3i Group (III ), the private equity giant that recently regained its title as the UK’s biggest investment trust from Scottish Mortgage, yesterday risked losing that status after its shares plunged 11% in response to a selloff on Wall Street caused by a profit warning by Target, the US department store.

Shares in the £11.4bn closed-end fund, which has nearly half its assets wrapped up in a 53% stake in fast-growing Dutch discount retailer Action and 16% in other European retailers, tumbled 146p to £11.78, the biggest fall in its 28 years as a listed company.

The sudden decline left the shares at an 11.5% discount to net asset value, which looked cheap compared to the average 20% premium the stock has traded at in the past year.

The shares recovered 3.4%, or 39.5p, to £12.17 today as JPMorgan Cazenove called the slump an overreaction and its analyst Christopher Brown reiterated his ‘overweight’ recommendation.

Brown said Action had a completely different business model to either Target or Walmart, the US supermarket which reported the day before on the impact of inflation and supply problems on its business.

‘The key to the Action model is its low average ticket price across all product lines (average Є2), many of which are essentials, while Target and Walmart sell many higher ticket discretionary items,’ he said in a note to investors.

‘Thus, as the lowest price European non-food discount retailer, Action stands to gain market share as consumers trade down, while at the same time its high stock rotation means it can change its flexible offering if there are supply chain issues, or certain goods have become too expensive.’

Although Action is valued at a high 18 times last 12 months’ earnings, Brown said it had recovered strongly from coronavirus disruption and its rollout of new stores enabled it to drive profits even on flat margins.

Its other retailers were also discounters and therefore well positioned, he said.

Shares in listed private equity funds have fallen this year as investors worry that the valuations of their unquoted businesses are out of date and do not reflect the falls in public markets. 

Brown believed 3i should be less exposed to this risk as it already applied discounts to quoted companies when valuing its investments. The analyst currently estimates 3i’s NAV to be £13.62, putting it on a discount of around 10%.

‘With the shares thus having only bounced a little today we believe yesterday’s correction provides an attractive entry point,’ he said.

Impressive results

Earlier this month reported annual results showing a 44% total return in the 12 months to the end of March, double its return the previous year.

Action was the main driver of performance with sales growth across its 1,700 stores in 10 countries of 23% and earnings 36% ahead of the previous year despite closures under Covid-19 restrictions for six months.

Chief executive Simon Borrows said 2021 was ‘a record year in terms of store openings for Action’ as it added 267 new locations, using its ‘simple and repeatable format, selling good quality but inexpensive products’. He said there was ‘plenty of expansion potential’.

‘Enhancements in Action’s IT infrastructure and the ability to directly source products have enabled better quality sourcing, more supply chain control, and improved the availability of products in stores,’ said Borrows.

‘The flexibility of Action’s product range and its significant buying power have allowed the business to effectively manage price inflation, while carefully maintaining price distance to competitors and ensuring value for money for its customers.’

Borrows said the portfolio had ‘good momentum and is well positioned to generate attractive, sustainable returns for our shareholders’ despite the ‘backdrop of geopolitical tensions and macroeconomic uncertainty’.

However, he noted the fierce demand for assets in the private equity market due to ‘a combination of pent-up demand and record levels of uninvested capital’ which was driving ‘aggressive pricing for private market assets’.

New platform

3i made six new investments over the year, investing a total of £335m in companies such as storage solutions group Mepal, home-baking business Dutch Bakery, Yanga sports water, and IT services provider Mait.

The fund also ‘adopted an innovative approach in forming a new platform’ called ten23 health to provide sterile drug product development and manufacturing for biologics, investing £69m in development and bolt-on acquisitions.

The ‘aggressive’ pricing in the private equity market has also been a boost for the fund, as it exited positions with ‘favourable exit valuations’, with a particularly strong demand for technology assets. Realisation lifted 3i coffers by £684m over the year, as it undertook a partial sale of value-for-money fitness group Basic-Fit, and the sale of Q Holdings, which develops and manufactures electrical connector seals.

After a strong year, Borrows said he entered the current financial year ‘acutely aware of the political and macroeconomic challenges the world is facing, but we do this from a position of strength’.

3i Group also has a 30% stake in 3i Infrastructure (3IN ), the separately listed £3bn investment company that recently reported strong results with a 17.2% return on net assets in the year to March.