Specialty retailers are thriving despite the gloom.

The economic downturn has sent profits for many companies crashing. Yet in the midst of the turmoil, certain sectors continue to shine.

Casting a brighter light than most are some of the specialty retailers. These are companies such as Super Cheap Auto Group, which also incorporates Goldcross Cycles and BCF (Boating, Camping and Fishing), and electronics chain JB Hi-Fi.

They rely on consumer discretionary spending and are normally among the first to suffer when economic recession hits. That has certainly proven to be the case overseas.

But in Australia, for a combination of reasons, many of the specialty retailers have proven quite resilient. In fact, they have done more than hang on: they have been booming.

For example, in its financial year to June 2009, JB Hi-Fi reported after-tax profit up 45 per cent, on sales growth of 27 per cent. Super Cheap Auto recorded a 25 per cent increase in profits on an 8 per cent sales rise. Discount variety goods retailer The Reject Shop saw profits up 14 per cent on sales growth of 17 per cent.

Even Harvey Norman, which saw profits drop sharply due to property write-downs and exposure to the struggling economies of Ireland and New Zealand, experienced reasonably firm business at home.

One reason for the glad tidings has been the Government stimulatory measures, which boosted consumer spending. Low interest rates have also been an incentive.

A key factor, however, has been the roll-out of new stores. For example,

JB Hi-Fi opened 19 new stores in its June 2009 financial year, The Reject Shop opened 22 and Super Cheap opened six.

The research manager at F.W. Holst, David Spry, notes this is low-risk expansion, which is usually based on renting premises rather than acquiring stand-alone stores.

“That means they can expand consistently without taking on a lot of debt,” he says. “In addition, they are not on an acquisition binge or anything like that. They are all modestly geared.”

Thanks to steady expansion, expenses continue to fall, helped along by the companies' drive to lower their cost base. In addition, their margins improve as the stores mature.

Other factors affect individual companies. Super Cheap Auto seems to be benefiting as Australians try to save money by fixing up older cars rather than buying a new model and by opting for low-cost camping holidays.

Meanwhile, JB Hi-Fi has been a clear beneficiary of the Australian appetite for the latest electronic gear.

Clime Capital chairman John Abernethy says: "It is doing much better than electronics companies in previous cycles.”

According to Spry: “JB Hi-Fi is benefiting from a big shift. Electronics retailers of the past specialised in selling TV sets as cheaply as possible. But today you have IT-savvy young people who want everything now and who are not concerned about taking on debt. They want IT, CDs, DVDs, iPods, digital cameras, computers and so on and

JB Hi-Fi has gone into that area."

How much longer can the good times continue? New store roll-outs continue; JB Hi-Fi and The Reject Shop expect to double their store numbers. Super Cheap Auto also plans more outlets.

In addition, specialty retailers import many of the goods they sell and so generally benefit from a stronger dollar.

However, there is also a negative side: more Government stimulus packages are unlikely, interest rates seem more likely to rise than fall, higher inflation is possible and more economic shocks cannot be ruled out.

The result is that experts are divided on the prospects for the companies.

OC Funds Management portfolio manager James Casey predicts that, after several quarters of decline, the rate of growth for retail sales in Australia is about to increase. “We are more positive on the retail outlook than perhaps some other observers or commentators," he says. "We think that retail sales should be strong for the next 12 to 18 months.”

A portfolio manager at Fidelity International, Kate Howitt, is especially positive on JB Hi-Fi.

“Household demand for consumer electronic items continues to be strong, fuelled by ongoing product innovation,” she says. "JB Hi-Fi has taken more than its fair share, confirming the company is positioned in the right segments. The company also has several more years of rolling out new stores, which will provide further support to its growth and makes it less reliant on the immediate outlook for consumer spending."

Abernethy says his company's valuations have JB Hi-Fi shares trading about 15 per cent below their real value.

Wilson Asset Management portfolio manager Matthew Kidman takes a more sombre view: “The majority of the discretionary retail sector has run its course if you believe interest rates are going to run higher over the next year.”

However, he suggests some of the smaller businesses, such as fashion chain OrotonGroup or furniture retailer Nick Scali, may still offer value although he warns that shares in these companies can at times be relatively illiquid.