Myer Ratings Cop A Beating

This story features MYER HOLDINGS LIMITED. For more info SHARE ANALYSIS: MYR

-To reinvest heavily in brand, stores
-Question of escalating costs
-Return to sales growth pleases
-Online now profitable
 

By Eva Brocklehurst

Weary of the continued slide in profits, several brokers took hatchets to Myer's ((MYR)) ratings in the wake of the FY14 results. There were a few positive aspects to the company's outlook and the department store retains some admirers.

Myer intends to spend an additional $35-50m in FY15 on initiatives to boost long-term growth. This decision was welcomed by some brokers as a step in the right direction, although Citi points out that earnings will decline before improving and even more expenditure may be needed. Citi expects another 8% decline in earnings in FY15. The reinvestment in the brand and stores is long overdue in CIMB's opinion but a large portion of the proposed investment is simply a means to stay in business. The broker does not believe it will widen Myer's catchment. Omni-channel investment, increasing the skills of personnel and optimising brand are just "maintenance" issues for this broker.

BA-Merrill Lynch is more critical, believing the gross profit drivers available to Myer are not significant enough to overcome the cost headwinds. The broker supports the investment to improve the business but does not believe Myer can afford it, given the depressing impact on earnings growth. The broker maintains a view that the stock is a structural underperformer. For UBS too, the strategy appears to be right but rising costs, increased competition and a falling Australian dollar are far outweighing the positives. The broker believes management is doing a good job but faces numerous challenges. UBS does not believe the stock is cheap, there are too many risks and downgrades its rating to Sell.

Whatever the amount of reinvestment to reinvigorate the business, marketing costs need to rise to lift the foot traffic at the stores. More staff are needed to lift conversion rates and provide a more dynamic product assortment, in Citi's opinion. The year ahead will have few refurbishment disruptions along with two new stores and sales growth could be lifted to 3.0% but Citi expects growth to revert to a 1.5-3.0% range beyond FY15. The broker notes a sharp drop in second half margins suggests a poor outlook heading into FY15. In CIMB's view guidance for modest growth in gross profit margins is aspirational. Moreover, Myer was cycling very low comparative results.

The big issues in the medium term are sales growth, gross margins and cash costs. JP Morgan notes sales growth has been elusive for the last 20 years, although the return to like-for-like growth in FY14 is pleasing. Currency headwinds are significant and this limits the expansion of margins. The prospect of reducing cash cost growth has been dashed with the reinvestment decision, in JP Morgan's opinion. Effectively, competition is increasing the required rate of growth in costs. All these issues do not add up to a bright outlook and JP Morgan downgrades to Underweight.

Now the negatives are sorted are there any upside risks? A better mix of private labels and tariff reductions may help. CIMB acknowledges sales momentum could accelerate from the upgrade/opening of Mt Gravatt, Joondalup and Melbourne Emporium stores. This will be partly offset by some closures, such as Hurstville. Completed refurbishment of four major stores – Adelaide, Miranda, Indooroopilly and Macquarie Centre should fully contribute in FY16. JP Morgan notes some limited valuation support with low price/earnings multiples but also believes the stock is not that cheap. Dividend support, furthermore, is debt funded.

Macquarie and Credit Suisse stand out amongst the downgrades, retaining Outperform ratings. Macquarie noted the final dividend was ahead of forecasts, at 5.5c versus 4.2c, reflecting a lift in the payout ratio. Sales were in line with forecasts but the quality of the result was low, the broker acknowledges. Moreover, investing in the business will hinder growth and Macquarie agrees most of the funds will be spent in order to maintain the current competitive position, rather than enhance it. Macquarie remains more hopeful the company can deliver the forecast improvement in sales in FY15 and achieve modest growth in operating margins.

The broker also expects the online sales contribution to again double in FY15. The company is targeting 10% of sales from online in the next five years. Still, Macquarie found it interesting that Myer will no longer outline the portion of total sales relating to online, nor the long-term expectations for online sales. The inherent difficulties in allocating sales revenue to either a store or online were cited for this decision.

Credit Suisse acknowledges that the reinvestment outlay is a point of contention but was pleased with the outlook statement, in that Myer appears to be controlling sales better and the online capability is now profitable. Promotional tactics are also becoming more effective. Credit Suisse is comfortable with the increased funds being directed towards improving the customer experience, such as web site, product range and store ambience. Moreover, the broker observes an increase in the number of personnel with international management experience, which should provide a better understanding of merchandising, marketing and supply chain capability. Credit Suisse accepts that the consumer remains vulnerable to negative sentiment and there are longer term risks from competitor activity. In the meantime, this broker believes the stock is inexpensive and cash flow is solid.

On FNArena's database there were four downgrades, three to Sell and one to Hold. Reflecting the diverging opinions, Buy ratings now number three. There are one Hold and four Sell ratings. The consensus target price is $2.17, suggesting 7.4% upside to the last share price, and compares with $2.30 ahead of the results. Targets range from $1.85 (Citi) to $2.54 (Macquarie). The dividend yield on FY15 forecasts is 6.9%, while on FY16 forecasts it is 7.2%.
 

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