-Greatest potential with Smiggle
-Softer growth in FY15 likely
-No currency support envisaged
-Stock overvalued for many
 

By Eva Brocklehurst

After winter panned out miserably for retailers, Premier Investments ((PMV)) provided some hope for investors. The company achieved like-for-like sales growth of 4.7% in FY14. Maintaining momentum may be difficult, and the stock is viewed by some as fully priced, but brokers were impressed with the company's ability to battle soft consumer sentiment, a warm winter and inroads from international competition. All the Just Group brands showed like-for-like growth in the second half, the first time this has occurred since Premier Investments acquired the business in 2008.

Premier is benefiting from international expansion, and several brokers believe pyjama retailer Smiggle UK has the greatest potential to materially lift earnings. The roll-out of UK stores is well under way, with eight now trading and 18 expected by Christmas. Three of the ten highest turnover Smiggle stores are now in the UK. WilsonHTM notes profitability for the UK has been brought forward to FY15, although a significant earnings contribution is not expected until around FY17. The broker expects the turnaround of core apparel brands to continue too, but warns that delivering consistent like-for-like sales growth to the magnitude seen in FY14 will be hard going.

Other brokers agree with this outlook. UBS expects FY15 sales growth to weaken to 2.1%. Citi forecasts a reduction to 1.8%, acknowledging the solid FY14 result and that good sales trends for all brands are a rarity. The broker suspects sales will slow as fashion trends are less appealing this year. Also, there will be no benefit in FY15 from NZ dollar translation. To Citi, the proof of renewed momentum during FY15 will come with the successful roll out of the Smiggle stores, with some 17-22 expected to open in the UK. Smiggle is estimated to represent 13% of FY15 sales and 23% of FY15 earnings. That said, the broker downgrades to Sell from Neutral, believing the stock has overshot on value.

Gross margins will come under pressure in FY15, BA-Merrill Lynch suspects. Premier Investment's Australian dollar hedged rates will fall and the consumer environment will need to stay buoyant to maintain margins. The broker estimates a 10 basis point movement in gross margins will move earnings by 1%. There are several strategies the company has outlined to mitigate the impact of the lower Australian dollar, such as sourcing from different geographies and price increases. In terms of the latter, Merrills believes it will be difficult to achieve price rises throughout FY15. The current share price ignores the downside risks to earnings in FY15 and the volatile sales environment, in the broker's opinion, and an Underperform rating is retained based on valuation.

The company is unlikely to consider adding more apparel brands, despite its net cash position, but UBS believes it could consider a broadening of the consumer or fashion categories. The company recently increased its stake in Breville Group (BRG)) to 27.3%. UBS also notes the strong share price performance but believes dividends will be limited, downgrading to Neutral from Buy.

Moelis does not find the investment fundamentals demanding in the context of the company's strategic benefits and operational leverage. The broker sticks with a Buy rating. Credit Suisse also expects the company's brands to outperform retail peers at Christmas. Premier Investments is one of the highest quality retailers in Australia in the broker's view and there are growth opportunities geographically, and from a channel perspective. Macquarie retains a Neutral rating. While the result was better than feared and the growth attractions of Smiggle and Peter Alexander are obvious, the broker is more cautious about momentum in the core apparel brands. Jay Jays and Just Jeans still contribute over 40% of group sales. Jay Jays is slowly turning around and Macquarie acknowledges a return to growth in Just Jeans.

On FNArena's database there is just one Buy rating now, with two Hold and two Sell ratings. The consensus target is $10.36, signalling 0.3% downside to the last share price, and compares with $8.95 ahead of the results. Targets range from $9.30 (Merrills) to $11.80 (Credit Suisse).
 

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-To reinvest heavily in brand, stores
-Question of escalating costs
-Return to sales growth pleases
-Online now profitable
 

By Eva Brocklehurst

Weary of the continued slide in profits, several brokers took hatchets to Myer's ((MYR)) ratings in the wake of the FY14 results. There were a few positive aspects to the company's outlook and the department store retains some admirers.

Myer intends to spend an additional $35-50m in FY15 on initiatives to boost long-term growth. This decision was welcomed by some brokers as a step in the right direction, although Citi points out that earnings will decline before improving and even more expenditure may be needed. Citi expects another 8% decline in earnings in FY15. The reinvestment in the brand and stores is long overdue in CIMB's opinion but a large portion of the proposed investment is simply a means to stay in business. The broker does not believe it will widen Myer's catchment. Omni-channel investment, increasing the skills of personnel and optimising brand are just "maintenance" issues for this broker.

BA-Merrill Lynch is more critical, believing the gross profit drivers available to Myer are not significant enough to overcome the cost headwinds. The broker supports the investment to improve the business but does not believe Myer can afford it, given the depressing impact on earnings growth. The broker maintains a view that the stock is a structural underperformer. For UBS too, the strategy appears to be right but rising costs, increased competition and a falling Australian dollar are far outweighing the positives. The broker believes management is doing a good job but faces numerous challenges. UBS does not believe the stock is cheap, there are too many risks and downgrades its rating to Sell.

Whatever the amount of reinvestment to reinvigorate the business, marketing costs need to rise to lift the foot traffic at the stores. More staff are needed to lift conversion rates and provide a more dynamic product assortment, in Citi's opinion. The year ahead will have few refurbishment disruptions along with two new stores and sales growth could be lifted to 3.0% but Citi expects growth to revert to a 1.5-3.0% range beyond FY15. The broker notes a sharp drop in second half margins suggests a poor outlook heading into FY15. In CIMB's view guidance for modest growth in gross profit margins is aspirational. Moreover, Myer was cycling very low comparative results.

The big issues in the medium term are sales growth, gross margins and cash costs. JP Morgan notes sales growth has been elusive for the last 20 years, although the return to like-for-like growth in FY14 is pleasing. Currency headwinds are significant and this limits the expansion of margins. The prospect of reducing cash cost growth has been dashed with the reinvestment decision, in JP Morgan's opinion. Effectively, competition is increasing the required rate of growth in costs. All these issues do not add up to a bright outlook and JP Morgan downgrades to Underweight.

Now the negatives are sorted are there any upside risks? A better mix of private labels and tariff reductions may help. CIMB acknowledges sales momentum could accelerate from the upgrade/opening of Mt Gravatt, Joondalup and Melbourne Emporium stores. This will be partly offset by some closures, such as Hurstville. Completed refurbishment of four major stores - Adelaide, Miranda, Indooroopilly and Macquarie Centre should fully contribute in FY16. JP Morgan notes some limited valuation support with low price/earnings multiples but also believes the stock is not that cheap. Dividend support, furthermore, is debt funded.

Macquarie and Credit Suisse stand out amongst the downgrades, retaining Outperform ratings. Macquarie noted the final dividend was ahead of forecasts, at 5.5c versus 4.2c, reflecting a lift in the payout ratio. Sales were in line with forecasts but the quality of the result was low, the broker acknowledges. Moreover, investing in the business will hinder growth and Macquarie agrees most of the funds will be spent in order to maintain the current competitive position, rather than enhance it. Macquarie remains more hopeful the company can deliver the forecast improvement in sales in FY15 and achieve modest growth in operating margins.

The broker also expects the online sales contribution to again double in FY15. The company is targeting 10% of sales from online in the next five years. Still, Macquarie found it interesting that Myer will no longer outline the portion of total sales relating to online, nor the long-term expectations for online sales. The inherent difficulties in allocating sales revenue to either a store or online were cited for this decision.

Credit Suisse acknowledges that the reinvestment outlay is a point of contention but was pleased with the outlook statement, in that Myer appears to be controlling sales better and the online capability is now profitable. Promotional tactics are also becoming more effective. Credit Suisse is comfortable with the increased funds being directed towards improving the customer experience, such as web site, product range and store ambience. Moreover, the broker observes an increase in the number of personnel with international management experience, which should provide a better understanding of merchandising, marketing and supply chain capability. Credit Suisse accepts that the consumer remains vulnerable to negative sentiment and there are longer term risks from competitor activity. In the meantime, this broker believes the stock is inexpensive and cash flow is solid.

On FNArena's database there were four downgrades, three to Sell and one to Hold. Reflecting the diverging opinions, Buy ratings now number three. There are one Hold and four Sell ratings. The consensus target price is $2.17, suggesting 7.4% upside to the last share price, and compares with $2.30 ahead of the results. Targets range from $1.85 (Citi) to $2.54 (Macquarie). The dividend yield on FY15 forecasts is 6.9%, while on FY16 forecasts it is 7.2%.
 

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-Sales productivity best for some time
-But how long will momentum continue?
-What form will shareholder returns take?
 

By Eva Brocklehurst

Harvey Norman ((HVN)) has lifted expectations markedly on delivering a solid FY14 result. The company demonstrated its resilience, despite weak consumer confidence, and an improvement in sales and reduced costs from store closures drove the better profit and cash flow. While the move to reduce franchisee support was greeted positively by most brokers, they disagreed on the extent to which benefits will accrue over the longer term.

UBS upgrades the stock to Buy for three reasons: the trading outlook is improving, with macro indicators suggesting householder spending is picking up; there is further upside potential to earnings forecasts, given housing strength and better franchisee margins; and lastly, there is capital management. The lift in the second half dividend to 8c per share was a signal that the board is becoming more confident about returning cash to shareholders.

Citi took an opposing tack. The broker acknowledges the reduced tactical support for franchisees, which provided higher earnings and dividends, but wonders how long this can continue. Probably two more years, in the broker's opinion. After that, growth is likely to be slow. Citi considers that while higher payables are helpful, lower inventory or receivables would be better quality drivers for the stock. Add to this the closure of stores and competitive markets and the broker believes the long-term potential is limited. A Sell rating is retained.

The store is leveraged to new and established housing markets and Deutsche Bank believes this will continue to provide momentum. The broker also expects additional capital management in excess of the increased dividend. Deutsche Bank's operating earnings forecasts have increased modestly for FY15 and FY16. Typically, Harvey Norman provided little definitive guidance but the broker did observe that management was more upbeat than it had been in a long while. As Harvey Norman operates across all home maker categories, the CEO observed the group was well placed. Deutsche Bank noted the language regarding sales being "stable" was not insightful but took this to mean there was no dramatic change in conditions.

All geographies bar Asia reported an improvement in profitability. Asia was affected by declining consumer sentiment in Singapore and the redevelopment of the Suntec Mall, as well a difficulties arising form the implementation of new IT systems. The company has signalled it would be more inclined to increase the dividend pay-out than institute a buyback of shares. Going forward, Deutsche Bank assumes a 70% pay-out ratio, consistent with FY14. The broker also noted the property portfolio accounts for a smaller proportion of the enterprise value and has less of an impact on valuation than previously.

BA-Merrill Lynch found the key positive was the increase in cash realisation. The broker expects there is further room for earnings growth from franchising fee revenue, interest from franchisees and further reductions in tactical support. The broker retains a preference for Harvey Norman over the apparel-based retailers in line with a sector preference for exposure to household goods. Merrills considers the company is performing better than at any point in the past five years, but continued improvement in operations will be needed for this strong earnings growth to continue. Another key positive is that sales productivity has increased at a faster pace in Australia over the last ten years than in other developed markets. Combined with the low level of store saturation this means there is little evidence to suggest space rationalisation is needed.

Macquarie expects the leverage to residential markets will become more evident as strong housing demand translates into demand for household goods and appliances. In this case the stock offers an attractive exposure with the potential for capital management as well. Macquarie retains a Neutral rating as the stock is trading above the target of $3.29. On the subject of a buyback or special dividend the broker suspects a key motivation for a special dividend option may be the pending fall in the corporate tax rate to 28.5% from 30%. As such, Harvey Norman may want to return franking credits before the rate declines at which they are able to be distributed. Macquarie would not be surprised to see a special dividend paid in FY15.

Management has effectively dismissed a buyback or special dividend, in CIMB's view. The broker has lifted dividend forecasts, believing the absence of property development opportunities means the company can yield to desires for a higher-pay-out ratio. The broker considers sector consolidation also remains a medium-term opportunity across most segments. Harvey Norman's property assets underpin the valuation but the broker finds there is still some risk, given links to the viability of retail operations, although concedes this is becoming less of a concern.

Credit Suisse wants a few more details on the franchise performance and cash flow. The broker noted the positive outlook, which reflected cost and working capital benefits and a supportive household environment. The franchise segment may have improved but Credit Suisse believes this is largely related to the closure of loss-making franchisees. The benefits of the more efficient management of capital in the franchise and lower cost base should be realised from FY16 onwards. The loss in Ireland was less and this raises the prospect of that geography returning to profitability. Credit Suisse also observes Harvey Norman's exposure to consumer electronics and IT is low relative to JB Hi-Fi ((JBH)) and Dick Smith ((DSH)) and less affected by a slowing of product releases and tablet demand. Hence, this positively differentiates Harvey Norman as an investment opportunity.

On FNArena's database there are four Buy ratings, three Hold and one Sell. The consensus target is $3.58, suggesting 2.5% downside to the last share price. This compares with $3.27 ahead of the results. Targets range from $2.95 (Citi) to $4.20 (CIMB).
 

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-Soft July numbers influence outlook
-Improvement expected in second half
-But will new products stimulate demand?
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) did not deliver the sales momentum brokers hoped for as FY14 came to an end and the outlook for FY15 is disappointing. The best features of the electronics retailer's results were the dividend, which increased, and the targeted pay-out ratio, raised to 65% from 60%.

2015 will be a year when the company only inches forward, in Credit Suisse's view. The outlook is affected by the cyclical slowing in household income while guidance is heavily influenced by July's subdued performance. From a trend perspective the profit impact of the company's venture into housing products, HOME, only becomes material beyond FY15. The next positive catalyst for Credit Suisse is unlikely until after Christmas, when the peak season's trading conditions are known. JP Morgan is confident the company's broader trajectory can remain positive and that earnings growth will recover in FY16. The company remains better positioned compared to other mid cap discretionary retailers, with no exposure to weather risk and improving electronics industry trends, as well as a lesser impact from a lower Australian dollar. The broker is confident that gross margin expansion can continue and costs can be well managed.

UBS believes the company is in for low growth but not no growth. Still, the stock is likely to underperform until management delivers positive like-for-like sales growth or undertakes capital management over and above neutralising the employee option scheme. Growth is expected to return in the second half as consumer spending recovers, easier comparatives are cycled and the HOME segment gains scale. Hence, UBS maintains a Buy rating and awaits the AGM trading update in October.

CIMB lowers FY15 profit forecasts by 7% and its rating to Hold from Add. July may be the low point of the year but the challenges beyond abound. New categories in commercial lines and appliances should offset the impact of the declining categories such as software and tablets but the broker suspects, as recent history suggests, underlying operating cash flow has been sacrificed. Capex will also increase in coming years to support the roll out of HOME. The broker observes the strong FY14 gross profit margin partly reflected a decision not to participate in higher industry clearance activity in June. It seems the company missed out on sales and the broker questions whether the margins are sustainable.

July's like-for-like sales fell 5.5% on the prior July, attributed to a decline in tablet sales, but Macquarie expects this weakness to be confined to the first half. The broker considers it too early to extrapolate July trading to the full year, and new technology due out later in the year should stimulate an improved performance. Macquarie maintains an Outperform rating, factoring in leverage to an eventual recovery in consumer spending and increased exposure to stronger residential construction activity via the HOME business. The company is focused on capital management and the lift in the pay-out ratio is an encouraging development, as the broker notes the company will again buy back stock to offset the diluting impact of shares which have been issued.

A more cautious consumer attitude is expected to prevail and this is why BA-Merrill Lynch downgrades forecasts for FY15. The broker was not surprised by the guidance for sales growth of 3.4%, given persistent headwinds from the post-budget deterioration in sentiment. Nevertheless, the company is confident enough to guide to sales growth and that fact, for the broker, is an indication of the strength of JB Hi-Fi's initiatives. Merrills expects double digit earnings growth can be achieved if any improvement in market conditions eventuates.

Citi dispenses with hope, not expecting any respite in the declining sales trend until 2015 at the earliest. Citi questions guidance for sales growth, because there is a lack of significant product innovation to stimulate demand. The broker is bearish on tablet prices, and other categories as well. Any revamp of the iPhone or sales of large screen TVs will not be enough to restore growth. The broker believes the store's electronics inventory consists of too many outdated technologies and expects weaker sales of tablets, laptops and cameras to continue. Moreover, HOME is becoming more expensive to roll out. Citi notes capex has gone up and the pressure to achieve more than $3m in HOME sales per store is high. Also, productivity needs to compensate for narrow aisles and limited service. In the end, success will be determined by gross margins in FY15 and the broker expects another 15 basis points on top of the 17 basis points achieved in FY14. Citi retains a Sell rating.

FNArena's database contains four Buy ratings, three Hold and one Sell. Targets range from $15.10 (Citi) to $21.00 (Merrills). The consensus target of $18.99 suggests 7.3% upside to the last share price and compares with $20.22 ahead of the results. The dividend yield on FY15 and FY16 forecasts is 4.9% and 5.2% respectively.
 

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