2024-01-12 02:57:47 ET
Summary
- Lojas Renner is a Brazilian retailer focused on fashion and lifestyle, with over 600 stores in Brazil, Argentina, and Uruguay.
- Positive aspects for investment include a strong net cash position, a new distribution center for efficiency, a strategic focus on digital growth, and potential benefits from new taxation on international purchases.
- Challenges include financing projects with cash, macroeconomic impact on stores in lower-income areas, and concerns about credit portfolio deterioration and elevated delinquency rates.
- Despite a significant share price decline since 2019, Lojas Renner's valuation remains unattractive, trading at a P/E ratio of 17x.
- The company faces challenges from high interest rates, international competition, and a prevailing market pessimism.
Lojas Renner S.A. (LRENY) is a Brazilian retailer focused on two retail segments: fashion and lifestyle. With a presence in more than 600 stores, primarily in Brazil, and additional locations in Argentina and Uruguay (to be discussed later), Lojas Renner owns four brands: Renner (offering clothes and accessories in various styles), Camicado (specializing in home and decoration), Youcom (targeting the young fashion market), and Ashua (targeting plus-size fashion audiences).
The company positions its target audience within the middle/high standard (or income) segment, a positive aspect as wealthier individuals are generally less susceptible to economic downturns.
Regarding the investment thesis for Lojas Renner, notable positive points include (1) a comfortable net cash position and well-controlled debt; (2) the establishment of a new distribution center inaugurated last year, enhancing efficiency in order processing; (3) a strategic focus on digital segment growth; and (4) the potential benefits from new taxation on international purchases for Chinese competitors who, in recent years, have experienced unequal conditions in the Brazilian sector.
However, there are some negative aspects, including (1) financing projects with cash from the follow-on, resulting in a higher cost of capital compared to third-party capital; (2) the impact of an adverse macroeconomic scenario on stores, particularly those in areas with lower average population income; and (3) concerns related to the deterioration of the credit portfolio and elevated levels of delinquency.
For international investors, Lojas Renner is accessible through ADR-sponsored level 1, indicating the company's active involvement in the administration of the ADR, theoretically resulting in greater transparency and information flow.
Even with its shares experiencing a significant decline of about 75% since its historical peak at the end of 2019, Lojas Renner continues to trade at a valuation multiple that, in my view, is unattractive, as confirmed by a DCF analysis incorporating market consensus assumptions.
Despite being a company with robust fundamentals in the Brazilian retail sector and potentially having weathered the worst macroeconomic impacts in 2023, I still find minor comfort in adopting a bullish stance on Lojas Renner.
Lojas Renner's business Model
Within the Retail segment, suppliers provide products to Renner with specific specifications. Renner conducts sales through various platforms such as its physical stores, partnerships with resellers, and "non-face-to-face" channels (website, WhatsApp, telephone, chatbot).
Renner, the most prominent brand within the conglomerate, has expanded beyond the country's borders, totaling 421 stores and contributing 92% of net revenue in 2023. Following Renner is Camicado, with 107 physical stores in 23 states of Brazil. Next are Youcom (with 118 stores in 12 states) and Ashua (with only 17 stores, having commenced its e-commerce operations in 2016). It is also noteworthy to mention Repasse, Lojas Renner's reseller platform, currently in 62 Renner stores.
In the financial realm, the company operates through the Realize brand. It offers the Renner Card (Private Label), established in 1973, and the Meu Cartão (Co-branded Card), usable both within and outside Brazil. Both cards provide payment options for Renner purchases of up to five interest-free monthly installments or eight with charges. Eligible customers can also access services like quick withdrawal, personal loans, assistance, and insurance.
A noteworthy aspect is the company's intention to foster customer loyalty through financial products, a strategy not considered innovative but deemed positive and essential for the company's sustainable future results.
Lojas Renner aims to be the leader in Latin America's fashion and lifestyle ecosystem. The company has undergone a new ecosystem cycle to achieve this and made significant investments over the past five years.
After undergoing a new investment cycle since 2019, marked by the digitalization of its business, Lojas Renner has progressively increased its debt by implementing the omni-channel ecosystem strategy, incorporating both physical and digital stores. Following the challenging year of 2020, marked by the pandemic, the company experienced an acceleration in its infrastructure investments in 2021, completing four years' worth of progress in just two. This led Lojas Renner to conduct an equity sale, raising approximately $702.5 million. The funds were primarily used in 2022 and 2023 to repay debts, resulting in a robust balance sheet with $526.8 million in cash and $324 million in net debt.
The Current Financial Landscape of Lojas Renner
Lojas Renner maintains a robust position in the domestic market. Yet, the prevailing economic conditions demand caution, posing challenges for its financial division and exerting pressure on margins, especially in regions with lower purchasing power.
2023 is unlikely to be remembered favorably for Brazilian retail companies, given the macroeconomic scenario influenced mainly by high double-digit interest rates. This scenario significantly impacts results and affects most of the sector's shares.
High interest rates bring forth multiple adverse effects on retailers. Sales decline as consumers face limited access to credit, resulting in reduced consumption. Given the sector's high leverage, financial debts increase, leading to a decrease in net income and, at times, turning it negative.
In the case of Renner, the company reported weak results throughout 2023, marked by a significant downturn in revenue growth and sharp declines in profits. This downturn was mainly attributed to high household defaults, elevated interest rates, and a reduced appetite for lending by financial institutions.
In the most recent quarter, Q3 2023, Lojas Renner experienced a 33% year-on-year reduction in profit. One contributing factor was expenses, where weak sales leverage, combined with the ramp-up process of the Distribution Center in Cabreúva in the State of São Paulo, impacted Renner's operating profit. The company reported an adjusted EBITDA of R$363 million, down 21% year-on-year.
Simultaneously, challenges in increasing sales in the "Clothing and Footwear" segment can be attributed to the highly disruptive moment. Competition intensifies with cross-border platforms offering competitive prices and capturing a portion of the national demand.
Furthermore, Lojas Renner faces competition from foreign peers, such as the Chinese fast-fashion retailer Shein, which benefits from unequal tax advantages. Operational improvements by domestic competitors also challenge Renner's position as the most efficient player in the sector.
While the high net cash position resulting from the 2021 follow-on offers comfort to the company, it raises questions about its ability to allocate capital that generates higher returns even in an adverse scenario.
Lojas Renner's Credit Portfolio Raises Concerns
In the last quarter, Q3 2023, the credit quality of retailers emerged as a significant topic of discussion during the earnings season. There are contrasting factors at play. Although some companies have initiated this process, assuming a widespread resurgence in credit card concessions is premature. Brazilian families, particularly those in the lower income brackets, still carry high debt levels, and banks are cautious about extending credit.
On the positive side, Non-Performing Loans ("NPL") for individuals have peaked, and further declines are anticipated, aided by lower core inflation and robust labor markets. In the most recent quarter, there was an improvement in the NPL 90 formation, 20.9% and 5.9% lower versus 2Q23 and 3Q22, respectively.
Realize, Lojas Renner's financial arm, significantly impacted the company's results throughout 2023, incurring a loss of R$10.3 million in the first quarter, R$53.7 million in the second, and R$35 million in the third.
The improvement observed in Lojas Renner's third quarter marks an initial step toward making the financial product profitable again. This is expected to enhance sales volumes, as customers rely on credit availability for purchases.
Although a concrete acceleration in credit growth might take some time, provisions will likely decrease, setting the stage for improved profitability trends.
Valuations and 2024 Outlook
Looking ahead to 2024, challenges are anticipated despite the belief that the worst is behind. Despite the overall challenging scenario for the clothing sector, I perceive the company as well-positioned compared to its peers. As consumer conditions recover, Renner, Brazil's leader in the category, is expected to distinguish itself and navigate the competitive environment more effectively.
Moreover, with a more favorable comparative base, Renner is poised to benefit from expense control from the review of its cost structure conducted this year. Completing the ramp-up phase at the Cabreúva Distribution Center, which has become a source of efficiency gains in terms of expenses, should also provide excellent stability for the company's balance sheet. The disinflation of costs, allowing investment in pricing to stimulate sales and narrow the pricing gap compared to cross-border platforms, is anticipated to expedite the prospect of a gradual recovery in demand.
Comparing Lojas Renner with its main competitors in the fashion retail sector in Brazil traded on the Ibovespa, such as Grupo Soma, C&A, and Marisa, the company stands out primarily due to a more conservative valuation than its peers, surpassing profitability metrics, being well-positioned in efficiency metrics, as well as maintaining a very comfortable leverage profile.
Shares in Lojas Renner have experienced a nearly 75% decline since reaching their all-time high in December 2019, anticipating the onset of the pandemic. Subsequently, the share price has gradually eroded, reflecting the stretched valuation the company traded at, surpassing 40x price-to-earnings at its historical peak and 38x in 2021.
Currently, Lojas Renner trades at a P/E ratio of 17x. While this figure is 27% below its historical average over the last decade, it still does not represent a low multiple, essentially aligning with the average for the clothing retail industry.
In a discounted cash flow ("DCF") analysis of Lojas Renner, considering consensus growth estimates for revenues, EBIT, and FCF from S&P Global Market Intelligence, incorporating various analysts' projections, and applying a Weighted Average Cost of Capital ("WACC") of 11.46% based on the risk-free rate of long-term interest rates in Brazil, an equity risk premium of 9%, and a cost of capital of 17%, the calculated equity value for Lojas Renner is $1.83 billion. This considers the company's cash and debt position, with a perpetuity growth assumption of 4.5%.
Dividing this equity value by the number of outstanding shares, which stands at 956 million, yields a fair price of $1.92 per share for Lojas Renner's ADR. This is approximately 43.2% below the value recorded on January 10, 2024, which traded at $3.38 per share.
I must clarify that I may not necessarily align with the consensus assumptions. This potential misalignment is likely one of the factors contributing to Lojas Renner's performance being in free fall over the last three years.
Contrary to these multiples, my more optimistic perspective is grounded in the fact that Lojas Renner currently trades at a P/E ratio still significantly below that of 2015, when it traded at 20x. Presently, it is practically valued at multiples akin to a value company. Additionally, the company holds leftover cash from a recent follow-on in 2021. This liquidity could be earmarked for potential mergers and acquisitions shortly.
The outlook for a "less bad" performance in 2024, driven by decreasing interest rates in Brazil (Selic) and the possibility of a spike in defaults alongside controlled inflation, could further support Lojas Renner in achieving a more robust performance in 2024 and positively influence its valuation multiples.
The Bottom Line
Lojas Renner navigated through the challenges of 2023 amid macroeconomic difficulties in the Brazilian retail sector. The year was characterized by high interest rates impacting margins and costs and revenue declines due to intense competition from Chinese e-commerce platforms like Shein, reflecting trends observed in Europe and the US with Temu's low-price model.
The challenges, including intense competition and elevated delinquency rates prompting accelerated credit origination, have recently impacted growth. However, the potential gains from the new Distribution Center ((DC)), particularly in terms of margin improvement and enhanced store productivity amid a more challenging environment for sales area expansion, combined with the benefits of declining interest rates for Realize and a modest valuation, leave a more optimistic outlook over a 12-month horizon.
Despite trading at lower valuation multiples than major domestic peers and its recent track record over the past five years, I find little comfort in adopting a more bullish outlook on Lojas Renner in the short to medium term. This anticipation stems from expecting the company to face challenges due to a persistent high interest rate scenario in Brazil and pressures from international platforms. However, even though the trend suggests that the worst is over, the market has a prevailing sense of pessimism regarding Lojas Renner's shares. I would prefer to wait for a more vital inflection point in the company's results before feeling more confident about adopting a bullish stance.
For further details see:
Lojas Renner: Why I'm Not Buying The Leading Brazilian Fashion Retailer