Retailers Could Surprise

This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

-Retailers offering mixed bag of results
-Surprise potential with low expectations
-Rental bargaining position improves
-Depreciation expected to rise

By Eva Brocklehurst

The retail sector will be in the spotlight from next week with interim results. Christmas trading appears to have been modest at best, given the latest retail sales data from the Australian Bureau of Statistics. Retail trade slowed 0.2% in this key month and grew just 0.8% over 2012. Deutsche Bank finds this at odds with industry feedback, which showed retailers thought the season was solid. Food and liquor were soft, which is in contrast to the commentary from Woolworths ((WOW)) at its recent quarterly sales briefing, according to Deutsche. Woolies suggested trading had improved. Maybe expectations are just a lot more level headed these days.

UBS said feedback from the market suggests larger retailers outperformed and apparel and furniture were the most successful segments. Credit Suisse thinks risk appetite will stay high and provide underlying support for retail share prices. Earnings expectations are relatively low so there is some potential for surprise.

Wesfarmers ((WES)) is expected to show the strongest growth, up 12% on UBS forecasts. Wesfarmers remains the broker's pick, given the momentum at Coles and the opportunities within Bunnings. However, the broker finds staples are looking expensive and there is limited scope with the supermarkets, given high valuations and cost pressures. Morgan Stanley expects Woolies' like-for-likes sales declined in the second half and this could be the start of a trend.

Credit Suisse prefers Metcash ((MTS)) in the staples department (it reported in December) and considers Woolworths, and for that matter, Wesfarmers, as fully valued. Wesfarmers displays a mixed bag of recommendations on the FNArena database with three Sell, four Hold and one Buy (BA-ML). Price target ranges from $32.20 to $40 (BA-ML). BA-ML's confidence in the stock is because of the potential for increased dividends.

Billabong ((BBG)) and Harvey Norman ((HVN)) should show the weakest results, according to UBS, reflecting weather related and structural issues. Morgan Stanley views the glass half full for Harvey Norman, expecting improved trading in Ireland and higher profits in financial services/share trading. Credit Suisse sees the stock with high downside risk from increasing franchisee support payments. Harvey Norman has four Sell, three Hold and one Buy on the FNArena database. The Buy recommendation comes from UBS on valuation grounds.

Here, this broker also thinks JB Hi-Fi ((JBH)) and Pacific Brands ((PBG)) have scope for upside in the share price, given deflated valuations and relatively low expectations. JB Hi-Fi is UBS' preferred pay on a risk/reward strategy. Credit Suisse agrees,noting the stock is the most shorted retailer on the ASX at the moment. However, recommendations are diverse. On the database there are three Buy recommendations for JB Hi-Fi but also three Sell. BA-ML recently decided on a Sell rating because of the tougher margin outlook over the next few years.

Credit Suisse highlights Pacific Brands, Super Retail ((SUL)), Fantastic ((FAN)) and The Reject Shop ((TRS)) as those to watch in terms of being highly leveraged to a fall in the cost of imported goods. Dividend reductions from Billabong, David Jones ((DJS)) and Harvey Norman are likely, in the broker's opinion, because of falling earnings. Among the larger cap discretionary names the broker prefers Myer ((MYR)) and Premier Investments ((PMV)).

Myer is Morgan Stanley's top pick in discretionary retail as it considers valuation is undemanding and the gross margin opportunity is significant. Again, the prognosis on the FNArena database is mixed. Two Sell, three Hold and three Buy. Credit Suisse finds Super Retail expensive, given the company is already leveraged to an improvement in the sports and leisure division. Oroton ((ORL)) is liked among the smaller stocks because of its Asian growth exposure and strong domestic brand position.

Of general interest, there has been a rise in store closures because of prolonged retail weakness and Morgan Stanley believes this strengthens the bargaining position of retailers with upcoming lease renewals. Larger retailers are better able to capitalise on these negotiations compared with the smaller non-chain operators. Morgan Stanley notes rental savings are also more relevant to specialty retailers compared with typical anchor tenants. This is because anchor tenants typically only pay a fraction of the rent that the specialty retailers pay and sign long dated contracts.

The broker also expects depreciation to rise as retailers shift capital expenditure from stores to online, as online capex has a shorter useful life. The broker cites US department stores as an example. They depreciate online investments over 3-5 years, much shorter than the store-related capex life ranging up to 25 years. Morgan Stanley finds, in the case of David Jones, the retailer has made a significant investment in online. The company has stated online expenditure will come from its existing capex budget of $70-80m. According to the broker, even if $30m were spent in online, additional depreciation could amount to a 3% cut to department store earnings.
 

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