A Challenging Season For Myer

This story features WESFARMERS LIMITED. For more info SHARE ANALYSIS: WES

-Sales and consumer sentiment soft
-Pressure on margins from discounting/costs
-Online gaining traction
 

By Eva Brocklehurst

Department store retailers hold a mirror to householder sentiment in terms of the goods they sell – homewares, apparel and cosmetics. Sentiment picked up at the start of 2013 but appears to have softened at the end of the March quarter and consumers do not appear well disposed towards shopping. Is it the looming election? Is it the warmer-than-usual autumn? On both counts, by the time Myer ((MYR)) has delivered the FY13 earnings report in September, it will be better understood.

Myer reported soft sales growth in the March quarter, up just 0.5%. The start of the year was positive but then it all went flat in March. This trend continued into April. Macquarie flags the fact that hard goods and homewares declined by about the same amount that apparel and cosmetics gained – around 2%. Myer has a clean inventory position, unlike competitor Target ((WES)), and is prepared to time clearances in line with the traditional stocktake sales at the end of June.

Where the retailer differs from Target is inventory management. The warm autumn did not lead to an excess of seasonal inventory. Nevertheless, the perceived need for Target to mark down items will put pressure on Myer to do the same. The company is resisting this somewhat, but will likely use the end financial year stocktake to flush out the bargain hunters. Myer may be confident in its inventory management systems but brokers are keenly aware that any major discounting will pressure earnings, given the tough consumer environment.

Store numbers may have increased but it is the inability to materially grow sales that concerns JP Morgan. The broker is the more negative of those covering the stock on the FNArena database and has an Underweight rating. The lack of sales momentum is partly from heightened competition but, in the main, the consumer hasn't been that willing to part with dollars. Management is forgoing margin enhancement to pick up better top line growth and the company is expecting to implement a new order management system by October which it hopes will deliver real productivity benefits and improve the experience for customers.

The cost of doing business is rising and is a considerable challenge for discretionary retailers. Gross profit growth has been the focus of attempts to offset this challenge but remains modest, in JP Morgan's view, such that earnings declines are likely to have accelerated in the second half. Improvements in managing mark-downs should lead to gross margin expansion. The broker concedes there is evidence this is happening, with mark-downs falling below 10% of sales in the first half, from a peak of over 12%.

JP Morgan believes consolidation of overseas factories will also lead to incremental gross margin expansion over the next few years. The falling Australian dollar does pose medium term risk to sourcing cost pressures but Myer has hedge cover above parity for the next 12 months and, at present, less than 20% of product is directly sourced. Myer suggests sourcing cost pressures from a falling Australian dollar would largely be compensated for by benefits of the consolidation, leading to an improved bargaining position.

Growth in online sales has been over 200% but that's off a very low base and JP Morgan suspects a significant proportion is replacement of in-store sales rather than incremental sales. Macquarie flagged the Myer One loyalty program, which, while not necessarily bringing in new customers, is better targeting those the retailer already has, enabling more sales. Morgan Stanley is quite happy that gross margins will continue to move higher in the second half, while the online offering is moving closer to break-even. The broker forecasts Myer will generate online sales of around $70 million in FY14, up from $40m in FY13. Break-even is seen around $50m. Following a period of significant investment in online, Morgan Stanley finds it heartening that this will become a driver of profits. Still, the positive aspects are not outweighing the concerns over the contagious nature of competitor discounting.

CIMB has moderated its rating to Neutral from Outperform and sees some risk that gross profit targets may not be met in the second half. The stock is still one of the preferred exposures to a domestic cyclical recovery – when that happens. The company has been open about the costs faced in the second half and the required gross profit expansion needed to offset this. CIMB believes this margin will have to increase substantially. Hard to accomplish in what appears to be a softening trading environment. The company has confirmed a shift in the mix of sales away form wholesale brands toward concessions which implies better margins. The private label penetration has also been helped by the growth in concessions. Consumer confidence is just what's missing, in CIMB's view.

Credit Suisse was the most upbeat and has gone the other way to CIMB, upgrading the stock to Outperform from Neutral because of recent share price weakness. The broker hailed the more positive autumn inventory story – no overhang like Target – and noted stronger sales growth in cosmetics and clothing in the quarter. Refurbishment impacts were also lower than the broker expected. Myer has thee stores being refurbished over the next 12-18 months and this impact will peak in the first half of FY14. Sales drag from this is estimated at two percentage points in FY14. Myer is a reasonably priced opportunity, in Credit Suisse's view. Moreover, the stock should benefit form improving consumer confidence after the federal election has passed. Interest rate reductions should also lift household spending over time.

Finally, Myer is trading on 12.5 times the broker's earnings forecasts for FY13 and offers a good dividend yield. In this respect, on the database, the dividend yield is 6.9% for FY13 consensus estimates and 7.2% for FY14. For Citi, the clean inventory may place it in a better position but discounting is still likely to escalate. Sluggish conditions are expected to continue and the broker finds underlying demand is even softer. The recent decline in the share price reflects the challenging nature of the retail sector and the company's low earnings growth profile. Citi targets a price of $2.60 and view the fair value price/earnings ratio at 10.6 times FY14.

The consensus target price on the FNArena database is $2.90, having ratcheted down five cents over the past week, and suggests 10.1% upside to the last share price. Targets range from $2.46 (JP Morgan) to $3.31 (Macquarie). In sum, the database is balanced, presenting two Buy (or equivalent) ratings, four Hold and two Sell.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms