The FTSE 100 (^FTSE, Financial) index might not have gone anywhere this year, but what is true for the index is not true for all its constituents. Consider the sportswear company JD Sports Fashion PLC (LSE:JD., Financial) as an example, which has seen a 31% rise year to date to a price of 1.70 British pounds ($2.10).
But there is a downside here. The stock is now trading at a trailing 12-month price-earnings ratio of 42.3 compared to its average over the past decade of 22.
So can it continue to see a price rise in 2024 as well?
What the company's outlook indicates
The company's outlook certainly indicates as much. It expects its pre-tax profits to come in at 1.04 billion pounds for its current financial year ending February 2024, up from 1 billion pounds last year.
For the first half of the year, its net profit attributable to equity shareholders is 64.2% of the pre-tax profit. Assuming that this ratio stays for the remainder of the financial year as well, the profit figure would come in at 668 million pounds for fiscal 2024, which results in a forward price-earnings ratio of 12.90. This is much lower than the trailing 12-month ratio and the average forward ratio over the past five years of 32.60.
Risks to the outlook
The question now is whether JD Sports Fashion can indeed meet its financial targets for this year. The question acquires validity in the context of its recent performance. In the first half of fiscal 2024, the company achieved only about 36% of its projected pre-tax profit. To be fair, this is not as bad as it seems. Even in the year-ago period, the company reported just a little over 38% of the profit number.
The crucial difference this year is the growth slowdown. In the first half, the company saw revenue growth of just 8.3% compared to a 38.8% increase for full-year 2023. Last year saw particularly strong growth as demand rebounded from the lockdowns, so some correction was due. Still, the growth is much softer than the average 27.35% seen over the past five years.
Moreover, the operating profits have declined slightly (see table below) after seeing an 87% increase for full-year 2022. So the lag in achieving the pre-tax profit target appears a tad more noticeable than it would otherwise.
Source: JD Sports Fashion
Factors supporting the outlook
However, it is not all bad. A look at the geographical distribution of sales shows the drag was due to a 9% contraction in the U.K. and Republic of Ireland sales, which in turn is due to a divestment of its non-core interests. Like-for-like sales at constant currency, by contrast, have seen a 4% growth during the year in the geography. Also, growth in other markets is firm. The 17% increase in North America is particularly notable considering the geography has been slowing down in general for consumer goods companies.
Source: JD Sports Fashion
Despite the decline in operating profits, the margin at 8.3% is largely in line with the 8.4% seen for full fiscal 2023. It is still lower than the five-year average of 9.3%, but with a come-off in inflation, the prospects look better. Further, operating expenses have grown on JD Sports Fashion's increased investments in store and distribution center expansion, which are likely to result in sales growth going forward. To that extent, the smaller margins compared to the five-year average need to be seen as a tradeoff for future growth and potentially higher profits.
Alternative market valuation
Still, on balance, the profit outlook looks like a stretch because if the pre-tax profit margin for the full year were to stay at the first-half levels of 7.8%, the revenue for the full year would be at 13.3 billion pounds. This is a 31.6% increase over the 2023 levels. Considering the 8% revenue growth seen so far, it appears most unlikely that this outcome is possible.
Keeping this in mind, a less optimistic scenario is considered here, which assumes revenue growth stays at the same level for the full year as seen in the first half. It is also assumed that the 7.8% pre-tax profit margin from the first half of the year stays constant, as does the ratio of net attributable profit to pre-tax profit at 64.2%.
This results in a forward price-earnings ratio of 15.67. This is a significant increase from the first estimate of 12.90, is still lower than the stock's historical average. In other words, no matter how the profit estimate is made, the forward price-earnings ratio shows an upside to the stock.
The takeaway
The balance of the trailing 12-mont and forward price-earnings ratio, however, indicates JD Sports Fashion is fairly valued right now. In fact, in the short term, there can even be a downward price movement since profits might turn out weaker than the company expects in fiscal 2024.
However, over the medium term, it still looks like it has potential as it carries out investments in stores, which can add to sales and margins going forward. Further, a cyclical macroeconomic upturn can work in its favor. Its forward price-earnings ratio is also lower than the five-year average, indicating positive prospects ahead. Hoever, it is best to err on the side of caution for now.
