Premier Investments Potential Lies With Smiggle

This story features PREMIER INVESTMENTS LIMITED, and other companies. For more info SHARE ANALYSIS: PMV

-Core apparel brand struggling
-Smiggle has most potential
-Concerns linger for FY14
 

By Eva Brocklehurst

By all accounts it was a warm winter in much of Australia and this means clothing labels have excess inventory to sell. This particularly affected Premier Investments' ((PMV)) lower-end brands such as Just Jeans and Jay Jays in the FY13 results. The company's earnings were describe as soft by brokers, again. Sales trends have been poor for three years, according to Citi. How long can this go on?

In seeking out the positive story, UBS thinks the Smiggle stationery brand's improvement and roll-out, along with the Peter Alexander sleepwear store expansion, should help offset the tough conditions in the other brands. Smiggle's sales per store in the second half were down 1% but that compared with being down 11% in the first half. This result was partly due to timing of new store openings but UBS thinks a degree of improvement can also be attributed to the underlying performance, driven by production innovation such as the launch of the Orange range. A strong Christmas season is also expected against the prior comparative period.

On a sales per store basis, for the key apparel brands, only Dotti and Portmans achieved growth. Jay Jays declined 11%, Just Jeans 3.3% and Jacqui E 2.3%. Dotti grew 7.3% and Portmans 2.5%.

Citi sees plenty of upside in the Smiggle expansion but gets a headache when looking at the core brands. They are seen losing share and competition is intensifying. Citi forecasts sales growth of 3.1% in FY14, lower than cost growth of 3.3%. The broker believes there are always good and bad performing brands within the portfolio, but the company has generally struggled to hold market share. Citi has decided to downgrade the rating to Sell from Neutral, reflecting a stock that has run up 27% over the past three months. This is similar to other discretionary stocks, but the broker remains equally concerned about those where share prices have run ahead of expectations.

UBS retains a Buy recommendation on the basis that management is capable of turning around mature brands and implementing initiatives to lift margins and control costs. Moreover, Premier is one of the only listed Australian retailers to offer a credible and profitable offshore growth strategy. Smiggle and Peter Alexander are expected to represent more than 30% of stores and sales by FY16.  The broker's underlying valuation is undemanding: stripping out the Breville ((BRG)) stake and net cash the underlying Just business suggests 11 times FY14 forecasts earnings. 

The company has put Smiggle Japan on hold given risks uncovered after further investigation, such as inability to launch the full product range and unfavourable lease arrangements. Instead, attention has shifted to the UK, with the first UK store opening in February 2014. From FY15, Premier envisages the roll out of 20-40 stores per annum to reach 200 stores in the UK. This profile is not dissimilar to the previous plan for Japan. Considering Smiggle management's former experience in the UK, and the closer cultural and commercial realities, the execution risk for UK is arguably lower than for Japan, in UBS' view.

The first store will open in Westfield Stratford in February 2014 and Citi factors in some success into forecasts, assuming the company has 63 offshore stores by FY16 across both Asia and the UK. Smiggle Malaysia still on the cards, and the first store is to open in Kuala Lumpur in the second half of 2014. This has limited risk considering proximity and similarities to Singapore. Peter Alexander's growth trajectory is for sales to increase 40-50%, driven by additional stores in Australia and New Zealand, flagship store opportunities in major CBDs, as well as new Myer wholesale and concession agreements.

 Deutsche Bank is positive about the earnings outlook and confident management can deliver. The broker commends the consolidation of the distribution centres into a single company-owned facility as good use of the balance sheet. Apart from targeted operating expense savings of $2m per annum within three years, there is also the strategic benefit of taking greater control of the supply chain. Macquarie, while recognising the importance of controlling the distribution infrastructure, questions the need to acquire the land and buildings. The new distribution centre for Australia will be near Melbourne while a new Singaporean centre is being established with a global logistics partner. The NZ centre capacity has been reduced and other NSW and Victorian facilities will be closed.

Other concerns? Well, the year-end inventory position per store increased 18% after falling 8% in the first half. Management defended inventory levels, saying the build up in stock levels was in anticipation of earlier and larger scale promotional activity from August. UBS also notes the company announced plans to roll out of Peter Alexander in Singapore a year ago but is still finding it hard to obtain a site.  Labour cost pressures aren't going away either. Wage cost inflation is offsetting other cost benefits. UBS expects similar base wage increases in FY14. The delays to the Jay Jays turnaround is also significant and the broker questions whether the change in brand management means uncertainty around timing and strategy.

Citi reminds investors that there was $3.4 million in gains on financial instruments in FY13 that are unlikely to be repeated in FY14. Citi also thinks investors should recognise the sales and profit split from the two growth brands and the remaining core apparel brands. The broker calculates that the growth brands, Peter Alexander and Smiggle, account for 33% of sales and 40% of group earnings and have implied margins of 18%. The remainder of the business has an earnings margin of 7%. The key question, therefore, is whether these margins are sustainable. The broker is less concerned with Peter Alexander because of the design focus and price point but Smiggle has many imitators and sustainable margins may be more like 12-15%.

Then there's that other (a little time-worn?) concern. Consumer confidence. When will it improve? Confidence is generally expected to improve after elections, supported by lower interest rates and capital city house price rebound. The market awaits. Besides this, brokers continue to expect incumbent apparel retailers will face competitive pressures from online and international entrants over the medium term.

Premier Investments has two Buy, two Hold and two Sell ratings on the FNArena database. The consensus target is $8.22, suggesting 0.8% downside to the last share price. The price target has moved from $7.73 ahead of the results. Price targets range from $7.60 to $9.05. The dividend yield is 5.0% for FY14 forecasts and 5.2% for FY15.
 

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