Equity Raising For Myer?

This story features MYER HOLDINGS LIMITED. For more info SHARE ANALYSIS: MYR

-More downside to come
-Corrective action constrained
-Morgan Stanley finds stock cheap
 

By Eva Brocklehurst

Myer ((MYR)) confirmed brokers' worst fears with its first half results. The earlier-than-planned exit of long-time CEO Bernie Brookes this month was considered a signal that the upcoming result would not contain a material divergence from expectations. The chairman confirmed the company was comfortable with FY15 consensus estimates – at around $90m for net profit – when introducing incoming CEO Richard Umbers, so to now guide to FY15 net profit of $75-80m is a shock, adding to investor concerns around future forecasting and strategy.

Two weeks is a long time in retail, Macquarie remarks. The broker suspects management had a preliminary understanding of the first half profit range and the following five weeks of trading through February at the time of the briefing on the CEO and CFO resignations. In the company's defence, the broker acknowledges management may have thought that the relatively strong January trading conditions would hold up.

Macquarie calculates the second half would have required 58% profit growth to meet the prior consensus estimates so, even with January trading conditions prevailing, this would have been hard to achieve. The broker considers there is more downside to come and the potential for a capital raising cannot be ruled out so it remains too early to be positive.

Broker insights into the new strategy reveal more emphasis on sales productivity, fewer ranges, less emphasis on the Myer exclusive brand, and closure of stores at the end of leases while managed for profit in the interim. Another issue to be resolved is an over-sized supply chain, but Credit Suisse accepts this is likely to remain the case into the future. The capital postilion is tight, as a 15% fall in earnings from current forecasts is required to trigger a covenant breach. The capital position therefore constrains corrective action, in the broker's view.

There is a high probability that profit will also fall in FY16, Credit Suisse maintains, as new store and refurbishment effects begin to be cycled. With the effect of a recent fall in the Australian dollar still to be felt, there is likely to be further downward pressure on gross margins as well.

Early indications of new management's strategy include a willingness to consider radical changes to address the serial underperformance. Despite this, JP Morgan observes the challenges are significant and the risk to earnings, balance sheet and dividends remains skewed to the downside. Sales growth has been elusive in the last 20 years and while new stores, online and refurbishments should drive sales in 2015, competitive pressures are mounting. Therefore, until there is some sign of resolution JP Morgan remains cautious, noting a lack of valuation support.

Sales were in line but UBS notes margins were hit hard because of heavier discounting and stronger concession sales. Cash flow also disappointed and the broker has reduced forecasts by 12% in FY15, expecting profit of $81m, the upper end of the guidance range. UBS accepts the new CEO has a lot of work to do and near-term earnings risk remains to the downside but remains comfortable with the balance sheet.

The brand needs to make substantial investments to have any chance of addressing the problems that stem from stagnant sales and a growing cost base, in Deutsche Bank's view. This pressure is being compounded by the impact of FX on gross margin. The problem is, the latest step down in earnings makes it difficult to address the issue given limited head room in the balance sheet. The broker observes management could avoid an equity raising by reducing costs of doing business but this will not fix the problem. Deutsche Bank downgrades to Sell from Hold and reduces earnings estimates for FY15, forecasting profit of $72m, slightly below the bottom of the guidance range.

Citi also downgrades to Sell from Neutral and considers a capital rating a distinct possibility. The broker believes the strategic review that will be forthcoming from the new CEO could be on the table by July and may provide a catalyst for the stock.

Morgan Stanley runs a counter argument to many brokers and believes the valuation is too cheap, given the volume of sales, strategic store locations and brand heritage. The broker maintains the market is discounting a long-term earnings margin of 2.2% which is too low as, by contrast, competitor David Jones is set to generate an 11.5% margin. Morgan Stanley does not believe Myer is set for a capital raising as it should be able to lower debt from operating cash flow and capex reductions. Myer still has an option to underwrite its dividend reinvestment plan or cut out the dividend altogether to reduce debt.

Morgan Stanley remains the only broker with an Overweight, or Buy, rating on the FNArena database. There are three Hold and four Sell ratings. The consensus target is $1.48, suggesting 9.9% upside to the last share price. This target compares with $1.81 ahead of the results. Myer offers a dividend yield on FY15 and FY16 consensus forecasts of 7.8% and 7.7% respectively.

See also Myer Revamps Management But Why Now? on March 3 2015.
 

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