The UK retail sector is enduring a challenging period which could get worse. Inflation is expected to rise this year and this could hurt consumer spending as wage growth may not keep pace. Therefore, budget retailers such as B&M(LSE: BME) could prosper. Its exposure to Germany also means that it could benefit from weaker sterling. But is this enough to make it a buy?
Improving UK performance
In the third quarter of the year, B&M recorded revenue growth of 20.7%. This took its sales to £741m and includes like-for-like (LFL) sales growth of 7.2%. This shows that the company's offering is proving popular among customers, with capital spent on improving the customer experience yielding a higher top line for the business. It also shows that the ambitious store opening programme followed by B&M is bearing fruit. This should continue over the medium term.
Looking ahead, the UK retail sector is facing a tough 2017. Brexit is likely to cause significant uncertainty for people in terms of their employment status, since negotiations regarding the terms of the UK's divorce from the EU are yet to begin. Furthermore, inflation is expected to hit 2.7% this year according to the Bank of England. This could equate to a fall in real terms of wages among workers in the UK. A possible effect of this could be trading down to cheaper products, with B&M well placed to benefit from this.
Strong international growth
The company's expansion into Germany is also proving to be a success. In constant currency terms, sales in Germany rose by 18.8%, but when the weakness of sterling during the third quarter is factored in this leaves top line growth of over 43%.
This figure has been boosted by a greater than 10% rise in the number of stores in the country and looking ahead, further growth is on the cards as a result of weaker sterling. Uncertainty surrounding Brexit could lead to further weakness in the pound, while a higher interest rate may be necessary to cool an expected increase in inflation over the coming months.
A fair valuation
B&M is on target to meet its guidance for the full year. It's expected to post a rise in earnings of 11% this year, followed by a further gain of 10% next year. This puts it on a price-to-earnings growth (PEG) ratio of 1.7, which indicates that it offers good value for money. It would be unsurprising for its bottom line results to beat expectations if UK consumers become more price conscious and the pound weakens further. Therefore, while the retail sector is a risky place to invest at the moment, B&M remains a sound long-term buy.
Certainly, it offers superior growth potential to sector peer J Sainsbury(LSE: SBRY). Its purchase of Argos could boost the company's outlook, but mid-tier operators could be squeezed if consumer spending falls in real terms. As was seen in the credit crunch, shoppers tend to become more price conscious during difficult economic periods and move towards budget retailers. And with Sainsbury's expected to record a decline in its earnings of 12% this year, B&M seems to be a more enticing buy at the present time.
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Peter Stephens owns shares of Sainsbury (J). The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.