TRS Update

The Reject Shop has fallen further since my previous post in April 2014. Results for FY 14 showed sales up 15% to $711.5m and Stat NPAT down 25% to $14.5m. Results were poor considering 46 new stores were added. Revenues increased as expected given the new stores and comp sales were down -0.45%. Excluding irregular accounting items in FY 13 (insurance claim) and excluding expensed items associated with new stores, NPAT for FY 14 is roughly in line with FY 13.

Investment Thesis

In the past two years alone, TRS have opened 87 new stores. The expansion in stores took place following the collapse of a competitor which provided an opportunity for TRS to increase their presence and market share. Store expansions provide the opportunity for TRS to grow their presence and grow their top line, however it has required substantial capex and investment in working capital. Additionally, the speed at which stores were opened looks to have caused inventory issues causing margin erosion. Combined with a difficult retail landscape, this has seen TRS perform poorly and the stock is down around 67% from the peak in January 2014.

At current operating margins alone, TRS looks to be good value. However as TRS moderate store expansions, capex and investments in working capital will reduce. This will have positive implications on earnings and free cash flow. TRS now need to turn their focus from expansion to improving efficiency. There are numerous headwinds to achieving efficiency: a higher Australian dollar, a difficult retail environment, high competition. Even if TRS maintain the current depressed margins I believe the share price is cheap enough to warrant investment. However should they succeed in increasing their efficiency the upside is even greater.

Current Valuation based on FY14 Results

At current prices, TRS trades at a multiple of 11.9 PER. On an underlying basis this equates to 8.9x after stripping out expensed items for new stores and asset impairments. EV/EBITDA is 4.8 for FY 14. On these numbers, to me TRS is trading way too cheap.

	Valuation Metrics
Share Price	$6.0
Shares Outstanding	28,844,648
Market Cap	$173,067,888
Cash	$7,675,000
Debt	$25,103,000
Enterprise Value	$190,495,888
Dividend Yield	5.7%

	Valuation Metrics (FY 14)	Valuation Metrics (FY 15 E)
PER	11.9	8.3
Underlying PER	8.9	7.8
EV/EBITDA	4.8	4.1
ROE	12.1%	16.1%