JD Sports Fashion (LSE: JD) and Frasers (LSE: FRAS) are similar companies. Both sell sports and outdoor wear on the high street and online. Each company has branched out into more mainstream fashion and gyms. The origin stories of the companies are eerily similar. JD was established in 1981 with a single store in the North West of England. Just one year later, in 1982, a single sport and ski shop was opened in Maidenhead by Mike Ashley, laying the foundations of what would become Frasers, which is probably most recognisable through its Sports Direct brand.
Similar assets should be similarly priced. Frasers and JD Sports are similar companies, but their stocks and shares are not similarly priced. JD Sports stock is priced at 23 times earnings per share (EPS) on a trailing 12-month basis. Frasers shares trade at ten times EPS. These are similar companies whose stocks are priced very differently. So, the natural reaction might assume that Frasers is cheap and JD Sports is expensive. I would buy something at a discount rather than pay over the odds so that I might buy Frasers then? Not so fast. First, I need to establish if these companies are as similar as they appear. Perhaps, there are good reasons for JD Sport stock price trading at higher multiples than Frasers.
Economies of scale in the stock price
JD Sports brought in over twice the amount of revenue that Frasers did in the last full year. Size could be a strength if it brings economies of scale. Larger businesses tend to have higher bargaining power with their suppliers, which they can parlay into cost reductions. Frasers and JD Sports had similar average gross margins over the last three years (47% vs 48%). Ok, so no evidence of significant economies of scale at the gross margin level. But, larger companies can spread their corporate and management costs across a more extensive base. JD Sports does have a higher average operating margin (7%) compared to Frasers (3%), so there is evidence of economies of scale moving down to the operating income line.
Moving down to net income, JD Sports has better margins here than Frasers (4% vs 1%). That’s probably due to JD Sports having a significantly lower net debt to equity ratio compared to Frasers. That means debt holders are getting a bigger chunk of Frasers operating income compared to JD Sports. Relatively smaller interest payments are all else being equal better for shareholders.
Same store sales
What is a perfect business from a shareholders perspective? One that generates more and more revenue each year, and sending more and more of that revenue to the bottom line is as good an answer as any. Frasers five-year compound annual revenue growth (CAGR) rate is 4.53%. JD Sports equivalent CAGR is 27.6%. JD Sports normalised EPS has increased by 19.7% per year on average whilst Frasers managed just 4.43%.</p><p>So, on those grounds, JD Sports is growing its revenues better and delivering more of them to shareholders than Frasers. But why is JD Sports earning more than Frasers? Again, it might come down to size and operating efficiency.
JD Sports has around 3,522 stores, and each store is about 4,132 square feet in size on average. Frasers has about 1,547 stores, but they are much larger coming in at 10,084 square feet on average. Smaller, more intimate stores for JD Sports then versus the larger department stores and warehouse-like Frasers ones. It’s a very rough measure but taking the total employees (yes, this will include non-retail staff) and dividing it by the total square feet in thousands of retail space across the two companies is illuminating.
JD Sports has around 2.6 staff members per thousand square feet of store, and Frasers has 1.7. What does this suggest? Well, it chimes with what I have seen. JD Sports stores are better staffed. Sports Direct (Frasers flagship brand) are less populated by staff, more warehouse-like and lean towards the discount market.
JD Sports earned about £424 in revenue per square foot of store in 2020. Frasers earned £232. It would appear leaning into more premium items, and staffing stores more fully has worked for JD Sports since its operating metrics look better over time.
Is Frasers stock a bargain?
JD Sports stock is more richly priced than Frasers. But, Just because Frasers is trading at a low price to earnings multiples compared with JD Sports does not make it a bargain automatically. Based on what I can see there I think there are good reasons for the disparity in prices across what are, at least on the face of it, two very similar companies.
DISCLAIMER: James J. McCombie does not own shares in JD Sports Fashion or Frasers. The Storied Investor has no beneficial ownership position in JD Sports Fashion or Frasers.
The Storied Investor 