Australia | Jun 29 2006
By Rudi Filapek-Vandyck
Recent profit warnings by the likes of Nick Scali (NCK), Repco (RCL) and Oroton (ORL) may suggest otherwise, but general business conditions for retailers in Australia remain positive. There is, however, unmistaken divergence between retail sub-sectors, a point again emphasised by National Australia Bank’s latest survey.
As one would expect, business confidence and sales have dipped following a surprisingly strong April month, but NAB’s team of economists is quick on its feet to point out that the general trend –which remains positive- is still very much intact.
Pre-empting the next sector update by the Australian Bureau of Statistics, scheduled for next week, NAB predicts May sales figures will come out 0.2% higher than twelve months ago keeping the June quarter on track for a 1% sales increase (adjusted for price rises and excluding cars).
ABS figures for April showed sales figures were up by 1.4% and the first three months of 2006 were up 0.9%.
NAB economists side with the likes of CommSec on the bullish side of the market when it comes to the outlook for retailers. This view is supported by the expectation that interest rates in Australia will not go further up from their current level– a view certainly not shared by everyone in the market.
If the Reserve Bank of Australia decides to hike one more time, it’s likely to be at the August meeting, NAB believes. Read between the lines and you can feel it won’t make such a big difference to the bank’s positive view on retail sector conditions.
NAB economists believe "domestic economic conditions will remain supportive of solid growth in retail sales, with the impact of the recent rise in the official cash rate and higher fuel prices countered by personal tax cuts, the wealth effects from higher share prices, stable housing markets and continued job gains."
But not all sub-sectors are equal in this.
Food is the strongest sector, the NAB survey shows, while cars and personal & household goods are the weakest. But even where things remain relatively buoyant margins are likely under pressure as the survey also shows price increases in general don’t match increased purchase costs.
NAB economists estimate annual growth in consumption of around 3.5% in real terms in the 2006/07 year ahead.
So why are Australians spending less on personal & household goods and cars? NAB explains it by stating both sub-sectors are very sensitive to fuel costs and interest rates.
During a telephone conversation earlier this week, Intersuisse retail analyst Darren Grubb said the retail market is currently being divided between players that have a strong foothold in an attractive niche, know how to please their audience and which products do well, and the others.
We’ll come back to Darren later.
First, let’s have a look at the worst performer in the retail sector over the past twelve months: Pacific Brands (PBG).
The share price of Pacific Brands has fallen circa 20% since the start of calendar 2006. While management may cry foul that the company has had to deal with weak demand and that this has flowed through to flat trading conditions, retail analysts at ABN Amro suggest they have only themselves to blame.
Management has not done enough to better manage the retail cycle and keep investors on side, ABN Amro believes.
In the broker’s view Pacific Brands should be more active and take advantage of its conservative balance sheet to introduce capital management initiatives designed to boost earnings and returns during periods when market conditions are not in the company’s favour.
ABN Amro believes the company’s balance sheet could comfortably withstand another $50-$100m in debt, which could then be applied to a share buyback. A buyback would be the most logical initiative, as the broker notes there are no excess franking credits to make a special dividend attractive. It estimates such a buyback would lift EPS by 2.2-4.7% in FY07, while interest cover would only fall to around 4.6 times from 5x currently.
Of course, we don’t know whether management is considering the broker’s suggestions. ABN Amro currently rates the shares as Buy with a price target of $2.64, but this, the broker explains, is primarily on value grounds.
According to Thomson One Analytics, the median price target on the stock is $2.62, which compares to a last closing price of $2.14
Others in the market have also recently started to recognise there is value in the stock. The FN Arena database shows JP Morgan upgraded its rating to Overweight earlier this month and Aspect Huntley moved to an Accumulate rating in April. In total, the database shows the stock is rated as Buy by three brokers and equity researchers, while it also receives one Accumulate rating, four Holds and one Underperform.
Not everyone is having it tough. Gadgets are still very much in favour, says Darren Grubb. His view is consistent with Citigroup analysts returning from a meeting with Harvey Norman (HVN) management last week with the message that sales of flat screen televisions and the likes are flying out the door at record high rates.
We noticed equity strategists at JP Morgan have added the retailer to their model portfolio for the month of July as they too believe the odds are in favour of a positive surprise partly based upon the expectation of ongoing market share increases.
Problem is, however, Harvey Norman shares are already trading near the average price target as set by the ten leading experts in the FN Arena database. This, no doubt, also explains why all but one (Macquarie) rate the shares Neutral.
At times when large caps such as Qantas (QAN) and BlueScope Steel (BSL) have started to issue profit warnings, it may not necessarily be a bad idea to look out for the likely positive profit surprise at the upcoming results season.
Darren Grubb believes retailer Fone Zone (FZN) is poised to surprise as well at its upcoming first full year profit report since listing last year, but we’ll keep that for part II.
Chris Shaw contributed to this story as well.