Why this AIM growth stock could be a better buy than ASOS plc
Is there a better AIM market growth stock than ASOS (LSE: ASC)? The online fashion retailer has risen by 207% over the last five years and by a whopping 1,495% since its flotation in September 2008.
Those are hard figures to beat. But floor covering group Victoria (LSE: VCP) has managed it. Victoria share price has risen by 975% over the last five years, when adjusted for last year's five-for-one share split.
Tuesday's 2016/17 results highlighted the stock's appeal. Sales rose by 29% to £330.4m last year, while underlying pre-tax profit rose by 61% to £29.4m. Adjusted earnings per share climbed 50% to 25.3p, putting the stock on a trailing P/E of 19.5. That's expensive, but not excessive for a company exhibiting this kind of growth.
This could get bigger
The secret to Victoria's success appears to be that it's able to acquire and integrate competing companies quickly and successfully. For many companies, a 'buy and build' strategy results in poor shareholder returns and excessive debt. That's not the case here, at least not yet.
Despite regular acquisitions, debt levels have remained reasonable. Net debt was £89.6m at the end of last year. That's equivalent to 1.63 times EBITDA, which looks acceptable to me. Profit margins are also rising as economies of scale and cost savings are delivered. The group's operating margin rose from 6.9% to 8% last year.
The board is targeting further gains from efficiency savings and acquisitions. Last year, Victoria sold about 30m square metres of flooring. According to the firm, that's just 1.6% of the total sold each year across its European, UK and Australasian markets. So further growth should be possible.
Although a major recession could slow sales, I think it makes sense to hold on in the hope of further gains. Earnings are expected to rise by 20% this year, putting the stock on a forecast P/E of 16.4. That looks reasonable to me, based on Victoria's performance to date.
Not such a bargain?
Earlier in July, ASOS said that sales rose by 32% to £675.8m for the four months to 30 June. Sales for the first 10 months of its financial year totalled £1,587m, 35% higher than for the same period last year.
Although these figures were boosted by around 6% as a result of exchange rate movements, they're still very impressive. Despite this, the stock has fallen by 11% since the start of June. Why is this?
One possible reason is that ASOS no longer seems likely to beat its forecasts on a regular basis. Guidance for medium-term sales growth has been set at 20%-25% per year. This year's pre-tax profits are expected to be in line with market forecasts, rather than ahead of them.
Investors need to ask if this kind of performance justifies the stock's sky-high 2017 forecast P/E of 75. I'm not sure it does, especially as profit margins seem to keep falling. The group's operating margin fell from 3.6% to 3% during the first half of this year, for example.
In my view, owning ASOS stock only makes sense if you believe it will become the Amazon of the fashion world. Otherwise I think these shares are simply too expensive to own.
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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon and ASOS. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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