Questor: difficult market conditions ahead convince us to bank JD profits now for the win

Director dealings are an important consideration for some investors. After all, directors are likely to know more about the state of the company they work for than anyone else.

Moreover, their buy-and-sell decisions are made using their own cash. As a result, some investors believe director dealings offer an insight into how a firm’s shares will perform in future.

However, in Questor’s view, knowing a great deal about a company does not necessarily equate to having an accurate view on its investment prospects.

Indeed, there is a great difference between thriving in the corporate world and being a successful investor. Furthermore, director dealings can be due to personal circumstances that do not reflect a company’s investment prospects.

As such, the recent decision by JD Sports Fashion’s executive chairman, Peter Cowgill, to sell around half his stake in the firm does not have a large bearing on our decision to downgrade the retailer from “hold” to “sell”.

Rather, our updated advice is based on an evolving industry outlook that could create increasingly challenging trading conditions for the business.

Notably, the prospects for consumers across the company’s key markets of the US, UK and rest of Europe are rapidly changing due to high levels of inflation.

For example, inflation has reached its highest level for 40 years in the US and has surged to a peak not seen in the UK since 1992. Meanwhile, eurozone inflation recently spiked to a record level.

Although wage growth could help to mitigate some of the ill effects of high inflation, a rapidly rising price level is likely to put severe pressure on discretionary incomes.

In turn, this may prompt consumers to delay the purchase of non-essential branded clothing or trade down to cheaper alternatives than the products sold by JD.

In addition, the company’s recent upbeat performance has been aided by vast stimulus measures that will not persist in perpetuity.

For instance, the company’s management estimated in its latest trading update that £100m of a forecast £875m pre-tax profit for the full year was contributed by US fiscal stimulus measures. And, with additional employment costs in the UK expected in the 2023 financial year, the firm anticipates that pre-tax profit will fail to rise from its financial year 2022 level over the next 12 months.

Separately, the company is set to make management changes in the current year. It has committed to separate the chairman and CEO roles ahead of this year’s AGM.

And, with further supply chain disruption likely to continue in the short term, it may experience difficult trading conditions that are not necessarily reflected in its buoyant forward price-earnings ratio of around 18.

Of course, JD continues to have a solid financial position that could be used to further extend its presence in the US and across other international markets. Its net cash position of £795m means that it may become increasingly geographically diversified and able to capitalise on international growth opportunities.

And, with a multichannel presence, it seems well placed to benefit from both a return to in-store shopping as the pandemic abates and also from a long-term shift to digital avenues among consumers.

Furthermore, this column has enjoyed strong returns from the stock. It was first tipped as a “buy” in April 2017 and has since doubled in price. Over the same period, the FTSE 100 has gained just 4pc. During that time, the firm has successfully navigated the pandemic and returned to its pre-Covid share price level.

Now, though, it is becoming increasingly difficult to make the case for investment in JD. Its lack of forecast profit growth in the 2023 financial year, the biggest squeeze on consumer discretionary incomes in a generation and a valuation that appears to lack a margin of safety suggest it is the right time to bank our profits and move on.

Questor says: sell

Ticker: JD

Share price at close: 179.05p

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