Why the cost of living crisis could be a boon for this cheap retailer

It’s an incredibly challenging time to be a retailer.

Not only are these companies having to deal with rising input costs across the board and demands for higher wages from employees, but the cost of living crisis is also weighing on consumer sentiment and spending power. These dual headwinds of lower potential sales and higher costs are the worst case scenario for the sector.

However, some retailers appear well positioned to capitalise on this environment. Next (LSE: NXT) has spent a huge amount of money building out its online infrastructure, which gives the firm a competitive advantage in the viciously competitive retail sector. Meanwhile, supermarket retailer Tesco (LSE: TSCO) is able to use its size and economies of scale to keep costs low for customers. Those are the reasons why these two stocks are my top picks in the sector.

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But keeping costs as low as possible is also at the core of B&M European Value Retail’s (LSE: BME) business model.

Putting customers first with low prices

Over the past six years, B&M has seen revenues nearly double as management focuses on providing what consumers want: quality goods at a low price.

This is going to be an advantage as consumers start to watch their budgets. According to the company’s own price comparisons, a basket of food and fast-moving consumer goods (things like shower gel and deodorant to you and me) is about 15% cheaper in its shops compared to a supermarket competitor.

What’s more, 93% of all the products sold at a B&M store are less than £20.

The organisation’s “stack them high, sell them cheap” business model has proved hugely successful, powering growth from just 21 shops in 2004 to 1,125 at the end of its 2023 fiscal first quarter.

It looks as these qualities are helping the group cope well in the current environment.

According to its latest trading update, covering the 13 weeks to 25 June, revenue declined by 2.2% on a constant currency basis compared to the previous year. However, this comparison is a bit unfair as it includes a period of lockdowns in 2021, when restrictions stopped consumers from visiting many of the company’s competitors.

As the economy has reopened consumers have returned to their normal shopping habits. This has had a disproportionate impact on B&M, which was classed as an essential retailer throughout the pandemic. Revenues dropped 19.1% on a like-for-like basis over the five weeks to the beginning of April due to this anomaly, although during May and June revenues declined just 1.6%, which I think is a better indicator of how the business is performing in the current economic climate.

Further, there was a notable improvement at the group’s French business with sales jumping from £68m to £91m. The company increased the size of its store portfolio in the region by 4%.

It’s not all good news for B&M

Unfortunately, the group is expecting consumer shopping habits to change due to the cost of living crisis. It’s mainly expecting consumers to shift their spending from higher margin general merchandise products towards food and other essentials.

This could hit B&M’s earnings before interest, tax, depreciation and amortisation (Ebitda) margin by between 70 and 130 basis points for the year. After factoring in this margin pressure, management is forecasting 2023 Ebitda of between £550m and £600m. That’s below the level achieved over the past two years, although it is nearly double pre-pandemic levels.

At the same time, the group is having to deal with a major internal challenge. CEO Simon Arora is stepping down and is being replaced by the firm’s CFO. Arora has been steering the company since 2004, when he acquired the chain of shops with his brothers. His vision and leadership have helped turn B&M into what it is today, one of the country’s largest retailers with a place in the FTSE 100.

Despite the economic climate, I’m more concerned about this change. B&M needs a steady hand on the tiller right now to help it navigate the storm. Transitioning to a new CEO is always a challenge, and it could become a distraction the company can ill afford.

Still, despite this factor, I think B&M possesses the sort of competitive advantages that are required to prosper in a tough market. The stock also looks appealing from a valuation perspective.

Based on Refinitiv analyst estimates, the shares are trading at a forward price/earnings (p/e) multiple of 10.6. Analysts are also projecting a dividend yield of 5.2% for the current financial year.

While there’s no denying the business is in for a rough ride, it seems there is a lot of negativity already factored into the share price. On that basis, I would be happy to consider this stock for my portfolio as a potentially undervalued growth play with attractive income credentials.

SEE ALSO:

Tesco looks well-placed to ride out the cost of living crisis – investors take note

The cost of living crisis is hurting retailers – here are the stocks to avoid

Next’s results stand out against a tough retail backdrop