Even The Discount Stores Are Copping It

This story features REJECT SHOP LIMITED. For more info SHARE ANALYSIS: TRS

By Greg Peel

It's a simple theory. When demand wanes in the discretionary spending sector the first stores to note dwindling sales are those at the top end of the price range. As demand weakens further, discounting begins among even those stores in the mid to lower ranges. But when you're already a discount store – to the point of being an example of what Australians still refer to as a “two dollar shop”, albeit a bit off the mark – the story is meant to be different.

It's taken a while, but the market has been slowly waking up to the fact that while Australia's economy is meant to be in such wonderful shape, the retail sector is in a deep, deep recession. Gerry Harvey has been screaming it from the roof tops, but there seems to be this mental block which ensures a belief that sales must surely return to “normal” given the economy and low unemployment. But what is “normal”.

It's becoming increasingly apparent that normal is not pre-GFC. Normal is pre the China-led boom of the early to mid noughties. Normal is pre the Gen Y spend-frenzy. Normal is not the normal young stock analysts are blindly assuming it to be.

Even before we talk of what level any sort of “inevitable” recovery might reach in retail sales, right now things are completely stuffed. The RBA's November interest rate rise which it now wishes it had never delivered has seen to that. The weather (and again everyone keeps talking about a return to “normal” here to, like, from tomorrow) is having a dramatic impact. Let's get this straight – it is going to rain and rain and rain all the way through to autumn.

The weather was a factor The Reject Shop ((TRS)) had not accounted for when it was placing orders for it's typical summer inventories – outdoor stuff for example. Having delivered positive November like for like sales it's all been down hill ever since. And TRS is a popular place to go for Christmas decorations and the like, but this year no one feels very festive.

In short, both TRS management and stock analysts had assumed that TRS would be immune from the retail downturn, given it already being at the bottom end of the discount food chain, and perhaps even a beneficiary of a consumer discretionary shift to the cheaper side of purchases. Your perfect defensive in a downturn, you might say. The market was so convinced it bought up TRS to the point three out of four brokers in the FNArena database covering the stock had hold ratings on a “fully valued” basis.

Then came yesterday's shock – a profit guidance downgrade to the tune of 15-20%. No one, it seems, has been buying anything since early November. Not even for two dollars.

The brokers have simply followed suit and downgraded their earnings forecasts by about the same amount, and so too did the market trash the stock yesterday by 20%. But given TRS still has a good business model, is well run, and is in the process of rolling out another couple of hundred stores over time, was the full percentage sell-off justified?

Two brokers don't think so. Both UBS and Credit Suisse have today upgraded their ratings to Buy from Hold (Outperform from Neutral for CS) on the basis that this bad news is (a) now priced in and (b) is short-term.

Macquarie, on the other hand, was the bigger TRS fan of the four leading into the profit warning. Macquarie notes that the 20% market de-rating still leaves TRS with a 20% premium multiple to the market which the broker believes is deserved, but which will also hamper near term outperformance even if TRS can turn its fortunes around quickly. The market has now learnt a lesson. No one is immune.

Thus Macquarie has downgraded to Neutral from Outperform.

The consensus target price, unsurprisingly, has taken a bath, by about $3 to $15.07.

The question is, nevertheless, just how much of a boom can Australian retailers really expect down the track just because Rio is producing more iron ore? And economists are talking RBA rate rises again, which ain't gonna help consumer confidence.

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