Leisure Drags On Super Retail

This story features SUPER RETAIL GROUP LIMITED. For more info SHARE ANALYSIS: SUL

-Potential for Ray's Outdoors, FCO closure
-Share price fall mitigates some pressure
-Christmas trading the key variable
 

By Eva Brocklehurst

Super Retail ((SUL)) is a poster child for the struggle retailers are having with an inconsistent start to FY15. Several brokers have now put opinions on hold until the company decides what to do with its leisure division. Trading over the first 16 weeks showed a slight improvement, but at its AGM the company said it expects gross margins to be flat on a full year basis. That spells further discounting for brokers.

Deutsche Bank considers the performance is reasonable in a patchy retail environment. Leisure continues to disappoint and the broker looks for clarity around the future of Ray's Outdoors and New Zealand-based Fishing Camping Outdoors (FCO) before taking a more positive view. The problems in leisure are worse than JP Morgan feared, the broker downgrading its recommendation to Neutral from Overweight. There is also lower-than-expected margin recovery potential in the sports division. Like-for-like sales growth for the period revealed automotive division sales were up 4% and sports up 3% while leisure was down 8%.

JP Morgan acknowledges it underestimated several issues such as the systemic challenges in leisure, including cannibalisation from new stores and the reliance on resources industry business in terms of the BCF brand, as well as the ineffective changes at Ray's Outdoors and the deterioration in the FCO business. The broker considers the problems are probably beyond repair in leisure, while a recovery in margins in sports appears weaker than previously expected. Automotive remains the only division where the broker is confident the targeted 11% earnings margin will be achieved. It could be worse. The share price has already declined and achieved some valuation support and this averts a more negative rating, from JP Morgan's perspective.

Credit Suisse retains a Neutral rating on the stock and believes Ray's Outdoors and FCO will likely close. The broker thinks the company has misjudged the attractiveness of these markets and the expense associated with repositioning Ray's Outdoors. Under such a closure scenario it is likely a proportion of the stores could be transferred to the BCF brand. Discounting is hurting margins in UBS' view and the broker reduces FY15 earnings forecasts by 7% to reflect revised guidance, despite the expectation that like-for-like trends should improve into Christmas. UBS is confident that execution is improving and acknowledges, if trends continue to improve, there is upside to its revised forecasts. Moreover, the broker believes it highly unlikely the Ray's Outdoors chain will be closed or sold, although a major overhaul is likely.

Macquarie revises first half earnings forecasts down by 5%. The broker believes Christmas is the key variable, particularly for sport and leisure. Leisure was expected to be weak, but not as negative as is the case. The broker observes trading conditions in mining-related areas remain challenging and it will take until the second half to confirm any improvement in leisure. As the stock is now trading at a substantial discount to the market, Macquarie retains an Outperform rating on a medium term view. Citi expects some more disappointment may be forthcoming at the interim result but remains confident in management's ability to turn around the weaker parts of the business.

Given the performance of Ray's Outdoors is already weak, Morgan Stanley considers the impact of any closure will be small. The broker arrives at a cash cost of $81m for the closure of both Ray's Outdoors and FCO. Ray's Outdoors contributes 1% to profits so the future earnings impact is expected to be negligible. Moreover, 30-40% of stock could be migrated across to neighbouring BCF stores, which would limit the need to make heavy write-downs. Morgan Stanley believes the share price pull back is overdone, having declined 14% since the FY14 results. Long-term growth potential remains intact in the broker's opinion and an Overweight rating is retained.

FNArena's database contains four Buy and three Hold ratings on Super Retail. Targets range from $8.30 (JPM) to $10.90 (UBS). The consensus target is $9.42, suggesting 23.0% upside to the last share price, and compares with $10.03 ahead of the AGM. Dividend yield on FY15 forecasts is 5.1% and on FY16 it is 5.8%.
 

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