Idea of the Week: Lojas Renner May Benefit as Brazilian Consumers Trim Spending

Brazil is in the midst of an economic and political turmoil. The Brazilian GDP has been in recession for two years now, and the currency is worth half as much as it was five years ago compared to the U.S. dollar.

A recent McKinsey report titled “Meet the New Brazilian Consumer” outlined consumer spending trends towards products that offer better value. While that may seem like bad news for retailers, local retailers may actually benefit as the consumer may look for cheaper local brands rather than expensive international brands. Once consumers abandon their loyalty to the global brands, they may be less inclined to return even if the economy perks up.

Lojas Renner (LREN3.SA) is a Brazilian retailer that sells everything from clothing to jewelry and perfumes. It has an online site and retail stores. The products are reasonably priced and management has put an emphasis on quality, which will resonate well with customers.

US Dollar/Brazilian Real FX Spot Rate

Source: Thomson Reuters Eikon

Brazil GDP Growth

Source: Thomson Reuters Eikon

Solid operations

With so much uncertainty in the economy, Lojas Renner displays signs of strong earnings quality. Despite the recession, the company has seen operating margins rise higher than they were at the beginning of the recession (19.4% vs. 19%). That has been mainly due to cutting costs and improving efficiencies, something that management is committed to continue. In the chart below, the blue line represents the company’s trailing 4Q operating margins, and the orange line represents the industry median. It’s impressive that the operating margins are so much higher than the industry median (19.4% vs. 11%)

Source: Thomson Reuters Eikon/StarMine

Good cash flow, inventory control

Lojas Renner is also generating strong positive cash flows from operation, another sign of strong earnings quality and these strong cash flows allow the company to continue making investments in new stores and efficiencies.  Finally, the company has done a good job of controlling its inventories, keeping them flat as measured by inventory days. In the last reported annual period, inventory days were at 90, after being above 90 for the last three years. That inventory management is a good sign for the future and something management continues to work on as it implements a new ERP system (expected later this year) to track inventories across stores more efficiently.  That will likely improve this measure even more.

Source: Thomson Reuters Eikon/StarMine

Lojas a strong competitor

Competitors have resorted to slashing prices – sometimes dramatically.  In fact, CEO  Jose Gallo on the last earnings call said that he’s never seen a market like this before and there are price reductions so out of reality that they cannot be explained,  and  pointed out that “we see many stores shutting down, and at a certain point in time you cannot really survive because you don’t have cash.”

Lojas Renner seems to have a solid balance sheet and looks in good shape to weather this storm. In the last quarter the company had almost one billion Brailian real in cash, and just under two billion real in total debt. That is not a very levered balance sheet, and with strong cash flows the company looks well set to consolidate and possibly take advantage of the chaos in the domestic market.

The company scores a 100 on the StarMine SmartHoldings model, the highest possible score. It is designed to predict changes in the percentage of institutional ownership which is correlated to price changes through the law of supply and demand. The model looks at the purchasing profile of institutional investors based on the underlying factors of the companies they are buying. Since investment styles don’t change over a short period of time, the model then looks at other companies with the same fundamentals that institutional investors might be screening for. The high score for Lojas Renner indicates that the company fundamentals are aligned with what institutional investors currently value. In fact, according to this Reuters News article, T. Rowe Price’s $20 billion emerging markets equity strategy has increased its positions in Lojas Renner. Chuck Knudsen, an emerging markets portfolio specialist at T. Rowe Price  said that he was looking to consolidate positions in the companies they had the most confidence in, and other institutional investors may be doing the same.