Australia | Mar 22 2012
By Greg Peel
“The retail store is not dead,” says Alison Paul of Deloitte, “but is likely to evolve as the lines between the physical and virtual worlds begin to blur”. There are four things retailers should keep in mind as they build a store in the new environment, suggests Ms Paul: (1) refresh strategy; (2) improve the in-store customer experience; (3) revive talent management strategies; (4) connect with customers virtually in the physical store.
It is perhaps no surprise, therefore, that struggling department store retailer David Jones ((DJS)) yesterday announced a new three-point strategy, “requiring the company to invest heavily in technology, people and processes over the next year or two”, as BA-Merrill Lynch puts it, or as Citi puts it, “a three year strategy plan with a focus on online shopping enablement, more staff service and continued store investment”.
Alison Paul could have been DJ's advisor, except that her above comments were made in reference to US retailers and noted by Citi's analysts across the Pacific. What does this tell us? Well, it tells us that struggling Australian retailers are not struggling simply from being Australian. Retailers are facing the same transitional issues in the US, and no doubt the story is the same across the Western world.
That is not to say that Australian retailers don't have their own unique problems as well, because they do. Australians were always going to be fast embracers of the internet and online shopping, but the strong Aussie dollar has accelerated that shift. A strong Aussie should help local importers of consumer goods, but rather consumers have found they can buy the same products online with very reasonable delivery times and freight charges for a lower net price. A much lower price.
And that is problem one that DJ's and co have had to wake up to, that which is known as “global price harmonisation”.
When I were a lad the Aussie was weak and freight charges from across the seas quite stiff, so everything imported was very expensive. And we got used to it. So used to it that every overseas trip was seen as a shopping expedition. And it lasted so long that even Apple recognised Australia as somewhere the base price of its iThings could be that much higher than in America. Us muppets would pay the price anyway. But global price harmonisation means prices around the globe for the same item must now fall into line because of the power and convenience of the internet.
This is a challenge for David Jones. Another problem for David Jones, and for many long established, large Australian retailers, is that the internet is not a fad. Online sales may represent only a small percentage of all sales at this point but it's where all the growth is. DJ's has not caught up, and must now catch up from a standing start. And another reason Australians are embracing the internet is because they're sick of walking into stores and not finding anyone to serve them. Or at least not finding anyone to serve them who could honestly care less. DJ's has treated Aussie shoppers with contempt and now they have to win those customers back with good ol' fashioned store service.
I have recently bought a few different things on the internet from both offshore and local suppliers. In the local case, I needed to ask a couple of questions so I rang, and was answered straight away by a human who fell about themselves to be helpful. I did this with three different suppliers and the experience was the same each time. Makes a difference, doesn't it?
David Jones saw its profits fall 20% in the first half of FY12 and no one was the least bit surprised. Analysts expected the second half to see another 20% fall, but management has alerted the market that the figure will be more like 40% as the company spends money to improve service and systems both in-store and on-line and because the company's credit card earnings will halve.
It's a funny thing about local retail analysts. After the GFC hit they assumed a period of consumer stagnation but were naively adamant it would not be long before pre-GFC spending frenzy levels would be back. It took a while, but eventually they realised those days are history, and adjusted down to simply expecting a return to more modest, historical spending trends by next year. That next year was unfortunately always next year, and now finally analysts have conceded that we may start spending again one day, but no one knows when that day will be. It is in this environment DJ's has to pick itself up and attempt to return to growing profits. Can they do it?
If the analysts agree on one thing, it is that David Jones' new strategy is a step in the right direction. However, as Deutsche Bank laments, if only DJ's had spent this money with some foresight back before the GFC when the company was rolling in it and trampling on rival Myer ((MYR)). Myer now has a big head start in doing exactly what DJ's now plans to do. But DJ's didn't use the money wisely, and now has to battle back through the headwinds of a still-weak consumer and growing internet use.
As for the longstanding DJ's credit card, it is a creature of a bygone era. Consumers are no longer buying on credit, having been severely burnt in the GFC. And if they are, the DJ's card with its lack of reward points and high charges is no match for the plethora of other offerings.
David Jones earnings expectations now have to be rebased, which means taking these new strategy costs into consideration and starting from a much lower level in forecasting earnings for the years ahead. RBS Australia does not believe the market is appreciating this rebasing, even after selling the stock down yesterday. Every analyst agrees that even a good strategy provides for extensive execution risk, and most believe DJ's strategy spending will have a long way to go, thus risking downside to management's current expectations of “flat” earnings growth in FY13-14. With little to be hopeful about in the near term, DJS is currently worth not much more than the value of its properties, Merrill Lynch suggests.
Yet the market remains hopeful, it would seem. Perhaps it was because DJS offered such great yields back in 2009 (which it achieved through cost-cutting, that's why customers have to send out search parties to find a shop assistant) that investors are loathe to fully abandon the stock. Analysts agree that DJ's valuation discount to the index is insufficient, and to that end both RBS and Deutsche have today downgraded the stock to Sell to join Merrills, JP Morgan and Credit Suisse (and Goldman Sachs who isn't in our database), while Citi, UBS and Macquarie are so far siting on Neutral. No one has a Buy rating.
Analysts have all taken a knife to earnings forecasts and the average target has fallen to $2.37 from $2.60, however both UBS and Macquarie are yet to update their forecasts.
The only other reason the market may be maintaining a bit of interest in DJ's is because of recent private equity interest in Australian retailers, with Billabong ((BBG)) the latest to draw attention and Myer having already been through the private equity turnaround. Credit Suisse's view on that subject is that DJS is simply not cheap enough to be attractive, unlike the other two.
David Jones is not dead – yet.
New Zealand-based Kathmandu Holdings ((KMD)) is a company that knows all about spending money, it would seem. Kathmandu has spent the last couple of years plying funds into promotion, new brands and store rollouts, and every time the company reported sales numbers it blew analysts away – until yesterday. Oh how the mighty have fallen. It seems KMD's spending has finally caught up with the retailer. DJ's beware.
There was nothing wrong with KMD's sales result yesterday. At 15.4% growth it was another great result. But what shocked analysts, and the market, was the disproportionate growth in KMD's costs. Margins in the period crumbled, with margins in Australia falling all the way to 9.1% from 18.4%. KMD spent money on a new distribution system, on new brand and store rollouts, and was stung with hefty local rent increases. It also spent an awful lot on inventory.
Did KMD get too cocky? Analysts agree that money spent has not been spent unwisely, and that it sets the retailer up for solid earnings growth if (and this is the perennial “if”) consumer confidence bounces back. But such result suggests now might be a good time for KMD just to settle back a bit and concentrate on what it's achieved so far.
The question analysts are asking is as to whether KMD's great sales results of previous periods were simply representative of all this spending, and that perhaps the music has stopped with not enough chairs. If that's the case then KMD is now going to find it just as tough as everyone else out there. As a cold weather and outdoor clothing supplier KMD's sales numbers are very weather sensitive, and conditions in Australia have been pretty favourable for a while, including, for example, Sydney's missing summer. A warm Easter and an unseasonably mild winter could impact severely on KMD's numbers which now have to stack up to those impressive numbers of past periods.
Kathmandu's result did not provoke any ratings downgrades from the five brokers in our database covering the stock, and they remain at three Holds and two Buys. But KMD's average target price has been cut to $1.41 to $1.92 and the stock has been hammered by the market.
Is there any joy at all in the Australian retail world? Well consider this observation from UBS:
“Oroton is benefiting from its investment in multi-channel retailing, with online sales up 70% year on year and now around 8% of sales.”
David Jones can only cringe with envy at such prescience. And Kathmandu can take note that OrotonGroup ((ORL)) has also been spending money on promotion and has been starting up outlets in Asia, but has managed to keep its operational costs tightly under control thus reducing its Cost of Doing Business beyond the Asian start-ups. Every analyst agrees that Oroton is a very, very well managed company.
Oroton's sales rose 9% in the period and there is little doubt promotional spend was needed to achieve this result, which means margins were impacted. Yet gross profit dollars still increased in the period, Citi notes. The Asian start-ups have cost money but analysts see Asia as a market of great promise for the little Aussie retailer.
In short, Oroton has shown other local retailers how it should be done. Analysts have cut forecast earnings on reduced margins but have little but praise for the company and faith in its potential to keep on growing sales. Unfortunately the market has not underestimated Oroton either, such that three of the five brokers in our database can only afford the stock a Hold rating. Merrills, on the other hand, suggests ORL “seems to be a rare commodity in the consumer discretionary environment” and retains Buy. Credit Suisse also has an outperform but is yet to update its view.
Oroton's average target has also slipped, but only to $8.85 from $8.95.
A tale of three retailers – how not to do it, how it can all go somehow wrong, and how to do it wisely.
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