Gamble of the week: Can this retailer return to profit?

This high-street retailer is in a mess. Like many others, in recent years it has had to battle against the big changes in people’s shopping habits.

Going up against the supermarkets and internet retailers is no easy task when you rent hundreds of expensive high street stores that are difficult to close. It’s virtually impossible to match their prices and hang on to your profits.

Its UK stores are losing money – £22m last year – which makes it ha7rd to pay the rent and interest bills. To make things worse, the company’s chief executive walked out a few months ago.

Rumours of it asking suppliers for bigger discounts and its banks to cut it more slack have seen investors sell lots of shares. In July last year, its shares were changing hands for nearly 500p. They are now less than 140p with the whole business having a stock market value of just £123m.

It doesn’t seem that anyone is expecting Mothercare (LSE: MTC) to go bust in the near future. More worrying is that it might have to ask shareholders for more money. That said, it looks as if Mothercare’s very successful overseas business is being ignored by investors for now and could be a source of hidden value.

Unlike its UK operations, Mothercare’s overseas business is based on franchises. The burden of paying rent on stores and staff wages rests with the franchisee, with Mothercare being paid a royalty. This makes for a less risky and arguably more valuable business  for Mothercare.

Mothercare share price chartThe overseas business accounts for over 60% of the company’s sales and selling space. It made £42m of trading profits last year and has been growing at more than 10% per year.

The strength of the pound has been holding this business back recently but there’s no doubt that it has a lot of value. Based on a multiple of trading profits of between eight to ten times, it could be worth between £300m-£400m – dwarfing the current market valuation.

So, the key question is how long will it take to get the UK business back to profit – if this actually happens at all? It will take a lot of hard work to make that happen, but with stores being closed and more stuff being sold online, things are definitely moving in the right direction.

If Mothercare can eventually get back to profit, then the shares could soar from their current depressed level. This is the gamble you are taking if you buy Mothercare shares; but if you are prepared to wait, it might be one that pays off in the end.

Verdict: speculative buy

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