Stock to Watch: Sports Direct International

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The FTSE 250 shares in sports and leisure clothing retailer Sports Direct International (SPD) are continuing a strong New Year performance - up from 215p to about 280p, buoyed by a 15 February interim management statement showing a 10.2% rise in gross profit to £184.4 million on group sales up 9.1% to £453.8 million.

This puts the shares back near their 300p flotation level in 2007 (after which they slumped to 32p by end-2008, due to trading disappointments and the bear market). The price doubled over six months above 200p after a September 2010 update cited a near 18% gross profits rise.

Institutional investors have generally been wary of SPD since its post-flotation debacle, with the founder Mike Ashley owning 71.2%, however a month ago Odey Asset Management took its stake past 6%.

The latest strength in gross profit is notable because SPD's interim results for the 26 weeks to 23 October 2011 appeared to suggest the company was boosting revenue with the help of discounting. Like-for-like figures showed an overall 8.4% advance in revenue, but the gross margin slipped from 42.6% to 41.5% and profitability/earnings were quite flat.

Admittedly, nine new stores had been opened since the year end and the consumer environment has been very difficult, but the income statement's profile appeared to suggest SPD had to discount aggressively - just to stand still. Online promotions featured discounts extending to 90% although the company says daily "90% off" sales have helped boost online sales. While this coincides with more typical year-end stock clearance, SPD sustains interest in web sales with ongoing, steep discounts.

Together with confirmation that SPD is set to meet its "super-stretch" profit target of £225 million for the current year to end-April, it suggests management is being adept with marketing and sourcing/manufacturing. Also, that the prospect of bonuses worth over £31,000 each, for over 3,000 workers, may be a motivating factor for shop sales - beyond the six million shares worth about £17 million for Ashley, if targets to 2015 continue to be met.

A significant aspect for the longer-term investment rationale is that if SPD is already outperforming other retailers, it may do even better when consumer spending improves. The interim results showed the bulk of sales were UK-oriented at £697.1 million, within which online sales grew 85% to £72 million - helped by a relatively low base but still impressive as retailing migrates from the high street.

Europe is a risk in that a 22% rise in "international" sales to £81.3 million was helped by 10 stores acquired in Portugal and the strategy is to expand into all 17 countries that have adopted the euro; so if economic woes spread from Greece then SPD is exposed. Yet it has already shown resilience in the UK and could replicate its skills in Europe to gain share during difficult times, then benefit nicely in the longer run.

When I drew attention at 220p last September, I noted how brokers were already projecting annual earnings growth of about 20% for the coming two financial years, forecasts that now look more like 25% growth. At 280p a share in the market, the forward price-earnings multiple is about 15 times falling to about 13.

While these forecasts seem ambitious in context of the interim results, the Euro 2012 football championship and Olympic Games are likely to provide a boost.

The main risk looks to be whether disruption unfolds from Greece's woes and spreads through Europe, affecting UK exports and ultimately consumer spending. It is also hard to be sure the UK's general improvement in January retail sales isn't just a blip. A latest survey by mortgage lender Nationwide suggests consumer confidence rose usefully in January and falling inflation may ease fears of recession - yet the rise in unemployment and weak economy may still make this a temporary bounce.

Bear in mind, nevertheless, how recessions can spur a precious few firms to superior competitiveness and market share gains, putting them in a strong position for when the economy does improve. Despite competition that has seen the likes of Blacks Leisure and JJB Sports fall by the wayside, SPD could be among the retail sector's long-term winners.

If the weak economy drags on, there is ongoing scope to capitalise on a trend to improve personal appearance and fitness, which can feature in recessions. Hiking and jogging involve little cost and SPD may also be benefiting from "trading down" from pricier brands: for example it says its ski ranges have done particularly well. This might be budget-conscious skiers looking to lower-priced resorts and gear.

The board says it will consider a dividend at the end of the financial year. There has been ample scope, however, since the dividend was axed in mid-2009, with earnings per share at least firm in a mid-teens pence range. One broker has targeted 5.6p for the current year and 8.4p in 2012/13 - implying a prospective yield of 2-3%. This could easily be wiped out with market volatility so it is important to focus on the wider risk/reward factors.

After the share price jump, likely enhanced by a tight market, with fresh money I would wait for some consolidation than chase a price to earnings multiple well in the teens - on the basis of one genuine "growth" report and the wider market being at risk from Europe. But it affirms a strong business model, and with share-based incentives across the company for the next three years SPD could distinguish itself.

The next key announcement is likely to be a pre-close update in mid-April, then prelims on 19 July, both of which could be useful for trading or to affirm a long-term investment.

For more information see sportsdirect.com and for more Stocks to Watch, visit Edmond's archive.