-Sunbeam on more sustainable footing
-Cash conversion still weak
-Automotive expansion a positive
 

By Eva Brocklehurst

GUD Holdings ((GUD)), a diverse supplier of consumer and industrial products, appears to have turned a corner. Brokers were relieved by the FY15 results, which signal the company has completed most of its restructuring.

There is still a busy period ahead, integrating the Brown & Watson (BWI) acquisition, ramping up its Dexion manufacturing plant in Malaysia and releasing capital to pay down debt.

Macquarie assumes further benefits will come from cost reductions but suspects they could be eroded by pressure on the underlying business. Cash conversion was weaker for the second year in a row, and remains below historical levels, but there has been increased investment to drive sales growth.

The broker was surprised by the increase in receivables in the second half, given there was always a first half skew. Macquarie attributes this to late sales in the first half with some clients taking on longer trading terms.

Margins were stronger in the second half and Sunbeam (consumer appliances) and Oates (household products) performed better than Macquarie expected. Dexion (storage solutions) was softer than expected but still delivered strong second half sales growth despite the transition of manufacturing to Malaysia.

This division is expected to deliver an earnings uplift over the next three years from profit improvement programs. Macquarie observes, maintaining all assumptions, Dexion needs to deliver 8.0% revenue growth to avoid an impairment charge.

Dexion was the bright spot, in Goldman Sachs' view, as revenue was up 12% in the second half on the back of new contracts. Sunbeam gained traction from cost cutting and new products and the broker expects this will continue to drive growth in FY16. This was a substantial part of the turnaround agenda - cost savings at Sunbeam and Dexion - and Goldman Sachs observes both are now on healthier, more sustainable margins.

Re-locating manufacturing for Dexion has enabled pursuit of new markets in Asia and the broker contends that once the start-up issues are worked through, the company is well placed to win new projects despite competitive trading conditions. Goldman Sachs retains a Neutral rating and $10.20 target.

JP Morgan is not so convinced about Dexion. The broker is looking for product innovation to continue driving growth and remains concerned about cash conversion. The company has been intent on cost cutting to improve earnings but now hopes to deliver new products through FY16 and FY17 to invigorate sales. In this sense the broker queries the restructuring costs which are still outstripping earnings generated by the business and worries about sustainability.

BWI (automotive products) appears a good fit, accretive in both earnings and business quality. Macquarie notes this takes the pressure off the overall contribution to earnings and growth from cost savings initiatives. The automotive business, overall, is the company's star performer and this recent expansion is considered a positive development.

A combination of the company's existing business in this field, plus the BWI acquisition, will mean the automotive after-market is more than 60% of earnings in FY16. The stock is inexpensive, UBS maintains. Its defensive aspects, a strong yield and the continued turnaround makes the stock attractive in an equity market where earnings certainty has weakened. A lack of top line growth outside of the automotive division is the broker's main concern.

Citi is encouraged enough by the results to upgrade the rating to Buy from Neutral. There was no quantitative guidance for FY16 but the broker highlights the commentary regarding a further substantial uplift in financial performance, expected to be driven by ongoing sales and the BWI acquisition.

Citi expects BWI will dilute automotive divisional margins but expand group margins to 12.8%, given its size. Sustainable, organic top line growth emanating from demand is still needed for the stock to genuinely re-rate while cost reductions remain paramount. Nevertheless, the majority of the restructuring is complete and Citi believes the benefit should be apparent in FY16.

The reaction in the share price suggests to Credit Suisse the market is increasingly confident in management's ability to turn the company around. Sunbeam is now back in a strong position, having delivered top line growth for the first time in around five years amid signs market share losses may have subsided.

The broker envisages the stock attracting further interest, given the price/earnings ratio of 14.4x in FY16 is undemanding. Cash flow is the only disappointment for Credit Suisse but commentary is comforting in that it suggests a strong forward order book across Dexion and Sunbeam.

FNArena's database has three Buy ratings and two Hold. Consensus target is $9.94, which suggests 5.0% upside to the last share price and compares with $8.80 ahead of the results. The dividend yield on FY16 and FY17 estimates is 5.06% and 6.0% respectively.
 

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-More subdued Oz outlook prevails
-Online competition heats up
-Offshore business still strong
-Healthy balance sheet
 

By Eva Brocklehurst

Flight Centre ((FLT)) is flying lower. Risks have become elevated in the face of a slowing domestic market, more competition and rising costs. The combination of risks suggests to brokers that caution is warranted. The company has also signalled it has begun to lose market share. Flight Centre has downgraded FY15 guidance to $355-365m, around 4.0% below prior guidance at the midpoint.

A reversion back to long-term averages in outbound travel growth rates, plus the competition that is affecting market share, makes Morgans cautious about the near-term investment view. The loss of domestic market share through consumers booking directly with online providers is of most concern, while positive aspects centre on the strength of offshore operations, particularly in the UK and US. Morgans downgrades to Hold from Add but would become a buyer of the stock under $35.50, believing the company is well placed over the medium to longer term as it benefits from a new era in travel - cheap airfares, more choice, greater comfort and less flying time.

Flight Centre's balance sheet is strong and Morgans does not expect capital management any time soon. The company has a noted preference to invest in the network and make strategic acquisitions, which increase vertical integration in a capital-light manner. Morgans believes there is still plenty of market share for Flight Centre to win in highly fragmented markets, particularly in corporate travel. There is also an opportunity for the company to review its cost base.

Credit Suisse downgrades earnings forecasts for FY16 by 7.4%, expecting current rates of growth, albeit soft, will continue. The broker concedes this point in the cycle means it is difficult to predict growth rates but household income remains subdued and the cost of international travel is unlikely to support outbound leisure travel in FY16. A loss of market share and growth in competitor products means constraints for Flight Centre's top line. The broker also observes Flight Centre grew consultant numbers by 5-6% over FY15 and there is a chance it has over-extended growth in that area at the wrong time.

Meanwhile, the US business is encouraging, with Flight Centre gaining more traction in long-haul leisure travel demand and corporate activity. Credit Suisse does not believe it will take long for the company's small base in the US to compound into a meaningful profit contribution while its market share is negligible. Offshore segments are an important source of growth and could offset the decline in Australian profitability, in the broker's view. Credit Suisse accepts some of the factors on the downside may be short term but downgrades to Neutral from Outperform.

Macquarie is of a similar inclination, downgrading to Neutral from Outperform. Flight Centre's downgrade to earnings expectations is principally reflecting sluggish demand but uncertainty around medium-term margins and market share means the broker finds better value in Qantas ((QAN)) in the sector. Capacity growth may be picking up but the impact on Flight Centre is less pronounced, given it has lost share to domestic carriers' direct distribution channels. Macquarie notes the agreement with Air Asia could offset some of this but is doubtful it will be enough. The stock appears fairly valued at current levels.

UBS reduces forecasts to allow for the weaker Australian results. The broker considers Flight Centre has done a good job in growing over the past ten years in the face of challenging structural trends such as hotels and airlines going direct to consumers, growth in online sites and growing consumer competence in booking online travel. Despite these trends, UBS retains a Buy rating as the business is strong and the stock not expensive. Nonetheless, greater clarity on Flight Centre's ability to reverse share loss is required at the FY15 results.

Australian profits have peaked and the various factors outlined above are likely to increase pressure on profitability, in Morgan Stanley's view. Online travel penetration is low in Australia compared with other developed nations so Morgan Stanley expects the share loss will continue. Outbound travel as also weakened as a result of the pullback in the Australian dollar. As Australians choose to travel domestically in response, these destinations do not necessarily require an agent and short-haul flights are now cheaper. The broker expects revenue margins will remain under pressure as capacity growth becomes rational and the airlines negotiate lower fees.

At current levels Deutsche Bank believes the market is pricing in a worse scenario than reality suggests, particularly given the company's growing cash balance. The Australian leisure market remains soft but the corporate market is performing reasonably well, in the broker's opinion. Internationally, all business, with the exception of Canada, are expected to be profitable. Deutsche Bank reduces FY15 estimates by 5.0% and removes its previous forecasts for a recovery in Australian leisure in FY16. The broker's dividend reductions have been larger than the changes to earnings forecasts, to reflect management's reluctance to distribute excess capital.

Flight Centre now attracts three Buy ratings, three Hold and two Sell on FNArena's database. The consensus target is $39.71, suggesting 12.8% upside to the last share price, and compares with $45.03 ahead of the guidance downgrade. The dividend yield on FY15 and FY16 consensus estimates is 4.3% and 4.6% respectively.
 

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By Greg Peel

Macquarie was surprised last month when Greencross ((GXL)) provided a slightly disappointing trading update at the broker's week-long conference, featuring presentations from a raft of invited companies. The broker has been a fan of Greencross since initiating coverage in March last year, and despite the disappointment maintains an Outperform rating.

Macquarie has until now been the only FNArena database broker covering the stock, and believes Greencross is still on track for strong profit growth. Greencross has established a dominant position in the pet services market, operating veterinary clinics and big-box format pet retail stores Petbarn and City Farmers. Australians love their pets, in increasingly growing numbers it would seem, and do not mind spending money on them.

Management downplayed what was effectively an earnings downgrade in May by noting Western Australia is suffering from weaker trading conditions, post the iron ore price collapse, and that second half trading was impacted by the severe weather experienced in the period by Queensland and New South Wales, which meant disruptions to the group's supply chain just at a time a new third party warehouse management system was being implemented.

As a result of the downgrade Macquarie pulled its target price back to $7.50 from $8.50 but, noting the share price response to the news at the time, noted the stock had pulled back to the market PE multiple on FY16 forecasts and hence an Outperform rating was still justified.

Deutsche Bank has now elected to initiate coverage of Greencross, noting the pet care market has shown above average growth over an extended period – a trend which is expected to continue, driven by an increasing focus on premium pet product and services. But while Greencross might be sitting in the big box seat, so to speak, Deutsche is concerned by the company's pace of growth through acquisitions and new store rollouts.

With rapid growth comes increased risk, and in Greencross' case, high gearing levels. Deutsche took the company's downgrade to potentially be a signal of further issues ahead beyond simply that of stormy weather.

The pet care market has been growing at an annual compound rate of 5% over the last decade. This is not simply a reflection of a growing number of pet owners, but of a structural shift towards premium products for pooch and pussy. Greencross' strategy of acquisition and consolidation leaves it well placed to improve on the 8% market share the company currently maintains. Deutsche is forecasting a 14% compound annual growth rate for the company out to FY18, driven by the expansion of its store and clinic networks, co-location of stores and clinics and increased penetration of private labels and exclusive brands.

In FY15 alone, Greencross has increased its retail network by a staggering 49%. Over four years, the network has tripled. Deutsche Bank is concerned the earnings downgrade may be symptomatic of aggressive expansion which may provide for further near term pressure. Supply chain disruptions served to highlight a lack of an integrated supply chain to service the fast-growing network. A ratio of 2.8x net debt to earnings also concerns the broker as it allows little room for error.

Deutsche has set its FY15 earnings forecasts at the low end of management's guidance range, some 11% below consensus which sits at the high end. The broker has set a $7.00 target and decided that risk and reward are currently balanced for Greencross, hence a Neutral rating is appropriate.

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-Margin, competition risks prevail
-Need to restore investor faith
-Success with strategy required
 

By Eva Brocklehurst

Super Retail ((SUL)) continues to restructure its business with most brokers considering the outlook robust, albeit with some caveats on the back of consumer sentiment, margin compression and exchange rate volatility. Nevertheless, successful execution of the company's strategy is paramount to any re-rating of the stock.

Sales were strong but margins weak in the March quarter and the over-riding outlook is stable, in Citi's view. By addressing its problems and overhauling its supply chain the company should achieve 17% earnings growth in FY16. Half of this relates to action by the company to close the loss-making Fishing Camping Outdoors business and scale back Workout World. Each of the segments may have lower earnings margins in FY16 but this does not worry Citi unduly. The drop may be 50 basis points, but 30 points of this can be explained by higher depreciation associated with investment in systems.

The broker also considers the company is managing its headwinds well, through initiatives such as a lower hedged Australian dollar and negative margin in sports and leisure. Growth opportunities prevail in store numbers, productivity, margin and supply chain costs and, in Citi's opinion, this is a rare combination for a large ASX-listed retailer - having all four areas contributing to growth.

Morgans observes the company is looking better than it has for some time but concedes competitive pressure on margins. The exit from the loss-making businesses and stores means FY16 forecasts should be achieved. That said, Queensland continues to be a major drag, the broker notes, with the region detracting around 1.0% in like-for-like sales growth.

JP Morgan is more conservative about the update and considers downside risks are to the fore, given margin contraction. The broker also maintains there is a risk that the restructure in leisure is insufficient, with the prospect that margins are slow to expand and more restructuring charges are announced. Moreover, expanding businesses such as Workout World, Amart (into NSW and Victoria) and Infinite Retail will weigh on the financial performance. While historically the earnings growth driver, JP Morgan is also concerned that the automobile division, Supercheap Auto, may slow. This adds up to a lack of valuation support and the broker retains an Underpeform rating.

Other brokers are more optimistic. UBS expects trends to improve over the rest of the second half as easier comparables are cycled. The broker considers Super Retail offers a compelling investment given its market position, with over 25% share in the categories in which it operates, and top line growth. That said, UBS acknowledges that execution over the past 12 months has been poor, with earnings forecasts downgraded four times amid a material de-rating in the stock. Further downgrades and/or signs its strategy is not working could spark further de-rating.

Macquarie retains an Outperform rating and believes the various initiatives underway, such as automotive store roll outs and the restructuring of leisure and sports, should drive double digit earnings growth in FY16. The broker observes sales momentum in BCF (boating, camping, fishing) is also improving as the cannibalisation of stores is reduced. Morgan Stanley, too, found the trends encouraging, and expects strong sales momentum should offset the margin weakness. Moreover, the upgrades to the distribution centre should drive future margin expansion. The Amart rollout has affected earnings margins but as these stores mature Morgan Stanley expects margins will strengthen.

Outside of margin issues, there are signs the leisure division has turned a corner and the broker expects like-for-like sales to improve. Vehicle sales softened in the quarter but Super Retail has increased its long-term Supercheap Auto store target to 350 from 325 and this provides confidence in the longer-term growth outlook. While Supercheap Auto remains resilient, Deutsche Bank notes customers are highly price sensitive and this will be a challenge for the company over the next year. Also, Super Retail is deploying a lot of capital to support earnings growth with only a modest outlook while the broker suspects the repositioning of Ray's Outdoors will not be easy.

Deutsche Bank also maintains the company will need to demonstrate that the previous internal issues will not recur. The deterioration in leisure is of concern and points to a highly competitive market with underlying weakness in its customer base. On this basis the broker retains a Hold rating, requiring evidence of stabilisation before becoming more positive.

So what is involved in the restructuring? Restructuring in several areas will cost $27m in FY15, including closure of five Workout World stores by the end of this month. Another five will close by the end of the year, with the business re-styled as a fitness brand and integrated into the Rebel division. The exit of Fishing Camping Outdoors is to plan and all stores will be closed by the end of this month. The savings are being redirected to the Workout World and Ray's Outdoors restructure. The new format at Ray's Outdoors will be trialled in five stores while four will be closed by July 31.

Super Retail has four Buy ratings, two Hold and two Sell on FNArena's database. The consensus target is $9.98, suggesting 0.8% upside to the last share price. The dividend yield on FY15 and FY16 forecasts is 4.0% and 4.5% respectively.
 

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