Investors now have access to two expansionist general merchandise discount retailers on the London market, each plugged into the structural shift towards value-led retailing and boasting compelling store roll-out narratives. The question is, which stock should investors buy, if not both?

Piling on the pounds

The retailers in question are Poundland (PLND), Europe’s leading single price discount retailer which floated on the Main Market in the spring (12 Mar) and B&M European Value Retail (BME), a multi-price value retailer chaired by former Tesco (TSCO) boss Sir Terry Leahy which debuted in the summer (12 June). While we note B&M’s growth potential we think Poundland stacks up better as an investment for now.

Floated on the stock market by their private equity owners, the pair are helping to redraw the retail landscape in the UK and also Europe. They are leaders in the disruptive force that is the high-growth general merchandise discount market, encroaching on the territory of the established grocers whilst also moving in on the turf of newsagents, homewares specialists, electrical specialists as well as greetings cards purveyors and even pet food sellers.

Though viewed as austerity winners, both players are primed to profit from economic recovery in the UK and continental Europe. Rising consumer footfall should drive larger basket sizes and greater spend on their higher-margin discretionary items, while the recession has also altered shopping habits so all socio-economic groups including the more affluent ‘AB’ socio-demographic have become hooked on bagging bargains.

On a roll

Both discounters are pouncing on an unprecedented rollout opportunity, with many leading national UK retailers looking to offload stores or sub-let their underperforming space.

A running Shares key selection - see Plays, 15 May 2014 - Poundland now boasts a total store estate of 557 shops. As well as expansion in the UK, where it is targeting over 1,000 stores long term, the pound shops chain is expanding internationally with 34 stores under its multi price ‘Dealz’ format in Ireland and three Dealz stores now trading well in Spain too. Guided by respected retailer and CEO Jim McCarthy, the company is in the volume game, sourcing and selling a vast range of products that span groceries, household goods, seasonal products, stationery and toys.

Less well known in the south and as a brand, since it spends next to nothing on advertising, is B&M, which opened its first store in Blackpool back in 1978. B&M is driving ahead with its own rapid rollout of high street and out of town stores, seeing scope to increase its UK store base from 400 stores to a stated goal of 850 over the long term. B&M is expanding out from its northern geographic heartland and boasts strong growth prospects in Southern England, where it now has around 100 stores. The company also operates in Germany, where it mainly trades under the ‘Jawoll’ brand.

B&M earned profit upgrades with its better-than-expected maiden interims (18 Nov), as Leahy highlighted good momentum in sales, profits and cash generation during the half.

Not to be outdone, Poundland’s forecast-busting first-half figures (27 Nov) showed a 34.2% pre-tax profits surge to £12.6 million on total sales up 15% to £528.2 million.

Margin call

Despite low-ticket prices, Poundland generates gross margins north of 36%, as the tightly-run business’ constant stream of new products drives heavy footfall, high sales densities and enviable levels of repeat business and combines with improving buying power, though selling products at just a £1 means EBITDA margins are slim at just shy of 4%.

Its multi-price value retail rival also generates surprisingly high gross margins of around 34.5%, supported by better buying including direct sourcing of cheap product from the Far East. Strengthening sales of non-grocery, gardening and outdoor ranges are enhancing margins, while EBITDA margin is around 10.5%, higher than Poundland’s with its multi-price approach playing a role.

Investors should note both businesses are likely to reinvest future gross margin expansion in price, given their emphasis on maintaining price leadership to drive growth.

Forecasts for both businesses should excite growth-hungry investors. For the year to March, Numis Securities sees B&M generating a £137.5 million pre-tax profit for earnings of 10.7p, underpinning a 2.8p dividend. Next year, the broker forecasts a 23.6% pre-tax rise to £170 million for earnings up 23% to 13.2p and a 4.63p payout. B&M does trade on a punchy prospective price-to-earnings (PE) ratio of 25.7 falling to 20.8 for the following year, reflecting its growth momentum, while the prospective yield on the shares is 1.2%.

Shore Capital forecasts £44 million (2014: £36.8 million) taxable profits for Poundland for the year to March, translating into earnings of 13.4p and a 3.8p payout. By 2016, the broker estimates 17.7% growth in pre-tax profits to £51.8 million for 20% earnings growth to 16.1p and a 4.6p shareholder reward. On these estimates, Poundland swaps hands for 23.9 times prospective earnings, reducing to 19.9 on 2016 numbers, while offering a yield of 1.2%.

Appraising the risk

For now, we believe investors should take some profits from B&M and reinvest the proceeds in Poundland.

Ever so slightly cheaper on a PE basis, we believe its brand recognition is greater and this should drive strong near-term market share gains and put the squeeze on its rival, the bigger business by profits though not by store numbers.

Furthermore, financial risk appears to be lower at Poundland, whose strong growth metrics and ungeared balance sheet represents a powerful combination. Half-year net debt stood at just £4.4 million, down £22 million year-on-year, while Poundland is forecast to swing from a debt to a £7.9 million net cash position by March 2015. Its cash balances are also forecast to build to £33.1 million and £63.8 million by March 2016 and 2017 respectively.

B&M is also highly cash-generative and able to fund its growth plans through its own cash flow. Yet the business is fettered by significant net debt, forecast at £384 million by March 2015 and remaining high at £324 million and £260.8 million for the two years thereafter.

Poundland (PLND) 320p

Growth: HIGH

Poundland’s top-line is growing at pace and like-for-like sales are positive, while the company flags a strong new stores pipeline.

Risk: LOW

Though Christmas trading is important, Poundland’s reputation for providing ‘amazing value every day’ is growing. A virtually ungeared balance sheet suggests financial risk is low.

Quality: MEDIUM

Single-price products translate into thin EBIT margins, yet Poundland enjoys high levels of repeat custom and cash-generation is copious.

[buy_or_sell b]

[broker_consensus 6 1 3 0]

B&M European Value Retail (BME) 275p

Growth: HIGH

B&M is generating strong growth through new store openings and positive like-for-like sales and sees scope to more than double its UK store base.

Risk: MEDIUM

Though B&M is highly cash generative, any future inability to reduce debt levels is a concern and the company could face increasing price competition from discount rivals.

Quality:MEDIUM

Gross margins are attractive and growing, reflecting increasing buying power and strong sales of non-grocery categories.

[buy_or_sell s]

[broker_consensus 7 0 1 0]