Broker Jefferies has jumped the gun on the Competition and Markets Authority's (CMA) decision on Poundland's (LON:PLND) proposed acquisition of 99p Stores.
It expects the CMA's provisional findings statement, due early/mid-August, will lead to a re-rating of Poundland's shares, and has upgraded the stock to 'buy' from 'under-perform' and whacked up its price target from 260p to 400p.
Having followed the latest iterations in the CMA process Jefferies believes that even if the CMA takes a strict line on Poundland's takeover of its fellow discount retailer, the authority may relax its view on potential competitor store openings.
The combination of the two chains would create an estate of around 800 shops, and the CMA has indicated that in 80 towns across the UK where the pair go head-to-head, removal of one or the other is likely to reduce competition in the area.
Obviously Poundland is not going to put its prices up, but in the CMA's view “without competition from 99p Stores, there is the possibility that Poundland may have the incentive and ability to deteriorate its offer in these areas to the disadvantage of customers that have come to rely on their offer,” which translates as fewer promotional offers.
Jefferies does not believe the worst case scenario of 80 closures of 99p Stores shops will occur; its base case deal scenario envisages Poundland will be allowed to keep 200 99p stores.
The broker's latest survey, however, suggests that only a net 3% of customers expect to spend more at Poundland if the merger goes ahead, and while 16% of 99p Stores customers expect to spend more if their local store becomes a Poundland, 7% would cut back on spend at another Poundland outlet and a further 6% would reduce their spend and shop elsewhere.
Nevertheless, the merger has significant cost synergies, with Poundland expected to save £15-£20mln a year, which should have a significant effect on a retailer making underlying earnings (EBIT) £44mln.
“Valuing Poundland ahead of the CMA's decision is tricky. We believe that the stock can rally back to 400p assuming the CMA's findings are no worse than in April, but then investor focus may switch to Poundland's rapid saturation of its core UK market. We recommend buying for the initial upside,” Jefferies concluded.