Myer float (MYR) and retail sector share analysis 2009
By Elio D'Amato, Chief Executive Officer, Lincoln
Interest in the retail sector has rocketed in the wake of TPG's decision to float Myer on the Australian Securities Exchange (ASX). With many retailers outperforming expectations, the market has 'woken up' and taken notice of our local stores.
Why has the market largely ignored the retail sector until recent times? Why is the sector viewed with some with disbelief? Why do some market commentators feel that the Myer float is an opportunistic undertaking to cash in on the surging sentiment?
The answer lies in the global landscape painted over the past two years as market expectations for the retail sector were dire and best reflected by the numerous discounts and sales promotions across the country as retail stores desperately attempted to unload existing stock.
Australian economic situation
Fortunately, Australia has weathered the storm admirably. The decoupling of our economy from the US and Europe was largely forgotten at the apex of the financial crisis, but has proved itself since. The domestic economic situation has stabilised, with GDP (gross domestic product) recovering, strong sentiment and falling unemployment rates. These factors are consistent with the strong consumer sentiment and improving household disposable income we are currently experiencing, signifying a promising future for retailers.
Despite the robust employment statistics, we cannot discount the benefits that the government stimulus packages and record low interest rates have had on both the resilience and resurgence of the sector.
|Retailing sector - quick stats|
|Sector market capitalisation ($mil)||$18,449 million|
|% of total market||1.31%|
|Number of companies||35|
|Highest cap company||Harvey Norman Holdings Ltd|
|Lowest cap company||TVN Corporation Limited|
The suite of stimulus packages introduced by the government has effectively increased the disposable income of households. This unorthodox approach to fiscal policy has benefited the retail sector because households responded by spending this bonus income shopping. However it is important to remember that this was a one-off boost to consumer expenditure and we do not expect the government to grant similar packages in the near future.
Similarly, the affordability of low cost credit is at a record high with interest rates on the rise but well below normal at 3.25%. As a result, consumers are likely to continue to increase spending due to their comfortable appetite for debt. However, like the stimulus package, such rates are not likely to remain in the long term and the Reserve Bank of Australia (RBA) has made no secret of that point.
|Top 5 companies by market capitalisation - Australian retail sector|
|Code||Name||Market cap. ($mil)||Div. yield (%)||EPS||P/E ratio||Forecast P/E|
|HVN||Harvey Norman Holdings Ltd||4,664||2.51%||30.3||18.63||16.32|
|DJS||David Jones Limited||2,764||5.07%||23.57||18.22||16.88|
|JBH||JB Hi Fi Limited||2,004||2.37%||87.63||21.15||17.32|
|PBG||Pacific Brands Limited||1,276||0.00%||17.02||8.05||11.32|
|PMV||Premier Investments Limited||1,188||4.23%||60.97||13.25||15.78|
Source: Lincoln Stock Doctor as at 12/10/09
Analysing the retail sector
What factors should investors consider when identifying companies in the retail sector that will provide good value, sustainable earnings and long term growth opportunities? Given the interest generated by the float of Myer Holdings Limited (Myer) (ASX stock code MYR), the company represents an ideal case study for this article.
For all companies, Financial Health should always be the first area to investigate. The reasoning behind this is simple - insolvency has a devastating effect on investments. Accordingly, the risk of insolvency always has to be assessed and the company should be avoided if this risk is significant. A retail company in 'Strong' Financial Health should be able to withstand shocks including cyclical trading conditions, unexpected debt refinancing, exchange rate movements and other operational issues.
Myer's cashflow and profitability is assessed as strong by Lincoln at $164 million and $103 million respectively. However, we are somewhat concerned about the company's balance sheet. Myer possesses $945 million of borrowings with a total tangible asset base of $1.055 billion.
|Return from Australian retail sector|
|Code||Name||1 Year return
|3 Year return
|5 Year return
|HVN||Harvey Norman Holdings Ltd||75.76%||10.49%||11.01%|
|DJS||David Jones Limited||93.97%||23.18%||31.08%|
|JBH||JB Hi Fi Limited||122.37%||52.61%||42.25%|
|PBG||Pacific Brands Limited||45.89%||-14.50%||-9.67%|
|PMV||Premier Investments Limited||122.75%||20.08%||19.27%|
Source: Lincoln Stock Doctor as at 12/10/09
The retail sector is a competitive one, arguably more so than most sectors. It is vital for companies in this industry to have a clear-cut and effective business model. The strategies employed to establish a dominant market position tends to fall within one of two categories:
- Lowest cost producer
- Product differentiation.
The 'lowest cost producer' is a concept which works well for the retail products that are easily substituted. If a company can provide a product which is effectively identical to its competitors for a lower cost, it can exploit this advantage by increasing sales, improving margins or a combination thereof. Myer and David Jones Limited (DJS) are the only multi-category department store chains in Australia. Myer utilises its cost benefits from operating on a larger scale as part of its business model, but the scope for this is limited due to the existence of discount department stores.
'Product differentiation' is a strategy used by retailers to distinguish their products from their competitors. This creates a consumer perception that a product is superior to its peers and allows a company to charge a premium for their products. This inherent preference is utilised to increase profit margin, market share and turnover. For department store chains like Myer, product differentiation is difficult since the same brands are sold elsewhere. As a result, Myer has to distinguish their business via their 'exclusive' licenses with certain suppliers and the quality of service offered in the store. However, David Jones' stores have historically led Myer in this area.
Strategies for low cost production
Although less appealing than sales figures, cost management is an important constituent of bottom-line profits for retailers and critical for 'low cost producers'. This is achieved though effective supply chain, distribution channel and inventory management.
Efficient cost management for a retail company aims for the following:
- low warehousing or storage costs,
- availability of full range on the shelves,
- high inventory turnover, and
- low transportation costs.
Cumulatively, these factors serve to make a retailer more competitive. The benefits are magnified when dealing with larger companies where economies of scale apply.
Myer has reorganised their supply chain in recent times, by consolidating its distribution centres and warehouses and upgrading its IT systems. This is acknowledged by most to be the company's catalyst for recent success. This could be a promising sign for the company going forward.
Investors should also be careful to note whether a retailer's products are produced locally or imported. The cost of imported products will vary with exchange rates and this will impact profit margins of a company. For example, currently the Australian dollar is strengthening, implying that retailers that import goods will benefit from obtaining their stock at a cheaper price. As a significant portion of Myer products are imported, the company will benefit from the currently strong Australian dollar but will suffer on weakness.
Finally, a retailer's relationship with its suppliers will have a direct impact on the profit margins it can obtain. Department store chains like Myer have historically maintained good relationships with its suppliers, or at least good from their perspective.
Other strategies for penetration
The retail industry is fiercely competitive across the categories due to the large range of substitute products available to consumers. The most common approach for companies to distinguish their product is via branding or obtaining patents for their products. Alternatively, some companies like Myer have been successful promoting loyalty programs like the Myer One card to get an edge over its competition. In fact the Myer One card holders account for approximately 61% of sales from Myer.
Although location is important to all businesses, it is vital for retail businesses to be positioned in areas best suited for convenience and promotional purposes. Location is actually quite a complicated topic as the factors are numerous depending on the type of business. However, foot traffic and targeted consumer groups are the key numbers for most retail stores. Needless to say, Myer stores in our CBDs and 25 of the 30 largest shopping centres (by turnover) in Australia is a positive sign for location planning at the company.
Advertising allows retailers to increase their market penetration and consumer awareness. In association with location, marketing can both improve consumer perception of and influence demand for the goods offered. An example would be Myer's use of its advertising expertise to successfully market its 'Initial Public Offering' (IPO) prospectus.
Other factors to consider
Like all businesses, organic growth potential should always be investigated. In the case of retail businesses, this is represented by plans for new stores and refurbishment of existing stores. Although this is generally treated as a positive, investors should be careful to gauge whether a company is overextending itself through this capital expenditure. Myer plans to open 15 new stores over the next five years which may cause some strain. The company possesses a significant amount of debt on its balance sheet currently and we will monitor its cash balance and cashflows carefully to determine if these plans are value accretive.
This list is by no means a comprehensive one on examining retailers, but should provide investors with a good idea of the key areas to assess. Examples of other important factors include:
- The company's supplier agreements and its ability to change them
- The shelf life of its inventory (which can be short in technology or fashion)
- Management of discounts and markdowns
At the high range of Myer's price ($4.90), the company appears to be fully valued with a forecast P/E of 17.61 (based on prospectus forecasts), particularly when compared to David Jones which trades at a forecast P/E of 16.88. Although the final IPO price has not been fixed, it is likely to be around this higher range because of strong institutional support. Overall we believe that David Jones should be priced at a premium to Myer due to its stronger balance sheet and impressive performance over the last year. That said, Myer's successful loyalty program has been a standout.
Overall we expect the IPO will be successful due to:
- the success of the majority of recent capital raisings,
- the wide level of marketing,
- strong market sentiment,
- Myer's reputation as an Australian icon and broad appeal to retail shareholders.
Looking forward, Myer is expected to benefit from the promising outlook for our retail sector. However, the company may face some challenges given its aggressive expansion plans and the significant amount of debt on its balance sheet.
There is substantial growth potential for the retail sector going forward, benefiting from the improving consumer sentiment, disposable income and favourable exchange rate movements. The recent seasonally-adjusted improvement in retail sales (August 2009) is a sign of better times to come. Clearly, TPG recognise the improving sentiment for the retail sector and is using the Myer float to leverage off this. In taking stock on the value of the retail sector, investors who may have discounted the resilience of the Australian consumer to keep the sector afloat will be sure not to 'sell the sector short' next time!
Here are five companies in the retail sector and their outlook in the current market:
David Jones Limited (DJS)
DJS is a leading upmarket department store chain in Australia operating 36 stores across Australia. DJS achieves product differentiation through its fashionable brands, high level of customer service and faultless presentation, providing a unique and pleasant shopping experience. It successfully delivered record profits for FY09 on the back of higher margins and effective cost control measures. The company boasts of a Strong balance sheet with significant debt reductions and healthy free cash flow levels. We expect the company's growth to be sustainable in coming years given the company's market position, the resilience of the Australian economy and the favourable structure and prospects for the department store sector.
JB Hi-Fi Limited (JBH)
JB Hi-Fi Limited is a discount retailer of branded home entertainment products. It has achieved a position as the lowest cost producer in its sector through a simple but effective cost minimisation strategy including tight supply chain and inventory management, and minimal advertising and marketing expenditure. As a result, the company's performance has been consistently strong, boasting a five year return above 40% per annum and continued market share growth within its sector. Recently, JBH reported excellent growth (EPS increased by 44.41%) amidst the weakest retail climate in years capping an impressive four year average annual EPS growth rate of 47 per cent. The outlook for the company is phenomenal now that signs of a recovery are evident. JBH is a testament to the strategy of operating as a low cost producer.
Harvey Norman Holdings Ltd (HVN)
Harvey Norman is an integrated property, retail and franchising business with operations in Australia, New Zealand, Slovenia, Ireland, Singapore and Malaysia. HVN's traditional retail business has underperformed in recent times due to declining profit margins and a more competitive environment, particularly in the electronics sector. Fortunately, the main source of HVN's income comes from its franchising segment which continues to perform strongly. However, HVN's overall performance has faltered due to weak property and retail results particularly from its Irish retail segment and significant property writedowns over the last year. We remain concerned about the retail giant's ability to dynamically grow profits, given the stimulus benefit received over the last year and its narrowing profit margin.
Pacific Brands Limited (PBG)
Pacific Brands is a mid cap company that manufactures, imports and markets a wide range of consumer goods primarily in Australia and New Zealand. PBG's performance has not been strong. In response, management implemented 'Pacific Brands 2010'. This strategy was aimed at restructuring and improving the business to deliver a sustainable future for the company, in particular, cleaning the company's cluttered portfolio containing over 200 hundred brands. PBG aims to discontinue, merge or divest more than 150 brands whilst strengthening its balance sheet through a rights issue that raised $256 million. The short to medium term outlook for PBG is negative with revenues expected to decline over the course of the transformation. However, their long-term outlook is promising albeit subject to the success of the restructure.
Wotif.com Holdings Limited (WTF)
Wotif.com is an online discount operator providing customers with a booking service for their travel needs including accommodation, flights, car rental, insurance, and travel packages. WTF is both a low cost provider and a provider of convenient service for consumers to evaluate different travel options. As such, the company has benefited from the tough economic environment due to increased deal searching by the public, reflected in the 24.65% EPS growth on the back of record room night volumes and transaction values. Outlook remains promising as economic uncertainty will encourage consumers to focus on value.
Author: Lincoln Indicators Pty Ltd ACN 006 715 573 (Lincoln) AFSL 237740.
This information is current as at 18 October 2009.
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