Australia | Mar 21 2013
-Focus on margin expansion
-But at the expense of sales growth?
-Broker sentiment divided on turnaround
By Eva Brocklehurst
David Jones ((DJS)) is transforming. For brokers it's not a moment too soon, as department stores have been plagued by a soft consumer environment and a need to respond to new trends in shopping. In its first half results the company has flagged progress with its strategic plan, reducing costs and expanding margins. Earnings were ahead of expectations for the half but sales growth was not. What pleased was the increased margin. What concerns brokers? A lot of things. Most importantly, a lack of sales momentum.
There's no Buy rating on the FNArena database. Two brokers have downgraded ratings to Sell in the wake of the results. There are five Sell ratings. There was one upgrade to Hold – JP Morgan, and there are three Hold ratings. The consensus target price is $2.73, suggesting 11.5% downside to the last traded share price. A dividend yield of 5.5% is reflected in consensus earnings forecasts for FY13.
David Jones is concentrating on improving quality sales. The company has decided to pursue more private label business, increasing this to 10% of sales against the current 3.5%. To reinstate the retailer's stamp on quality and higher margins, sales growth will be affected as the store exists music, DVDs and games. More store space will be allocated to fashion/beauty and home. Some home categories such as electrical are on the exit plan and stores with the wrong demographics will be closed. Macquarie has noted that the company did not specify any closures and, as all stores are profitable, doubts the retail footprint will actually be reduced. The broker suspects the planned review of expiring leases, something all retailers do at the time, is just a shot across the bows to the landlord. Macquarie flags the planned opening of seven stores over the next few years, with four of these by end FY15.
The broker finds David Jones trading at a premium to domestic peers and, given a loss of around $25 million in financial services business in FY14, the company will have to move ahead forcefully just to maintain ground. Macquarie dismisses the strategic plans regarding margin expansion, omni-channel retailing, credit cards and property as not having enough focus on sales growth. In terms of credit cards, Macquarie believes the number of cards issued needs to be boosted as does the spending rate on the cards. The broker observes that the DJS/Amex card relationship is hampered by the fact that customers tend to view it as a "special occasion card" rather than the preferred card.
CIMB is concerned there are no big cost savings identified in FY14 to offset the decline in financial services earnings. The broker hails the improved margins but notes there is little opportunity for earnings growth without a cyclical recovery. The broker believes increasing the footprint of fashion/beauty and exiting certain areas may be alright but argues that this undermines the place as a full service store that the company has treasured.
JP Morgan has gone the other way, finding there are enough reasons to be more confident in the future direction of the company. Reasons include more detail on the quality sales focus and drivers of gross margin expansion. Earnings growth is coming closer too. Although financial services earnings should halve in FY14 the broker is confident that FY15 will produce the improvement in department stores necessary to be a bigger driver of future earnings. Moreover, the share price performance was poor over the past 12 months but has improved a bit recently. Signs, in the broker's view, of an impending turnaround.
There's comfort to be had in the progress being made on the strategic plan but for Deutsche Bank the big concern is sales decline, particularly as other retailers are showing some improvement. Like Macquarie, the broker believes gross margin improvement, while helpful, doesn't compensate for sales growth. Deutsche Bank agrees that a premium department store should not be leading the market with discounting, but sales declines are not part and parcel of that. Moreover, management was coy about how the current quarter's sales were going, providing more uncertainty. Another thing, Deutsche Bank ponders whether increasing private label percentages may cannibalise existing branded sales.
Morgan Stanley (not a contributor to the FNArena database) has decided the consensus is too bearish. The broker now has a Buy rating on the stock, believing the dividend yield is sustainable and will rise with improved gross margin. All the parts of the strategic plan coming to fruition should be enough to turn the company around after a long downgrade cycle, in the broker's view. In Morgan Stanley's words: we would prefer to own the shares before signs of the turnaround emerge as when they do they will likely be capitalised into the share price.
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