Small Retailers Feeling The Chill

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

-Garment retailers particularly vulnerable
-Morgan Stanley downgrades KMD, SRF
-Citi highlights appliance sector competition
 

By Eva Brocklehurst

Discretionary retailers are facing challenges. Easter was early this year, the weather throughout autumn was much warmer than usual and now there is a looming federal election to add to uncertainty.

Brokers also highlight deteriorating economic conditions, whereby the Reserve Bank may elect to cut official rates further later in the year. Morgan Stanley expects the RBA to cut the cash rate to 1.0% in a scenario which will not necessarily support consumer confidence.

The broker believes all these factors amount to negative pressure on small cap retailers at present. Retailers likely to be affected by the weather and the timing of Easter include Pas Group ((PGR)), Premier Investments ((PMV)) and The Reject Shop ((TRS)) and Morgan Stanley retains Equal-weight ratings on the three.

The most resilient in the current conditions are likely to be Burson Group ((BAP)) and Baby Bunting ((BBN)), the broker asserts, with both these carrying Overweight ratings. Burson, which sells vehicle parts, is rolling out new stores and has made wholesale acquisitions of brands which should ensure market share gains and growth are maintained. Baby Bunting is less affected by weather too, as it sells mainly hard goods, and apparel forms only 5.0% of its range.

The broker is less confident in the near term for The Reject Shop and Premier Investments but, overall, suspects company-specific opportunities – non-apparel Smiggle in the case of Premier – will prevail and drive significant growth in the next two to three years.

While clothing, and the lack of interest in purchasing winter attire, is more obvious for Pas Group and Premier Investments, The Reject Shop, which does stock some winter related product and downgraded earnings last year because of a warm May, has been shifting its ranges to reduce seasonality, the broker acknowledges.

Morgan Stanley is more negative, recently downgrading Kathmandu ((KMD)) to Equal-weight . The company is highly dependent on three key trading periods and two of these, autumn and winter, have been affected by the backdrop cited above.

Moreover, the broker envisages the restructuring at Ray's Outdoors, owned by Super Retail ((SUL)), signals clearance activity in the near term, and the emergence longer term of a new competitor for Kathmandu in the re-formatted stores, which target hikers and other outdoor pursuits.

The turnaround at Kathmandu, therefore, is expected to take longer. Morgan Stanley has also become more negative on Surfstitch ((SRF)), downgrading the stock to Underweight a few weeks ago.

Citi suspects the appliance category, while sound, is becoming more competitive. The broker has recently downgraded JB Hi-Fi ((JBH)) to Sell, level with its rating on Harvey Norman ((HVN)), believing the share prices do not reflect the earnings risks. Harvey Norman is facing sales pressure as JB Hi-Fi rolls out its Home segment while the latter is facing downward pressure on earnings margins as a result of the roll-out.

Citi also suspects there are risks for JB Hi-Fi in acquiring The Good Guys. While the process is at an early stage, the broker believes investors should focus on the returns on invested capital rather than the weighted average cost of capital as the measure to value the transaction.

If the acquisition does not proceed, a listed re-capitalised and corporatised The Good Guys is likely to grow materially and take market share from both Harvey Norman and JB Hi-Fi, Citi contends.

Why does the election affect retailers? Morgan Stanley observes the July 2 date is right in the midst of a key winter trading period. Moreover, the campaign is long and Myer ((MYR)) recently indicated it is expecting an impact on consumer sentiment, although acknowledges this is difficult to quantify.

The broker's historical analysis shows that there is a strong pattern around elections in terms of retailers. Share prices rally into an election and subsequently underperform. Morgan Stanley suspects that pre-election promises engender expectations of stimulus which are subsequently deflated.

Another headwind is pressure on the Australian dollar as a result of any forthcoming rate reduction from the RBA. Morgan Stanley forecasts US71c by the end of 2016 and US65c by end 2017. Stocks that sustain a substantial impact from currency given a large portion of direct sourcing and/or more elastic demand include Kathmandu, Lovisa ((LOV)) and Pas Group.

More broadly, the broker has assessed 18 consumer-facing stocks in terms of their diversity and supplier relationships, as well as management and governance. Of the above mentioned stocks, Myer and Kathmandu stand out in terms of gender diversity in employees and boards, while JB Hi-Fi and Surfstitch are poorer.

The broker notes, to date, only Woolworths ((WOW)), Wesfarmers ((WES)) and Pas Group have signed the Bangladesh Fire and Safety Accord for ethical sourcing, a key area of focus in the wake of the Rana Plaza disaster. Harvey Norman rates the poorest on the metric of governance, with just two of its nine board members being independent.
 

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