Myer Is Making Some Waves

This story features HARVEY NORMAN HOLDINGS LIMITED. For more info SHARE ANALYSIS: HVN

By Andrew Nelson

High street retailer Myer last month returned to the Australian Stock Exchange after thousands of mum-and-pop investors stumped up their hard earned cash into a $2.4bn float. The move came after three years of private equity ownership following the dismantling of Coles Myer Limited back in June 2006.

You might recall that Coles went to Wesfarmers and the Myer business went to TPG and Blum Capital, The Myer Family Company and Myer management for $1.4bn. Since the float TPG and Blum quickly departed these shores with the ATO hot on their heels looking for its cut of the profit that was booked on the sale. Myer management and The Myer Family are still on the scene, with 7.7% and 1.5% holdings respectively.

Myer remains the largest department store in Australia by revenue and by number of stores, with sales of $3.3b and 65 stores. The company is also one of the country’s largest retailers overall, with its stores located in metropolitan and regional shopping centres across all 7 states and territories.

Given the scale and 110 year history of the company, Myer is still one of the most recognised retail brands in Australia and is also the highest ranked of all Australian retailers in the latest AMR Interactive and Reputation Institute survey for large companies.

What can’t be argued is the positive impact that the years of private ownership have had on the company. After the buyout, the new management team went on to improve earnings before interest and tax (EBIT) margins from 2.3% in FY06 to 7.2% in FY09.

And analysts from GSJB Were, for one, believe this was a very strong performance indeed, noting the success was due to numerous business improvement projects including cost reduction, an upgraded supply chain, overhaul of IT, store upgrades, improved product mix and the introduction of an employee culture that is more focused on service and performance.

The broker is one of two who have picked up coverage on the stock today and it is of the firm belief that Myer can further improve its margins in the future, given positive fixed cost leverage, higher revenue and ongoing strong cost control.

The broker has initiated its coverage on the stock with a Buy and a 12-month share price target of $4.99, which implies a 12-month total return of 39%. Weres says its price target is based on a 1-year-forward PE multiple of 16x to its FY11 EPS forecasts, which it notes is consistent with its approach for comparable companies like David Jones ((DJS)) and Harvey Norman ((HVN)).

A few weeks after debut, the stock has also become the broker’s preferred exposure in the large market cap listed discretionary retailer space, with Weres saying that despite the strong earnings turnaround over recent years, Myer is nonetheless entering a new growth phase.

The broker notes the company is looking to grow its network of stores from 65 currently to around 80 within the next five years. The broker is also pencilling in some serious benefit from the opening of the redeveloped Melbourne CBD store, which will be the largest store by sales in the network.

Finally, the broker is also expecting that earnings will grow at a faster rate than sales, given the gross margin improvements and positive fixed-cost leverage that have been developed over the past few years.

Citi is the second broker to initiate coverage on Myer today and it too has slapped a Buy call on the stock, noting the significant momentum the company gained during its years under private equity. Citi is especially optimistic about the strong recovery in profit margins via cost savings that management have been able to put together over the past few years.

Looking forward, Citi analysts expect EBIT margins to hit 8.3% in FY12, compared with and already strong 7.2% in FY09. Now that most of the fat has been trimmed, Citi expects that future margin expansion will primarily come through increased offshore sourcing and the higher Australian dollar. The broker, however, rules out further significant cost reductions and expects that any savings will be reinvested into staff service.

Much like GSJBWere, Citi believes the key will be the store roll-out, with the 15 new stores planned adding up to 18% space growth. The broker notes that most new stores have even better population density and income characteristics than existing stores. So even after some cannibalisation of its own customer base, the broker estimates the return on capital will be greater than 28%, post tax.

Citi values the base business at $3.35 per share, the store roll-out at $0.75 per share and margin expansion opportunity at $0.25 per share, thus it has a 12-month target price of $4.35. The broker notes the valuation is also supported by a fully-franked dividend yield of 5.6%.

At closing prices yesterday, Myer was trading on 13.9x FY10 EPS and 12.0x FY11 EPS on GSJB Were’s numbers, which represents a discount to David Jones of 10% and a discount of 13% to Harvey Norman on the broker’s FY10 numbers. Both Citi and GSJBW believe that as Myer delivers on its expansion plans and margin growth potential, the PE multiple will re-rate towards, if not beyond, its major peers.

At 1220 PM, shares in Myer were trading 4c higher at $3.79 versus a 6 week trading range of $3.60 – $3.98.

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