There Are Other Stores Like David Jones

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

By Greg Peel

I'm a bloke. As a bloke I approach shopping as any other bloke does – with all the enthusiasm as is generated by a pending dental appointment. But eventually there comes a time when even a bloke has to succumb to the frightening reality that he needs to visit A Department Store.

My recent ordeal was forced upon me by the need to acquire some new Reg Grundies, realising the elastic had now gone in more than half of my available drawer full. So it was off to A Department Store in town. Shouldn't have been too hard really. Finding the right floor, section and corner can be a bit of a trial but once there, surely all one does is ask where the Grundy section is and just grab a few in the right size before making a rapid exit. But noooo…

Once upon a time the Menswear section of any store was laid out simply so even blokes could manage. Over there is a rack of shirts, shirts, shirts. Over there is a rack of trousers, trousers trousers. And over here is a rack of jocks, jocks, jocks, all clearly marked as to size and price. And there'd usually be a kindly Mr Grainger type in attendance who could point Sir in the right direction and discuss male smalls with withering discretion. Not now though.

Now the Menswear department is laid out according to brand rather than item. So over there are Yves Saint Laurent shirts, trousers and jocks, and over there are Dolce & Gabbana shirts, trousers and jocks and if you keep going you'll find another ten designer sections, each offering their own take on the humble jock. Selection, therefore, becomes an overwhelming task of having to flit from one to the other like a bee in training, all the while wishing there was simply a bloody great sign somewhere saying “Here are the ones you want!”.

For some strange reason, this is the system decided upon by a guy who might be construed as (allegedly) even too blokey a bloke. But in actual fact, I was in Myer ((MYR)).

But I did have cause more recently to “rush” into David Jones ((DJS)) (oh what an ingenuous fool I am for thinking so) to hopefully pick up an omelette pan as a birthday gift. Kitchenware – should be straightforward huh? But noooo. A completely disinterested 18 year-old girl just waved her hands about in response to my naïve enquiry, “where might I find an omelette pan?”, and indicated the dozen or more displays separated into kitchenware designers rather than kitchenware items. Had Girly even the slightest clue, she may have saved me a good twenty minutes by simply knowing that DJs didn't have even one omelette pan in its range.

It was with this experience under my belt (I bought my friend a book, by the way) that I was in no way surprised to learn the David Jones “solid” FY10 result was all about cutting costs and nothing else, particularly in the area of customer interface. Perhaps one day department stores will learn that the Big Four banks all went down the customer disdain path in the nineties to their disastrous detriment and have been fighting each other over improved interface ever since, even to the point of overkill.

DJs managed to post a 9% profit growth in FY10, right near the top of 5-10% growth guidance. It was achieved by reducing the “cost of doing business” margin by 100 basis points, all the way fighting a 30 basis point reduction in gross margins which basically reflected the fact everything in the store had to be discounted in order to move anything. According to UBS, it was important within the result that “service levels were maintained” (?). According to RBS, DJs' “customer facing costs” have been reducing for three years now relative to sales.

Don't I know it.

Citi points out that over the past four years, 80% of the retailer's margin expansion has come from cost cutting. That can't go on forever (Why not a “serve yourself” model? Seems pretty much that way already) so while UBS believes DJs is in a strong position to deliver further margin expansion in FY11, RBA is forecasting only a 40 basis point cost reduction this year compared to last year's 80bps.

It means that DJs has to do more than just cut costs if it wants to make good on ongoing guidance of 5-10% profit growth. One way to do this is to open new stores, and that's exactly the plan. The only problem is, the plan to open two new stores has now been delayed by as much as two years. Instead, DJs will refurbish two existing stores and introduce even more brands (oh good).

Management believes the earnings growth provided by this strategy will be equivalent to opening two new stores anyway, but analysts argue otherwise. Analysts have made across the board forecast earnings reductions, believing growth will be a slower and longer proposition given the rollout delays.

Macquarie points out that DJs' retail strategy is all to do with being the Home of Brands as a means of delineating from the competition. “While differentiated,” note the analysts, “it is not unique and not without competition”. Tell me about it. While DJs might be a bit more swanky, the whole Home of Brands thing looked all the same at Myer as far as this hapless shopper is concerned.

And that provides a considerable challenge for David Jones. Myer used to be a bit more low-end, but since reinvention and re-listing it is moving up the scale. Deutsche Bank notes that Myer has now closed the price/earnings gap between it and DJs from 20% to 12%. This has not altered the analysts' preference for Myer in the space.

RBS further suggests that Myer's decision to take its rival on in terms of service will mean DJs may actually be forced to reinvest in the same service costs it's been busily cutting for the past four years. And the decision to delay the store rollouts will not reduce capex, because the same amount will be spent on refurbishments.

Furthermore, critical to analyst forecasts for DJs is an expectation that consumer frugality will likely trough in 2010 and a decent Christmas will lead to a better 2011 for retailers. But as JP Morgan alludes to, an RBA interest rate on Cup Day (now considered likely, if not before) is not going to make for a particularly merry Christmas after all. And further hikes in 2011 could well see the “Everything Half Price” signs dusted off once more.

The upshot is that analysts think David Jones is travelling along okay, despite wishing (alleged) hanky-panky had not forced out the otherwise praiseworthy former CEO. But it comes down to a matter of valuation. The general belief is that DJs still deserves a PE premium over Myer, but that that premium is already pretty much accounted for.

That's why six out of eight FNArena database brokers have DJS on Hold. Credit Suisse had already downgraded to Sell (Underperform) ahead of the result and Macquarie cited valuation grounds for its subsequent downgrade to Sell (Underperform).

The brokers' average target has fallen from $5.27 to $5.23.

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