-Slower Oz store openings welcomed
-Dividend yield support
-Retreat to traditional ranges
-Price reaction a corporate signal?
 

By Eva Brocklehurst

Kathmandu ((KMD)) had a tough first half. The company cleared inventory aggressively in August and September, which drove top line sales but lowered gross margins. Christmas trading deteriorated sharply and comparative growth in Australia was weak. Broker opinions are divided about the extent to which the company can turn around, and how quickly. They are unanimous, however, on the fact that uncertainty clouds the outlook.

Morgan Stanley looks past the near-term weakness and believes the current sell-off puts the stock at an attractive entry point vis-a-vis a six to twelve month view. The broker suspects the clearance in August-September cannibalised sales later in the half, whilst a weak retail environment in Australia also affected the business. The company now plans to slow its roll-out of stores in Australia and focus on existing stores, and Morgan Stanley welcomes this move. From FY16 inventory will be more optimised with stocking on a store by store basis. The broker expects this to be of help to the smaller outlets in Australia which have underperformed.

Expenditure of around NZ$5m per annum is targeted for building the brand in the UK and Morgan Stanley believes capitalising this cost undervalues the business. The broker maintains a positive view and considers one-off issues drove the first half loss. A cleaner inventory position and a focus on improving performance is expected to ensue so an Overweight rating is retained by the broker.

The results highlighted a deterioration in Australian sales and gross margins for Deutsche Bank, which suggests that customers are increasingly blase about the company's traditional promotions. The broker acknowledges the company is reassessing its sales strategy but believes weakness is exacerbated by a more aggressive push into the UK and a transition in the CEO. This adds up to more uncertainty over the next twelve months. While the stock enjoys dividend yield support and leverage to a cyclical pick-up, the broker is cautious and maintains a Hold rating, wanting evidence of stabilisation before becoming more positive.

Deutsche Bank also observes comparative growth in Australia was just 0.9%, well down on the five-year average of 9.0%. This reflects not only soft consumer sentiment but also brand-specific issues, with a failure to drive sales through promotional activity. Moreover, Deutsche Bank refers to the trading update for the seven weeks to March, which shows a reduction in like-for-like growth of 2.0%. The first week of Easter sales was soft in Australia albeit satisfactory in New Zealand, the company reported.

Macquarie considers weaker sales in non-technical ranges have implications for just how much the brand can be stretched. Management has flagged a reduction in these ranges and a reassessment of promotional activities, citing a need to reduce the number of days the brand is on sale. Macquarie suspects the casual/urban ranges were important contributors to the Australian store network and provided some of the justification for smaller format stores in shopping centres. The broker considers a retreat to focus on technical ranges is significant in terms of the longer-term returns from these higher rent locations.

Initial results in the UK from promotional campaigns have been positive but Macquarie considers it too early to draw conclusions from that geography. The broker also points out the new CEO, Xavier Simonet, will start on July 1. Acknowledging that the near term multiples are undemanding, Macquarie still expects the stock to trade with a high degree of uncertainty until there is evidence the longer-term strategic issues are addressed.

Low confidence in the earnings outlook makes pointing to valuation metrics rather futile, in Morgans' view. Still, the broker likes the brand and expects a more targeted promotional strategy could lead to renewed upside in the medium term.

The near-term outlook may be soft but Credit Suisse considers it naive to discount the potential for the slump in the share price to attract corporate activity and revises its recommendation to Outperform from Neutral. The broker also observes that while New Zealand gross margins deteriorated, this was nowhere near the magnitude of what occurred in Australia. The broker likes the conservative stance regarding store roll-out in Australia, given current trading conditions, and the fact the company has conceded that the aggressive clearance activity in the first quarter did not help the brand, or the finances.

The stock has two Buy ratings and three Hold on the FNArena database. The consensus target is $1.70, suggesting 22.1% upside to the last share price. The dividend yield on FY15 and FY16 earnings estimates is 5.2% and 6.0% respectively.
 

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-Underperforming brands turn around
-Upside from efficiencies offsets FX
-Brokers welcome return to special divs
 

By Eva Brocklehurst

Premier Investments ((PMV)) has cut across the fashion retailer grain, delivering a strong first half result. The launch of pyjama retailer Smiggle UK was the key element which surprised to the upside but the company is also showing signs of a turnaround across its core suite of brands. An interim dividend of 21c was declared along with a 9c special dividend. No formal guidance was issued but the company indicated trading in the second half to date has been robust.

UBS found like-for-like sales growth a little soft, while earnings quality was not as high as in recent periods. Nevertheless, the gross margin expanded as a result of the move in the sales mix to Smiggle and Peter Alexander, the two bright stars in the company's universe. The two brands which suffered sales falls in the first half - Dotti and Portmans - have now returned to growth post the balance date.

UBS forecasts the Smiggle store network to lift to 450 by FY25, from 177 stores currently. A total of 19 stores have commenced trading in the UK with 14 more stores due to open in that market in 2015. Should western Europe and other parts of Asia be rolled into the brand's coverage, the broker envisages total stores could rise to 1,000. UBS suspects upside risk to current forecasts remains in train.

Morgan Stanley also notes both the two underperforming brands in the first half have had a strong start to the autumn campaign. Smiggle UK is expected to break even in FY15 and its expansion will likely be the key driver of the group over the next five years, in the broker's opinion. Peter Alexander's growth plan is also on track, with eight new stores opened in the half. However, Morgan Stanley calculates that these stores have a significantly lower contribution compared with the average. Morgan Stanley retains an Underweight rating.

It was a stellar result, in Credit Suisse's view, driven by Peter Alexander and Smiggle UK as well as improved performances from Jay Jays, Just Jeans and Jacqui E. The broker expects the core business will outperform retail peers, given management's track record of successful turnarounds. A longer hedging profile, tight cost control and efficiencies from the national distribution centre provide further upside and the broker expects this will offset FX headwinds. Credit Suisse notes, with $205m in franking credits, further special dividends appear likely in the absence of acquisitions. The broker's rating is downgraded to Neutral from Outperform.

Macquarie also has a Neutral rating, observing Smiggle and Peter Alexander present exciting growth opportunities but, with the remaining brands largely mature, growth prospects are captured in the group's valuation.

Premier, like other apparel retailers, will cycle a weak fourth quarter from 2014, which was affected by softer consumer sentiment after the May budget and a warm start to winter. The broker's forecasts assume second half underlying retail earnings will be up 20% as a result. The long-dated currency hedge book will also afford time to adjust sourcing and pricing in response to the recent fall in the Australian dollar until well into FY16. Macquarie is encouraged by the return to paying special dividends but does not read this as a change in approach towards acquisitions or investment opportunities.

Management is doing an outstanding job in negotiating a tricky retail environment and obtaining the right mix of growth and margin, in Deutsche Bank's view. The broker envisages potential for positive earnings surprise, namely from the initiatives in turning around brand, store refurbishments, supply chain investment and offshore expansion. The stock price/earnings ratio, ex cash and the company's Breville Group ((BRG)) investment, is in line with the discretionary retail sector, which the broker considers is a fair call.

FNArena's database contains five Hold ratings and one Sell. The consensus target is $11.20, suggesting 12.4% downside to the last share price, and compares with $10.20 ahead of the results.
 

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-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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-Earnings remain weak
-Substantial investment needed
-Time required to turn Myer around
 

By Eva Brocklehurst

Myer ((MYR)) is revamping its top team. Long-time CEO and managing director, Bernie Brookes, will depart immediately, to be replaced by Richard Umbers, who joined Myer last year. Daniel Bracken, who also joined Myer last September, is appointed deputy CEO. In an unrelated event, chief financial officer, Mark Ashby will depart in May to take up a position in the US. His replacement is pending.

JP Morgan observes the management moves have come sooner than expected, as a strategic review is underway already and a longer period for execution was expected before changes to management were considered. As is the case with such transitions a re-basing of earnings is possible, although not certain. Earnings have been weak for some time and a $35-50m additional investment in FY15 was already signalled as part of the strategic plan.

JP Morgan suspects further downside to FY16 and FY17 earnings. Moreover, the broker does not consider replacing management is a panacea for declining profitability. Headwinds still exist as the company struggles to find its position on the quality scale. Discount department stores are increasingly making inroads in fashion and soft goods at the low end while David Jones is providing competition at the high end, as it increases its private label offer. JP Morgan also observes the entry of international specialty retailers into the Australian market are putting price and logistics pressure on Myer.

The timing of the departures, two weeks ahead of the first half results announcement, has raised some eyebrows at Credit Suisse. The broker acknowledges the chairman's confirmation that the performance of the company remains in line with consensus expectations. This suggests any underperformance on short-term expectations, if it exists, is not material. There were few clues about the strategy that is being embarked on, although the broker expects the company will reconsider the breadth and size of its store network and accelerate changes to its product range as well as broaden e-commerce capability.

Credit Suisse contemplates a potential $200m rights issue or an underwriting of the dividend in order to facilitate change. While the opportunity to bring forward structural change is never better than when a CEO departs, Credit Suisse acknowledges the uncertainty and downgrades to Neutral from Outperform, suggesting shareholders should be aware of the potential for a capital raising.

To UBS, the chairman's rationale, that the current CEO needed to be the one who could lead the group to completion of the review, is reasonable but the lack of new guidance is a niggle. Previous guidance provided by Bernie Brookes was soft, and the lack of further advice could be taken as a sign guidance will not be met. UBS had expected Bernie Brooks would remain at least until the first half results were known. Changes must be afoot and therefore uncertainty prevails, the broker reasons.

A revitalised management team may be the catalyst that is needed for significant investment in the brand, in Deutsche Bank's view. The new team have solid credentials but the broker would have also found merit in the appointment of a CEO with more global department store experience. Deutsche Bank believes substantial investment is needed in the brand and the strategy could take years to turn the business around. Earnings forecasts are downgraded to reflect this view, with some benefits expected from FY17.

Macquarie considers the dual departures ill-timed. The broker believes the appointment of Richard Umbers is a significant move, as his department store experience is limited to his brief time at Myer. Prior to this he held a senior logistics position at Australia Post and, earlier, general manager roles at Woolworths ((WOW)) and Aldi. Macquarie also suspects, with the state of Myer's balance sheet, equity capital may be required to fund investments emanating from the strategic review. A lack of an earnings update reduces the risk of upside surprise at the first half result. This is despite evidence of favourable department store trading conditions in January. Macquarie finds little value in the stock at the current price and retains an Underperform rating.

While the changes at the top may signal near-term earnings downside, investment in the business has to be uppermost in the company's strategy, regardless, in Citi's opinion.Time will only tell but the broker notes, compared with other major department stores, Myer is trading at a large discount and may need to shut stores and overhaul its product mix.

The change at the top should accelerate the pace of change in strategy and at first blush Morgan Stanley maintains an Overweight rating. The newcomers bring complimentary but differing experience to Myer, although the broker acknowledges making the changes two weeks out from the results is odd. Still, Myer would have an obligation to update the market at this point if profits were wildly different to consensus views, so Morgan Stanley suspects the announcement could actually be a confirmation of expectations.

FNArena's database has one Buy, five Hold and two Sell ratings. Consensus target is $1.85, suggesting 10% upside to the last share price. Targets range from $1.50 (UBS) to $2.50 (Morgan Stanley) The dividend yield on FY15 and FY16 forecasts is 7.5% and 7.7% respectively.
 

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-Higher quality franchise growth
-Store numbers contract
-Property JV income lower
-Audio visual more competitive
 

By Eva Brocklehurst

Harvey Norman ((HVN)) enjoyed improvements in franchising margins and sales in the first half. All businesses grew, with the highlight being Australian franchises, while international businesses were boosted by FX benefits.

Margin expansion signals lower tactical support payments for franchisees, which in turn reflects higher quality growth, in Macquarie's view. With three stores closing and no new ones opening over the half, store count is lower than it was four years ago, the broker observes. This will remain a headwind to sales growth, although Macquarie found it interesting that the company claims it is winning market share in a number of large categories, despite the contraction in the store network. All up, Macquarie considers the positives are now captured in the share price and downgrades to Underperform from Neutral.

JP Morgan acknowledges store closures will weigh on sales but considers the like-for-like growth and focus on home categories will compensate, by leveraging the improvement in housing in Australia, particularly in NSW.

Australian franchising stood out while New Zealand was also strong. Ireland appears on track to break even in FY16. This has led to increased confidence on the part of UBS that management can deliver cost savings. The stock is expected to continue to outperform over the next 12 months, with scope for further capital management as well. UBS expects Harvey Norman to return to the historical average 4.6% for franchisee margins in FY16.

Debt metrics are comfortable, but Credit Suisse envisages little room for active capital management. The pay-out ratio increased to 68% in the first half and there remains scope for a moderate increase in the ratio because of low capital investment requirements. The company has a $600m franking account surplus. Nevertheless, Credit Suisse considers it unlikely the franking credits will be released by raising capital to fund a dividend.

Cash flow was lower than brokers expected but this was explained by the early purchase of inventory ahead of FX-related price increases. This should help second half margins, although sacrificing working capital efficiency in the short term, Deutsche Bank maintains. It also provides the company's franchisees with a competitive advantage. The second half has started well and Deutsche Bank also expects momentum to continue on the back of new housing starts, upgrading forecasts on the back of the Australian franchise operations, somewhat offset by reductions to the Asia and property segments.

Property was affected by a weak performance in mining accommodation, which reduced the share of profits from joint ventures. Management plans to tender for infrastructure projects to offset the weaker demand from mining. Deutsche Bank notes there was little in the way of definitive commentary but pointed to the upbeat outlook on consumer sentiment. Management is confident that Australian sentiment will remain stable, citing strong equity markets and housing strength. Petrol prices were also singled out as a boost to sentiment, although this has subsided a little since the start of the year.

Morgans notes NSW remains the strongest region and the commitment from Australia's central bank to support the housing industry underpins confidence that the tailwind from housing will continue into the medium term. Harvey Norman is a late-cycle beneficiary of housing starts and demand should be strong for some time to come. Downside risks come in the form of an inability to pass through FX inflation or poor execution of internal cost reduction programs, as well as further market share loss in the audio visual/technology segment, which the broker observes has become more competitive.

Asia remains the weakest geography. Singapore led the weakness as the retail environment remains challenging. A strengthening of Malaysia's economy was insufficient to offset cautious consumer sentiment in that country. In New Zealand, growth came despite commentary from competitors about soft consumer sentiment. Management indicated it made gains in market share, helped by the exit of The Good Guys from the NZ market.

Ratings on FNArena's database run the gamut, with four Buy, one Hold and three Sell.The consensus price target is $4.18, suggesting 5.5% downside to the last share price. This compares with $3.67 ahead of the results. The dividend yield on FY15 and FY16 forecasts is 6.6% and 4.6% respectively.
 

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-Tight cost control
-Risk to margins from FX
-HOME ramp up slower
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) flagged strong January trading and affirmed sales guidance but viewpoints differ as to the rest of FY15. The first half results were solid and given downgrades to guidance from other retailers, a relief, but brokers have some lingering concerns about the outlook. 

Morgans liked the tight cost control which minimised the impact of softer sales. The key downside risk is softer gross profit margins from FX-driven inflation. The broker would review its rating on evidence that stronger pricing is passing through in key categories, given consumers are very likely to mount resistance to anticipated FX-driven price increases. Like-for-like momentum is expected to remain solid, amid the maturing of the new Home category. The broker attributes the delay in expected outcomes in this segment to labour reductions in store, as the company has targeted its rosters to make savings. The Home category is expected to take time to bed down, as the entry into white goods is a significant development for the JB Hi-Fi brand.

Simply meeting expectations in the current retail environment should be considered a positive, in Macquarie's view. The broker gives credit to management for its focus on the potential longer term in the Home category. Management has admitted it was too bullish at the start and that store maturity in HOME is taking longer than expected. Other positive factors underpinning Macquarie's Outperform rating include lower fuel prices and the potential for reductions to the Reserve Bank's cash rate that are priced into futures markets by July 2015. This is expected to more than offset the headwinds emanating from a weaker Australian dollar.

JP Morgan is disappointed with the Home segment, with the current earnings contribution appearing to be around break even. The broker accepts the sales trend is improving but is concerned about the outlook for margins. The company has managed costs well but these are expected to build. All up, JP Morgan wants to witness more progress on costs and an improvement in the performance of HOME. Deutsche Bank is also subdued in its outlook, while noting the balance sheet is robust and guidance is better than expected. Still, the Home concept, while not a failure, remains of concern given the sales conversions are not occurring as fast as anticipated.

Stronger cash flow and trading in January provided reasons for optimism but Morgan Stanley is still not completely convinced, given the delays with HOME. Of note, there were no significant product launches in the period and this means the strong performance reflects the importance of back-to-school sales and the increased significance of IT in education. The broker also observes the company quashed expectations of capital management in FY15, so investors are unlikely to benefit from improved cash flow in the near term.

Citi remains the most bearish on the FNArena database with a Sell rating. The broker considers sales visibility is low, with guidance implying 4.0% comparable store growth in the second half. Moreover, this seems to be based on the January sales outcome. Citi points out that, in the past, January sales have not provided a reliable guide to overall growth in the second half. The broker expects sales to be slow over the next three years because of a limited number of new products in the pipeline and more competition.

First half profit was down 2.0% and 2.0% below UBS' forecasts. Still, the broker took away some positives including the improving trends, as the second quarter like-for-like result was up 1.3% year on year and January was very strong. Cash flow was aided, in part, by timing but also improvements in inventory. The FY15 profit guidance of $127-131m is in line with the broker's expectations. UBS expects the stock to outperform over the next year as earnings momentum builds with scale in the Home category. The broker expects an easing Australian dollar will bring back some inflation and reduce the attractiveness of offshore online sales. In terms of capital management, UBS believes this is probable in FY16.

Calls still diverge on the database since the stock was last covered at the AGM update, although, overall, they have become a little less bullish. There are two Buy ratings, five Hold and one Sell. Targets range from $15.40 to $19.40 and the consensus is $17.57, suggesting 3.1% upside to the last share price. This compares with a consensus of $17.69 ahead of the result. The dividend yield on FY15 and FY16 forecasts is 5.1% and 5.3% respectively.
 

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