I have sold my holding in Diploma for a 14% profit. My main reason for selling was to make way asap for a new holding – JD Sports. I chose Diploma for a combination of reasons: the valuation was quite full; I found the recent results OK but not great (driven mostly by currency gains) and the share price momentum is starting to tail off.
With some of the proceeds I topped up Gamma Communications to 2.4% of the portfolio, but with most I bought a new holding in JD Sports (2.9%)
I’ve mentioned a couple of times previously that I am undecided about JD Sports. I remain quite ambivalent but after it published some outstanding final results this week I decided to finally pull the trigger.
JD Sports is a retailer of fashion sportswear – it owns several retail brands and is mostly focused on trainers but also some outdoors shops. It currently operates predominately in the UK but is expanding in Europe and recently Asia. It is a share that looks great on paper (i.e. the numbers) but then seems a lot more questionable when qualitatively analysing what it does. I’ve decided to follow the numbers in this case:
- Business economics: JD Sports has very high and growing ROCE (currently 37%), decent margins for a retailer (about 10%) and converts a high proportion of its profits into cash. It looks like a very high quality business based on these figures.
- Track record: JD Sports recent track record is very good. Profits and free cash-flow have grown at a consistently fast rate for the last few years
- Competitive advantage: JD Sports suggests in its reports that its competitive advantage is due to the quality of its retail space, which is increasingly ‘multichannel’ and ‘digital’. It appears to have negotiated advantageous agreements with sportswear manufacturers because of this. Qualitatively I am not convinced that JD Sports has a very strong and sustainable competitive advantage. Based on its recent performance, however, I believe it has some competitive advantage, most likely arising from the sources it suggests.
- Growth prospects: As a bricks and mortar retailer it is difficult for JD Sports to continue to expand at a very high growth rate. However, I think the growth potential is fairly good. JD Sports appears to have fairly ambitious international expansion plans and has also shown itself to be rather adept at growing through reasonably priced acquisitions of businesses it is able to radically improve.
The valuation looks quite reasonable given the likely continued but slower growth. My back of the envelope DCF approximation suggests it is significantly undervalued on quite cautious estimates of growth. Momentum in the business is really excellent. The share price has just broken out upwards from a very long uptrend following the publication of recent results. These results were significantly ahead of a recent upgrade in January. JD has warned that there may be some currency headwinds later this year – I am somewhat concerned about this but not enough to put me off buying.