David Jones’ CEO Resigns: Another Earnings Setback?

This story features MYER HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: MYR

-New CEO may lift performance
-Sales urgently need a boost
-Changes to current strategy possible
 

By Eva Brocklehurst

Upmarket retailer David Jones ((DJS)) has been thrown a curve ball. Or has the retailer thrown one? The chief executive, Paul Zahra, has suddenly announced his resignation. The resignation was for personal reasons and it has taken brokers by surprise. The company is part way through a strategic plan to reinvigorate the business. Mr Zahra, who has been in the post since June 2010 and with David Jones for 15 years, will continue as CEO until a replacement is found.

Morgan Stanley has made light of the news, believing this is not a sign that the company's performance has deteriorated. Moreover, the broker has conducted some analysis and finds company shares often perform better after a change of CEO. The consumer sector has experienced plenty of changes at the CEO level in the past three to four years. Competitor Myer's ((MYR)) CEO will finish up in the next year and, since 2009, Pacific Brands ((PBG)), Woolworths ((WOW)), Premier Investments ((PMV)) and JB Hi-Fi ((JBH)) have changed personnel at the helm.

The search for a replacement will be occurring at the same time as Myer looks to replace Bernie Brooks, so there will be a lot of interviews taking place in the department store sector over the next few months. JP Morgan expects succession uncertainty will result in a disruption to operations to some extent. Questions regarding potential changes to organisational structure and strategy are likely to persist. As a result, the broker is concerned that like-for-like sales growth, having improved a little in the first quarter of FY14, could remain subdued for the remainder of FY14.

Citi notes sales per square metre are 11% below the 2010 peak. The broker maintains the company has tightly managed costs but urgently needs to grow sales, not just cut costs. This means staff and marketing costs may need to rise first. A 10% rise in operating costs would wipe out 45% of group earnings so Citi envisages near-term downside for the stock. The company's property may be supportive, but the real opportunity lies in the store.

Morgan Stanley is of the view that David Jones can generate significantly more in earnings. The company has department store earnings margins, adjusted for property ownership, of just 3.3%. By comparison, Myer generates margins of 6.8%. Historically, DJ's has actually generated a higher earnings margin and Morgan Stanley thinks the company can get back above 5%. To do this the company needs to act on recent initiatives, including in-store service, online business and a new point-of-sale system, as well as improve store design, get out of underperforming categories and improve the private label offering. Morgan Stanley expects it will be the incoming CEO's ability to execute on this criteria that will ultimately drive earnings and the share price.

Citi observes that Paul Zahra was only interviewed in an Australian newspaper last week saying that there was still a lot to do at David Jones. There was no indication of an impending resignation. The broker notes he worked hard to restore years of under investment in staffing and online business. An international executive is considered the most likely candidate to replace him. Locally, Citi hails former executives Colette Garnsey, now at Premier Investments, Patrick Robinson, now at Gazal ((GZL)) and Sally Macdonald, formerly of OrotonGroup ((ORL)), as possibilities. A merchant who can drive sales per square metre is what's needed and Citi thinks this person is best coming from an overseas department store such as Nordstrom, Macy's, Selfridges or John Lewis. The pay scale could be over $3 million, compared with current CEO's pay of $2.5 million.

Paul Zahra continued with the execution of the 2008 strategic plan when he took up the post and then, in March 2012, launched his own strategy, which addressed several structural and company specific issues. JP Morgan lists these as the slow response to online, the challenge of global price harmonisation, the reduced service proposition over recent years, and the low credit growth environment which reduced earnings expectations for financial services. While there was a significant re-basing of earnings at the end of FY13 much of the changes had occurred and the business was on a more structurally sound footing. The broker notes that Paul Zahra was awarded around 88% of his short-term incentive payment in FY13, indicating the board was comfortable with his performance.

The valuation changes may be immaterial from a change of leadership but several elements of the current strategy might be reconsidered. In this list Credit Suisse includes the new small format store strategy and the concession agreement with Dick Smith Electronics. Online initiatives appear strategically sound and systems and infrastructure commitments are operating soundly as far as the broker is aware. The strategy for increasing private label brands has been modest at this stage and should not have a high impact if it is reversed. No commitments to the future of the CBD property appear to have been made.

On the FNArena database, David Jones has two Hold and five Sell ratings. The consensus target is $2.61, suggesting 5.9% downside to the last share price. Dividend yield is 5.% on FY14 consensus forecasts and 5.7% on FY15.
 

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