Myer’s Outlook Refurbished But Still Subdued

This story features MYER HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: MYR

-Weak sales, cost pressures continue
-Better season ahead with lead to Xmas
-Online growth but benefit takes time
 

By Eva Brocklehurst

When FNArena looked at department store Myer ((MYR)) at the end of the March quarter it was hoped shoppers would be in a better frame of mind by September, when the FY13 results would be known. It appears they were not. Myer's sales growth in the June quarter contracted 0.8% after growing 0.5% in the March quarter. Sales grew by just 0.4% for FY13. Subdued trading continued into the September quarter but brokers are prepared to accept this may be related to uncertainty ahead of the federal election.

Will that now change? Goldman Sachs observed several retailers pointed to political uncertainty in the lead-up to the September federal election as contributing to subdued trading conditions but the broker's economic analysts have found little evidence to suggest retail spending, confidence and asset prices have historically surged in the months following a federal election. In fact, they found that retail sales have tended to slow in the period post a federal election, with consumer confidence largely unchanged. The two areas that were found to benefit following previous elections were building approvals and business confidence.

Things are staying tough out there in retailing land, it seems. The company's position typifies a lot of Australian retailers. Soft sales and growing costs. The Sass & Bide label was a highlight and shows the potential of a strong brand and good design. Myer acquired 65% of the women's fashion label in March 2011 for $42.25m and has announced it will acquire the remainder this financial year for $30m. Morgan Stanley suspects that, while the brand was a strong driver of the department store's profits this time, it will be unlikely to get the same benefit again. Taking out that label, Myer's business appears to have deteriorated at a faster rate than sales have grown.

Oh to have more brands like Sass & Bide, laments Citi. The broker considers the company has price/earnings value relative to other discretionary retailers like JB Hi-Fi ((JBH)) and David Jones ((DJS)) but that doesn't deny the fact that absolute prospects remain weak. Near-term upside is most likely to come from rising house prices, creating a wealth effect and reduction in household savings, but Citi asserts this is dependent on consistent house price growth greater than 10%. The broker has revised down earnings forecasts by 7% and 3% for FY14 and FY15 respectively. Myer's operating costs are expected to rise 4-5% in FY14 and by 3% beyond that year, as wages and rents rise. Growing sales faster than costs is not easy, but Citi thinks it is possible. The broker maintains that staff levels need to rise by 10% as a precursor to better sales growth. The rating is downgraded to Sell from Neutral as Citi believes the recent run in the share price looks unjustified based on the earnings trajectory.

UBS is cautious but retains a Neutral rating. Sales trends are subdued but the broker thinks this will start to improve. Trends slowed through the June quarter because of the cycling of stimulus in the prior corresponding quarter, subdued pre-election spending and a warm winter. Looking forward, the broker expects improvement will be underpinned by a more confident consumer, rising house prices and normal spring/summer weather. The weaker Australian dollar should slow online leakage and drive more inbound net travel. FY14 is being labelled as a transition year with earnings pressured by rising costs and higher depreciation. The broker expects the net impact of refurbishments and new store openings to be neutral in FY14, with like-for-like sales broadly in line with reported sales.

Morgan Stanley has downgraded to Equal-weight from Overweight but still likes the business. Earnings are seen pressured while refurbishment and the building of the online business occurs. Operating cost growth is expected to increase by 4-5% during FY14 and this equates to a $40-50m headwind in the broker's calculation. A significant portion of the cost increase relates to building the online business but this should enable Myer to compete better and boost like-for-like sales growth. Gross margins in FY13 were driven by less discounting of wholesale branded products and continued reduction in shrinkage, but Morgan Stanley thinks these opportunities are becoming limited. Gross margin is still likely to rise, but at a slower rate than in the past.

In FY14, the broker expects Myer to post the strongest like-for-like sales performance since FY07 amid strong online growth and less price deflation. Myer has struggled for sales growth and costs have often been removed to enhance profits. This has supported earnings over the past few years but left the business exposed to headwinds like the shifting to online. Morgan Stanley doesn't doubt the company has the right strategy, but expects it will take time for results.

The contraction in June quarter sales disappointed Deutsche Bank but the broker thinks consumer confidence, which has recently improved, may continue to do so in the lead up to the key Christmas trading period. Under this scenario, the broker thinks appetite for discretionary retail stocks is likely to increase and Myer should outperform, as it is the cheapest stock in the sector and offers very attractive cash generation. Hence a Buy rating is retained.

Credit Suisse has also hung onto a Buy rating. The broker suspects Myer may be be downplaying expectations. On the surface, the results suggest a continued emphasis on business downsizing and the absence of further profitable opportunities for growth in the short term. Moreover, company specific initiatives will result in revenue and profit from new stores being offset by the refurbishment activity on three major stores. So, where does the broker get the confidence for a Buy rating? Excluding the refurbishment and online expansion initiatives, the growth rate in like-for-like sales is likely to improve through the course of FY14 from an acceleration in online sales and a generally improving retail environment. Growth in operating costs are also seen moderating. In addition, cash generation remains strong and Myer has a modest valuation.

On the FNArena database there's a 6.7% dividend yield on FY14 consensus forecasts and 7.1% for FY15. The consensus target price of $2.73 suggests 2.8% upside to the last share price. There are two Buy, three Hold and three Sell ratings.
 

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