Sports Direct investors spooked by cost of upmarket shift

By Paul Sandle

LONDON (Reuters) - Sports Direct's efforts to move upmarket with new flagship stores contributed to a softening of its top line, a margin squeeze and a jump in debt, hitting its shares on Thursday.

The retailer, which has been criticised for its disclosure, corporate governance and past treatment of workers, is trying to revive sales and profit growth with smarter stores that sell more premium products from the likes of Nike and Adidas.

The group, founded and run by Mike Ashley, wants to become the "Selfridges of sport", emulating the status of the department store on Oxford Street in London.

But the move upmarket resulted in retail revenue in its core British business falling 1.0 percent to 1.14 billion pounds in the six months to Oct. 29 as it reduced online promotional activity and closed stores.

And net debt increased to 471.7 million pounds from 182.1 million pounds at April 30, which it put down to investment in long-term strategic partnerships, the cost of the new stores and share buybacks.

Also in the negative column was a 80 basis points squeeze on its UK retail gross margin to 39.4 percent due to an increase in inventory levels and an adverse dollar effect.

Sports Direct shares fell to a near five-month low of 341 pence and were down 10 percent at 345 pence by mid-morning.

"Ashley has described trading at the new format stores as 'spectacular', but it's difficult to see evidence of that in the numbers. Improved profits are being driven by cost cuts rather than sales growth – which is actually negative in the UK," Hargreaves Lansdown equity analyst Nicholas Hyett.

Ashley, who has a 61 percent stake in Sports Direct, said the group planned to open between 10 and 20 new flagship stores next year.

"Our high street elevation strategy is currently delivering spectacular trading performance within our flagship stores," he said after the group reported a 7 percent rise in first-half adjusted earnings to 156.1 million pounds ($210 million), in line with market expectations.

Analysts at Jefferies downgraded Sports Direct to "underperform" on Wednesday, saying there was limited visibility on the progress of the "premiumisation" strategy.

They said Sport Direct would struggle to make real inroads into rival JD Sports Fashion's position in the more-expensive and exclusive fashion end of the market, while the threat from French group Decathlon was increasing at the discount end.

Hargreaves Lansdown's Hyett also noted that Sports Direct's corporate governance practices continued to attract headlines for all the wrong reasons, with independent shareholders rejecting an 11-million pound payment to Mike Ashley's brother on Wednesday.

Sports Direct, which trades from around 700 stores in Britain and continental Europe, said it still anticipated that it would grow core earnings by 5-15 percent in the full year.

(Editing by Guy Faulconbridge and Jane Merriman)