Australia | May 28 2013
– March quarter sales poor
– Weather unfriendly, sentiment weak
– Brokers question the push for margin growth
By Greg Peel
Autumn arrived in Australia in May. Forces more powerful than the calendar decided summer should stretch into March and April this year. It made for some cracking weekends, but it meant ladies were not encouraged to snap up this year’s cool weather fashions in any hurry.
Department store proprietor David Jones ((DJS)) felt the impact of lower than expected autumn sales, in women’s apparel in particular. The company also suffered from ongoing weak consumer sentiment across the range of products, particularly in the dour home wares segment. DJ’s was not alone, with competitors across the spectrum also suffering from weak general sentiment and the warm autumn.
In retrospect, it was not a good time for the company to put its foot down on discounting. Having suffered through a long discounting war phase, DJ’s management decided this year to focus on margins rather than sales. This means not trying to match discounting at other stores, and also keeping a tight lid on inventories. Such a strategy has its advantages and disadvantages.
The first disadvantage is that DJ’s failure to discount meant customers who did engage in autumn buying went elsewhere. Sales revenue declined a total of 2.2% in the March quarter and 3.4% on a like-for-like basis. Comparables can’t be blamed, given LFL sales fell 3.1% last March quarter. The fact that DJ’s kept its winter inventories lean ahead of the season should be an advantage, but the problem is the company’s competitors have not been quite so sensible. Another discount war is expected to ensue in the June quarter, suggesting DJ’s may once again struggle to sell what inventory it has.
Management has announced it will compete with, but not match, price discounting. That said, the new strategy of focusing on margins rather than sales will continue.
The strategy involves various elements. One is to place less focus on home wares and discontinue extraneous, low margin lines like music and DVDs. A shift to higher quality lines and a tight control of costs, including promotions and sales events, should then help to improve gross margins. Thereafter, it becomes a story of hope. Eventually, it is assumed, Australian consumer sentiment will begin to cycle back up again. If so, DJ’s will be well leveraged to such an improvement.
Credit Suisse believes the weak performance from DJ’s of late smells mostly of cyclicality. If the RBA is to cut further, this would provide a boost to sentiment, and sentiment also has more chance of improving once the federal election is out of the way. With a combination of expected discounting ahead from competitors, an RBA cut not being a certainty now, the Aussie's correction and the election not being until September, any cyclical upswing is looking more like a 2014 story.
Deutsche Bank is not convinced on the gross margin story. Sales continue to deteriorate and despite cost controls, the company’s fixed cost base is formidable. Deutsche is forecasting a second half margin increase of 140 basis points, but suggests this may not be enough to provide positive earnings growth. JP Morgan is only one broker to note the planned halving of Financial Services in FY14, putting even more pressure on margin growth to carry earnings growth. BA-Merrill Lynch suggests that if DJ’s maintains its strict margin focus, the rate of sales decline could accelerate in what may well be a challenging June quarter.
CIMB is not even convinced FY14 will see a turnaround. The broker argues the market is too optimistic in believing margin improvement can lift company earnings in the face of the loss of Financial Services earnings, and is sitting on below-consensus forecasts. DJ’s weaker than expected sales result has prompted earnings forecasts downgrades across the board from brokers.
Macquarie does not believe management knows what it’s doing. “It remains clear to us that DJS has little data on, or insights into, who its customers are and why they shop,” say the analysts. “Given a period of under investment under previous stewardship, DJS now has to play catch up. A lack of basic retailing metrics such as foot traffic through to detailed customer insight by way of a loyalty program have resulted in DJS having a substantial ‘Big Data’ gap in its retailing capability”.
The company is now investing in some Big Data technology, but it will take time for any benefit to flow.
Following the sales result, the consensus price target for David Jones in the FNArena database has fallen to $2.47 from $2.73. Five out of eight brokers have maintained Sell or equivalent ratings on the stock. Despite reservations, Macquarie has upgraded to Neutral from Underperform, suggesting the market has already captured the weak story in the share price.
UBS (Neutral) notes that DJ’s has now fallen from a 10% forward earnings premium to rival Myer ((MYR)) to a 10% discount, and is trading at a 15% discount to consumer discretionary sector peers. While this might otherwise give UBS cause to apply a Buy rating, the broker is wary of execution risk for the company’s shift in strategy. JP Morgan believes that risk is now moderating, hence the broker’s Neutral rating.
Citi suggests that, as DJ’s is a high-end discretionary retailer, its sales trajectory is not so closely correlated to general consumer sentiment but more closely correlated to wealth. This should have provided a boost in the March quarter given stock market and house price rises, but then the weather stuffed things up, exacerbating DJ’s decision not to discount. It’s an opportunity missed, Citi believes, given “wealth effects are likely to be more muted over the next 12 months”.
Citi thus maintains its Sell rating.
Outside of the database, Goldman Sachs also retains Sell. Morgan Stanley, on the other hand, is a stand-out in maintaining an Overweight rating. The broker is a believer in the margin growth story, points out the autumn weather thing is just an uncontrollable set-back, and is impressed with the rapid growth in on-line sales now that DJ's has caught up to the 21st century.
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