc) which attempt to explain this dynamic, the key takeaway in the current context is that there are no indications that a change to this trend is on the immediate horizon.

It is this trend which underpins the investment case for Poundland Plc and other discount retailers operating in the UK. While these have proved resilient to the economic recovery and have also to a degree managed to attract custom from other more cost conscious segments of the income spectrum, there are a number of risks that come attached to shares in Poundland.

Today’s report provides an overview of these risks, an insight into the likely future growth prospects of the group as well as a price target for the shares.

In addition to this, the group is thought to be exploring the potential to launch an online offering with home delivery service very much similar in nature to those of the leading supermarkets.

The below graphics illustrate the growth trajectories of various income groups within the UK over the last ten years as well as the density of populations across the income groups geographical dispersion.

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Poundland continues impressive growth during 2013

Poundland’s 2014 IPO saw the company announce another year of stellar growth as the economic recovery which began to take hold in 2013 failed to slow the pace at which the group acquired new customers over the period.

With incomes still under pressure and the general population reeling from a multi-year period of employment insecurity, below inflation pay increases and persistently strong price pressures to the upside within the economy, consumers have continued to flock toward the emerging discount brands of the high street.

The company is now the first to have listed on the UK stock market and as such should prove popular over time given the limited means that home based investors have to gain exposure to the single price value merchandise industry.

For the year of 2013, Poundland management reported that the group managed to increase its operational store count by 17.7% over the period, which supported a further increase in revenue by 15.05%, underlying EBITDA by 17.57% and underlying profit by 24.11%.

The above trends were further complemented by management’s announcement, in response to analyst questions, that 20% of the group’s customer base belonged to the semi affluent AB socioeconomic demographic, indicating the appeal of the brand does not stop at the final stages of the lower tier on the income spectrum.

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Expansion: Planning for the future

While further store expansion within the UK remains an integral part of Poundland’s growth strategy, the firm also has plans to move into the online sales arena with an offering that would be based upon the “home delivery model”, according to Chief Executive Jim McCarthy.

This could potentially enable the firm to diversify its product offering to incorporate the sale of items that cannot be readily sold inside their stores with the current set up. This could include items such as larger home and garden furniture as well as cold and frozen foods.

Such a move is likely to require significant financial investment and may take time to become fully operational; however, should it prove a success then Poundland will have an ideal platform from which it can attack the customer bases of the discount retailers such as Aldi and Lidl.

In addition to expansion within the UK, PNDL management also intend to continue their march upon overseas territory. These plans follow a successful entry into Ireland under the Dealz brand during 2011, one which has now expanded from a two store operation to 31 at the start of 2014. This year will see the Dealz brand expanding into the recession hit nation of Spain with a trial balance of ten new stores.

This form of expansion, while risky, affords PNDL the opportunity to mitigate the risks posed by increasing competitive pressures on home soil. Given the short turnaround time between when a new store (UK) has opened and when it has recouped its start-up costs, if the same rate of success is achievable on the continent then Poundland Plc could find itself having a competitive advantage over many of its nearest rivals.

Valuation

The shares currently trade upon a multiple of 31X 2013 earnings, which is a high valuation compared with other bricks and mortar retailers. However, PLND’s fast turnaround time between when it opens a new store and when it has recouped its initial investment into the site is short (12 months). As a result, the rate of growth that the company has undergone throughout recent years has been rapid.

When viewed in this light the valuation becomes more palatable. Our view is that the PLND’s growth strategy is credible and for this reason, the high valuation is of no concern to us at present.

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Risks

Despite PLND’s success to date and the positive outlook going forward, the shares do come with a number of risks attached.

On a micro level, and given the amount of retail space available on UK high streets, individual Poundland stores are vulnerable to competition from other single price value general merchandise retailers, whether singular store outlets or national brands. Although some of these are not likely to have the same level of purchasing power as PNDL, they would nevertheless be able to pose a competitive threat for a time at least.

On a higher plain, the greater risk to Poundland’s future growth prospects comes from the larger, more established, discount and non-discount supermarkets such as Tesco, Morrisons, Aldi and Lidl.

The danger posed by this group is the greatest and most immediate. This is because, given the relative scale of the businesses, brands and balance sheets in question, they have the potential to inflict the most long term damage upon Poundland’s future growth prospects.

It is of particular concern to note the recent announcement made by Tesco Plc, which indicates that the retailer intends to enter into the discount space as part of efforts to counter the threat already posed to its business by continental rivals Aldi and Lidl,

The current plan sees the group incorporating discount sections into its main stores where many regular shopping items and household goods will be sold for less than a pound. This development significantly increases the threat posed to Poundland by the supermarket sector.

If this was to become a mainstream strategy among the “Big Four”, then Poundland’s dominance in the single price value general merchandise space could begin to erode. At the very least, already thin profits would be expected to come under further pressure which will dent investor confidence in the shares, while leaving a lesser margin for error when it comes to PNDL’s international expansion plans.

On the other side of the same coin are PNDL’s intentions to incorporate the online home delivery model into part of its core operation. Given that this is a lucrative area which has typically been served by the “Big Four”, there is a risk that if the strategy extends to the remainder of the discount sector then the higher tiers of the UK supermarket sector could respond by making a greater push into the discount space.

Each of the above has the potential to increase competitive pressure upon PNDL. Although there are no official figures to support this, it seems rational to assume that in a sector such as Single Price Value General Merchandise, customer loyalty is likely to be low as the critical success factor for the company has always been offering the right goods at the right prices. As a result, the key determinant of a shopping site’s success will be the prices of goods sold and the convenience of a store’s location.

This makes securing the right sites in and around town centres critical to the success of new stores. Should geographic expansion activity among Poundland’s competitors begin to increase, then the company could be forced into paying higher rates for its leases or face losing out on prime locations altogether.

Given that there are limitations to the number of customers that can be served in any one individual outlet and that many of these are already operating at full capacity, much of PDNL’s annual growth will come from the opening of new stores. Should management begin running into difficulties when it comes to securing new leases, then the group’s overall pace of growth could begin to slow.

In addition to this, Poundland is the only single price value general merchandise retailer to be listed on the London Stock Exchange at present. However, after a successful IPO demonstrated an appetite among investors for shares in this sector, the risk exists that Poundland’s IPO could lead to an increase in the number of single price retailers listing in London.

This would provide investors with an alternative means of exposure to what is presently a high growth market could lead to pressure upon the shares, with some potential investors opting to hold alternatives.

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Summary

Poundland is the oldest, largest and most successful operator in the single price value general merchandise arena. The group is also the first of its kind to have listed on the London Stock Exchange and as a result, presents the UK retail investor with a unique opportunity.

The management team at Poundland draws upon a wealth of experience across the bricks and mortar retail environment and have demonstrated, over time, an ability to execute the clear growth strategy which the group has in place.

Even with this taken into consideration, there are a number of risks that could influence the longer term performance of the group. Management have taken steps to mitigate some of these by seeking to expand internationally, as well as by diversifying into the on-line home delivery market within the UK.

However, these risks cannot be fully mitigated and may have the effect of constraining growth, or eroding already fragile margins, over the longer term.

With this said, the group’s geographical growth strategy is likely to yield results over the medium term as the model is tried and tested. This is while competitive efforts from rivals remain in their early stages and may take time to have an effect, if at all.

Although the risks attached to Poundland Plc are above average, the group remains a quality play upon stagnant or declining incomes across various segments of the UK consumer population.

Our overall outlook for the shares sees strong support at 325.00 pence for shares currently trading at 349.00 pence. Our longer term view sees another year of stellar growth for 2014 and accordingly, a return toward, and eventually above, previous highs at 400.00 pence.

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