Ted Baker shares are a bargain – here's how to play them

The sharp decline in Ted Baker shares looks excessive, say Matthew Partridge. 

Woman in a Ted Baker dress

Sales have nearly doubled in five years

All retailers have struggled recently, but none has had worse luck than Ted Baker (LSE: TED). Founder and chief executive Ray Kelvin was first forced to take a "leave of absence", and then had to quit permanently in March after a personal scandal. The group then issued a profit warning this summer, noting that trading conditions were far worse than expected. As a result of all this furore, shares that were trading as high as £23.50 last September fell as low as 806p a few weeks ago. Even now they are over 60% below their 52-week high.

Nevertheless, there is plenty of evidence that the fall is due to an overreaction. A strategy of growing the business through small-scale concessions in larger stores, rather than spending large sums of money to open its own outlets, has not only helped Ted Baker nearly double sales between 2014 and 2019, but it also means that it is not lumbered with uneconomic long-term leases. It has also had enough foresight to invest in the digital side of its operations, with the result that even as the growth in physical sales slow, online sales continue to expand at double-digit rates.

Expanding in Asia

As well as trying to grow online, Ted Baker is attempting to expand its international business, especially in Asia. This summer it concluded a five-year deal that should help boost its customer base in Japan, with a subsidiary of the Sojitz conglomerate helping it sell its clothes through department stores. It is also making efforts to grow its operations in mainland China.

Closer to home, it has ended its relationship with the eternally struggling Debenhams in favour of one with Next. Overall, analysts expect sales to continue to grow in 2020 and 2021, though not quite at the rate they initially foresaw.

There has been a lot of speculation that a consortium could take advantage of the lower price to launch a buyout of the company, taking it private. This has already caused the shares to bounce back by 15% from their summer lows. However, they may have to offer a sizeable premium to shareholders to convince them to sell. Even if this buyout offer doesn't materialise, Ted Baker could be an attractive takeover for another retail firm. In any case, the company makes sense as a value target since it trades at just under ten times 2020 earnings. An 18% return on capital expenditure also enables it to produce a large amount of cash flow, which means that it can pay a very generous dividend yield of 5.4%.

I'd suggest that you go long on Ted Baker at the current price of 929p at £4 per 1p (compared with IG Index's minimum of £1 per 1p). I'd then set the stop loss at 709p, which would give you a potential downside of £880.

Trading techniques... picking up fallen angels

The credit ratings agencies that assess bonds have a bad reputation, not only due to their patchy record, but also because of the way they make their money. While equity analysts are paid (either directly or indirectly) by investors who use their research, bond analysts get their money from the companies whose bonds are being covered. This has led to a perception that they lack objectivity.

Many traders believe that the best trading opportunities may come from bonds that have been downgraded, especially those that have been moved from "investment grade" to "high-yield" or "junk" status. The rationale is that many investors, especially large institutions or pensions funds, have strict rules limiting the number of risky bonds that they can hold. So when the bond is downgraded, or even shortly before, these investors will be forced to get rid of the bonds, even if they believe that they are actually worth holding onto. As a result, the price of the bonds (known as "fallen angels") falls to an unwarranted extent.

A 2016 study by Andrew Clare, Stephen Thomas and Nick Motson of Cass Business School found that the price of fallen angels typically started falling a month before they were officially downgraded and then continued to fall for nine days. But they then recovered; by a fortnight after their downgrade they had made up the lost ground. The research also found that between 2000 and 2016 a strategy of buying a portfolio of fallen angels would have outperformed the wider high-yield bond market by the equivalent of nearly 4% a year (11.04% versus 7.1%).

How my tips have fared

This has been quite a good fortnight for my long tips. Three have appreciated, two stayed the same and only one declined. JD Sports went up from 601p to 626p, Safestore from 641p to 648p and Bellway from 2,842p to 2,961p. Hays and Superdry remained the same at 146p and 392p respectively. Bausch Health Companies bucked the trend by slipping from $21.72 to $21.34.

Overall, my open long tips are making a net profit of £585, up from a loss of £42 a fortnight ago, with only Superdry, Hays and Bausch losing money.

My short tips have also moved in my favour, with all but one declining. Weis Markets fell from $39.40 to $38.23, bitcoin decreased from $10,695 to $9,895, Netflix from $309 to $294 and Uber from $35.70 to $32.57.

Only Tesla increased slightly, from $224 to $225. Overall, all of the five short tips are making money, with the group collectively $1,395 in the black (compared with net profits of £908 in the last roundup).

I have made two short tips, Beyond Meat and Zoom Video Communications, which both remain above the price at which I suggest that you should start shorting them. So I suggest that you cancel the Zoom short entirely, though I may revisit the share if things change, because I still believe that it is overvalued. I also recommend that you close the long position in Hays, taking a small loss of £52, because it is still losing money over six months after I first tipped it.

So counting the latest tip, I have six long ideas (JD Sports, Safestore, Bellway, Superdry, Bausch Health Companies and Ted Baker), five short tips (Weis Markets, Tesla, bitcoin, Netflix and Uber), and one short bet (Beyond Meat) that will be triggered if it slips below $120.

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