Tag Archives: Consumer Discretionary

article 3 months old

The Long Term Demise Of Myer

- Myer to see a positive FY15
- Positives then dissipate with competition
- Trapped in an outdated model
- Forced capital raising a prospect
 

By Greg Peel

A year ago department store Myer’s ((MYR)) share price peaked over $3 – its highest point since re-listing – on a tailwind of lower interest rates and rising consumer sentiment, along with general market strength. Myer was unable to convert this expectation into actual earnings, so down the share price came again. It’s been a rollercoaster ride ever since, and the stock is currently sitting around $2.25.

The expectation versus actual earnings cycle has perpetuated into 2014, a year in which it was revealed the company had approached rival David Jones ((DJS)) to propose a merger of Australia’s two remaining department store chains. The move was seen as desperate, and the market assumed that while DJs might prove a saviour for Myer, shareholders of Myer would be the losers in any merger structure.

This view was no more apparent than when Woolworths of South Africa announced its takeover offer for DJs at a healthy premium. Myer’s share price bounced. One might suggest the bounce was a case of one takeover offer within a sector “floating all boats” on anticipation wider corporate interest would be stirred, but the bulk of commentary suggested the market was simply pleased the takeover meant a junior partner merger with DJs was now off the cards.

Is the department store model of the twentieth century now dead in the twenty-first? Both Myer and DJs have already spent this century redirecting to a private label model, becoming less of an “everything under one roof” supermarket for discretionary products and more of a co-operative of brands. Name brands, particularly in fashion, can avoid the cost of establishing their own outlets (such as in a shopping mall) if they simply take up space in a department store instead.

For this writer, not known for his style leadership, a department store became a place in which trying to buy a shirt was frustratingly difficult and time-consuming experience within a place that once boasted a whole array of shirts to choose from, over in that corner there. Now each label occupies such a corner, with its shirt, pant, short and undie offerings all together, and thus selecting a shirt means roaming the whole floor. Without shop assistant in sight.

And it’s not just fashion. I’m still recovering from the time I tried to buy an omelette pan at Myer. Half an hour later I left vowing never to darken the door of a department store again. It took me that long to establish, thanks to the indifference of a shop assistant I did manage to find, that Myer didn’t sell omelette pans. I have been true to my vow.

But I can only assume the private label model does suit some patrons. Therein lies the catch. CLSA expects that over the next few years Zara, Topshop, H&M, Uniqlo, Sephora and Williams-Sonoma all will establish a “firm footing” in the Australian market by opening their own chains of stores.

You may have heard of these brands, I haven’t, but that’s not important right now.

Indeed, CLSA expects the competitive landscape to evolve significantly over the next five years, with international retailers, many best-in-world, featuring vertically integrated business models, opening up to 250 stores. It’s taken this long for Myer, and David Jones, to even begin to catch up to the competition on the interweb thingy. And in the case of DJs, it is the intention of Woolies SA to focus even more on private label offerings as the source of incremental sales growth.

Where does this leave Myer?

Well in FY15, looking quite good, CLSA suggests, as the tailwinds of low interest rates and rising consumer sentiment finally fill the sails. But it will be a last hurrah for the department store during a period in which DJs will be undergoing restructure and the private label standalones will only have just landed. Says CLSA:

“Myer will not sit still but the troubled department store model, skewed to an aging demographic, will make escaping this trap almost impossible.”

(I’d like to give a shout out to all the other members of the aging demographic.)

Among the FNArena database brokers, it’s difficult to find a Myer fan even at its current, seemingly cheap PE multiple (by historical standards). The retailer’s March quarter sales numbers were better than a year ago, and a quarter ago, but gross margins still fell. The margin issue surprised JP Morgan (Neutral) and sent UBS (Neutral) off to cut earnings forecasts. CIMB (Hold) wondered whether management was underestimating market competitiveness or misreading customer perceptions and BA-Merrill Lynch (Sell) highlighted an apparent lack of connection between strategy and execution.

Macquarie (Neutral) highlighted “uncertain implications from structural changes in the retail footprint” and Citi was another to cut forecasts, but at least upgraded to Neutral from Sell on the low PE.

When the DJs takeover bid was announced, Credit Suisse (Neutral) saw longer term risk for Myer in a DJs restructure, despite the short term removal of the merger discount. Only Deutsche Bank saw the end of the merger prospect as a true positive, looking to the low PE to justify an upgrade to Buy from Hold.

That leaves one Buy to six Holds and one Sell (or equivalent) in the FNArena database. The current consensus target price of $2.54 suggests 13% upside, but only on a twelve month horizon.

CLSA, by contrast, has cut its target price to $1.30. It’s still a twelve-month target, but clearly the broker’s valuation is discounting for a longer term demise.

The “floats all boats” argument of Myer becoming a takeover target because rival David Jones is can be quickly dismissed by the “real” reason Woolies SA chose one and not the other, in most observers eyes, being DJs’ property portfolio. DJs actually owns most of its stores while Myer only leases. Yet Myer is the most indebted of all the discretionary retail majors, notes CLSA, and is further carrying significant off-balance sheet lease liabilities. A forced capital raising becomes a real possibility when fixed interest cover is so “skinny”, warns the broker.

How popular would a Myer capital raising be?

Hello? Hello? I’m trying to buy I shirt. Is anybody there? I have money, see? Hello?
 

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article 3 months old

Resurrecting Confidence In Dick Smith

-Price deflation abates
-Private label underpins margin
-Better store composition
 

By Eva Brocklehurst

Consumer electronics retailer Dick Smith Holdings ((DSH)) is a familiar name but relatively new to the listed market. At a time when retailers are troubled by declining margins and profitability, Dick Smith may be better placed. CLSA thinks so and has initiated coverage on the stock with an Outperform rating and target of $2.30. On the FNArena database both CIMB Securities and Macquarie rate the stock similarly for an average target of $2.65. Other FNArena brokers are yet to initiate coverage.

Dick Smith had more than 400 stores and contributed 5-6% of earnings when it was owned by Woolworths but after being taken private this unravelled, notes CLSA. The broker expects the current salvage operations to continue and set the company up to deliver on FY14 prospectus earnings forecasts. Store numbers should head back to 400 from around 375. The severe price deflation of the past few years should abate and make sales growth achievable, in the broker's opinion. 

Can Dick Smith return to the glory days? CLSA believes the new management is up to the task. In FY07 the business contributed $71.1m in earnings to Woolworths. Subsequently, five years of mismanagement meant costs went through the roof and earnings fell to $24.6m in FY12. Lower short-term incentive payments should drive lower costs from FY15. In FY14 these payments are around double what the broker thinks should be the case on an ongoing basis, reflecting the transition of the organisation away from a private equity model. Supply chain optimisation should also result in more direct to store and direct to customer deliveries.

CLSA thinks gross margin expansion is less of a profitability lever now. Indeed, the broker expects FY15 to be flat. Private label penetration, expected to rise to 15% from the current 11%, is touted as the key support for gross margins. In Morgan Stanley's opinion, private label business has been key determinant why Dick Smith's gross margins are ahead of listed peer JB Hi-Fi ((JBH)), even though the latter has three times the turnover. CIMB also welcomes the lifting of the private label offering to include the New Zealand market. Dick Smith branded TVs have been in the Australian market for some years now and are the largest seller in the sub-40 inch category.

CLSA thinks the composition of stores will be better in FY15 and FY16. Closures have focused on stores that were the wrong size for their location or where there were onerous rents. Expansions are now based on the store-in-store format as well, such as the partnership with David Jones ((DJS)), which extends the reach to a more affluent consumer. CLSA also lauds the new MOVE format, which targets a younger consumer that may not have previously engaged with the Dick Smith brand. The broker notes customers now recognise that the company's offer has improved and thinks investors should follow suit.

What about price deflation? The Australian dollar's slide below US$1 has helped, and a reduction in discounting has alleviated the pressure across the AV/IT sector. CLSA cites the latest inflation data from the Australian Bureau of Statistics that showed price deflation is the lowest it has been in five years, supporting like-for-like sales growth. A stronger NZ dollar versus the Australian dollar will also assist Dick Smith. The sector will remain competitive and the broker does not necessarily think the Dick Smith brand is the best on offer but... the stock is cheap and should outperform.

CIMB also thinks there's a buying opportunity. Forget the negative overhang of private equity (Anchorage retains 20%) and lack of listed history. The initiatives the company has unveiled sell the story for the broker. As a one-time only provision, the company will report third quarter sales on April 16, in order to clarify the confusion around the underlying sales momentum. The broker thinks the cycling of last year's December clearance event could be concealing an improvement in like-for-like growth. CIMB is increasingly confident the re-worked staff incentive structure, a refined marketing program and category management a can deliver underlying sales growth, sustainably.

The company continues to target a working capital release as it pushes out vendor terms in New Zealand. Factoring this in, and a FY15 dividend at the top of the 60-70% target, CIMB expects a net cash balance at year-end of close to $55m. The broker thinks the pay-out ratio has potential to increase, or the company can assess acquisitions, possibly to rebuild the commercial business. CIMB notes Dick Smith has expressed a desire to maintain a conservative balance sheet and will not incur debt for acquisitions or dividends. The company has also signalled an intention to rebuild its commercial business, which could, in the broker's opinion, be supplemented by an education-based business.

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article 3 months old

Treasure Chest: Re-Rating For JB Hi-Fi

-Guidance upgrade expected
-Capital management expected
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) is robust enough to stay on top of the Australian consumer electronics industry. That's what several brokers believe. Morgan Stanley thinks the consumer electronics and white goods retailer is the best in the class when it comes to performance and this is set to continue via earnings upgrades and capital management.

We'll next hear from the company when it delivers a trading update on May 9. At that point Morgan Stanley expects the company to raise guidance for FY14 profit to around $126-129m. Morgan Stanley's forecast sits at the high end of expectations, at $133m. Such an earnings upgrade would accelerate capital management expectations and the broker notes the company will also become debt free by FY16. Morgan Stanley believes this improved scenario emanates from several quarters. Furthermore, the valuation looks reasonable, not cheap, but providing an attractive entry point nonetheless. Hence, an Overweight rating and $24.00 target.

BA-Merrill Lynch recently upgraded the stock to Buy from Neutral, foreseeing double digit compound annual growth rates as achievable over the next three years. The broker thinks the company's earnings potential has been undervalued. The three growth avenues are new stores, further roll-out of the JB Home format and continued expansion of the commercial business. Even taking into account an expected decline in mature store earnings over the next three years, the broker thinks JB Hi-Fi can still grow earnings by over 30% by FY16. Merrills also believes a positive update on May 9 could drive a re-rating. The broker concedes that the consumer electronics industry remains highly competitive and elevated discounting may cause some near-term earnings pressure but, this aside, the stock appears undervalued when considering the organic growth potential. Merrills is encouraged by the JB Home roll-out and thinks another 50 stores by FY16 will drive meaningful sales growth.

For Morgan Stanley the underpinnings of growth are coming from a fragmenting of suppliers, new gaming consoles and the fact the company now has greater leverage to the housing recovery. Finally, the consumer electronics market is looking more consolidated and rational.

The broker wasn't always so constructive. There's been several issues plaguing the industry and keeping a lid on profits such as a shift to online software, flat panel deflation and the dominance of Apple. Now, the company's potential, that's yet to be universally acknowledged, is around capital management, increased margins via private label product and the white goods market. Morgan Stanley observes unprofitable competitors have now left. Harvey Norman, Retravision and Betta have all closed stores while department stores have reduced their consumer electronic footprints. Flat panel volume growth is now aligned with the replacement cycle rather than relying on increased penetration. Flat panels represent almost a third of the company's revenue and the market has been very weak over the past few years, as prices fell and the Australian dollar rose. Prices were then lowered to win market share.

Thee headwinds are now easing. Moreover, Apple, having represented 20% of the company's business in 2010, is losing market share in the smartphone and tablet market as manufacturers such as Samsung, LG, ZTE and HTC crank up their share. JB Hi-Fi tends to generate a higher margin from non-Apple suppliers. Morgan Stanley expects 2014 should produce healthy growth in the game category from pent-up demand. There were few games for the new generation consoles at the end of 2013 and this should be resolved this year. The broker thinks the new generation consoles could boost like-for-like sales growth by as much as 3% on an annual basis.

The company is also benefiting from a national store footprint and the diversification into markets that are more leveraged to the housing market. White goods products are typically purchased soon after a new home is acquired. JP Morgan has noted these improving trends too, becoming more confident that earnings margins are not set to decline further. This broker also retains an Overweight rating.

Where Morgan Stanley suspects JB Hi-Fi may be able to get one up on competitor Dick Smith ((DSH)) is by replicating the latter's success in private labels. Dick Smith, at present, generates higher gross margins than JB Hi-Fi and the broker suspects, given JB Hi-Fi's sales are three times those of Dick Smith, that this is largely down to private label products.

What about the capital management? The company pays out 60% of profit in dividends so has built a healthy franking credit balance over time. The company also has a history of returning capital and completed a buy-back in March 2011. JB Hi-Fi can purchase share at up to 14% discount to the prevailing market price and allow shareholders access to franking credits, so Morgan Stanley believes this would be the logical way to go. The ongoing accretion to earnings per share is key here, because it permanently reduces the shares on issue. The broker thinks an acquisition or special dividend is unlikely.

On the FNArena database the stock has five Buy ratings, two Hold and one Sell. The price targets range from $13.90 to $23.06 with a consensus of $20.20, suggesting 1.8% downside to the last share price. The dividend yield for FY14 and FY15 forecasts is 3.8% and 4.0% respectively.
 

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article 3 months old

New CEO For Treasury Wine But Can He Deliver?

-Confirmation of marketing strategy
-Questions over FY14 guidance
-CEO accepts there's too many brands
-Strong upside potential, in Merrills' view
 

By Eva Brocklehurst

A new CEO graces the stage at Treasury Wine Estates ((TWE)) but the story remains fairly similar. Michael Clarke yesterday conducted a conference call and Q&A with analysts and reiterated prior earnings guidance for the company of $190-210m for FY14. He confirmed the focus on improving retailer and distributor relationships, reducing overheads, reinvesting in consumer and brand marketing and addressing excess production capacity. The CEO also spoke about potential restructuring and brokers heaved a sigh of relief. But...

To JP Morgan this is all well and good but will the required discipline prevail when the inevitable pressure on short-term earnings materialises? The CEO has reiterated a commitment to guidance but said he does not want to chase a full year number to the detriment of long-term objectives. Citi thinks the transition from reducing trade spending to a step-up in marketing has risks. Marketing will have to increase for some time before trade spending can be cut. Hence those long-term objectives may be a long time coming. To CIMB it's a case of, with promotional programs already in place for the fourth quarter trading, trade support being pulled back to avoid a repeat of the channel loading that occurred in the prior comparative quarter. As a result, volume growth forecasts for the second half in Australasia have been reduced and CIMB thinks this will also hold back a recovery in volume growth in FY15.

It's too early to tell if Michael Clarke will achieve what many of his predecessors failed to do and JP Morgan remains unconvinced. Largely because there's a lack of valuation support, strategic uncertainty and continued disappointment likely for the second half and FY15 results. The broker believes any bull case is predicated on the potential to lift value through asset divestments and this is either priced in or unconvincing. CIMB notes the stock is trading at a slight discount to the average FY15 earnings multiples for large international wine businesses. The broker suspects a steeper discount is warranted because of the risk around the Americas and Asia for the business. CIMB's recommendation is therefore, Reduce.

Deutsche Bank notes the CEO emphasised a lack of emotional attachment to brands and that everything is on the table for consideration. Michael Clarke remains enthusiastic about the US business because of the cost cutting and potential step-up in marketing. He also thought China presented a big opportunity. The broker also noted Clarke's statement that it was harder to differentiate brands on price and that commercial brands might be "better in somebody else's hands". Specifically, the CEO conceded the company had too many brands. Deutsche Bank urges caution at the mention of China, where business could be subdued for a number of years, compounded by excess inventory at the distributor level. The challenges associated with selling through a concentrated retail channel are likely to be compounded by a decreased appetite for premium wine in China. It adds up to a Sell rating for Deutsche Bank.

Citi notes the flagging of asset sales to cull the brands but thinks sales are likely to be in crushing and bottling rather than vineyards. Hence this is not going to provide the positive read in book value that the market would be hoping for. The question is just how much the brands are worth, given the proliferation of wine brands in the US and Australia.

BA-Merrill Lynch casts aside the doubts. If four objectives are met, the broker is confident TWE can reach its upside potential. These include allowing the CEO to operate independently, a continued investment in high end luxury wines, competent management of the commercial wine portfolio and exiting poor performing businesses, notably the US wine assets and parts of the commercial portfolio. If this happens then earnings can improve to a point which would justify $10/share in Merrills' opinion. Sure, events over the past nine months have dented the broker's confidence but Merrills is not giving up yet and retains the only Buy rating on the FNArena database.

CLSA is encouraged by the conviction that a turnaround can happen. The broker thinks there's significant value in the assets and retains Buy rating. The premium strategy should improve margins and smooth earnings and the endorsement by the new CEO is encouraging. The broker believes Treasury Wine suffers from a higher cost of doing business than rival Constellation Brands. Reducing this gap is critical to sustainable returns, and CLSA maintains a view that re-investing the proceeds of cost cutting in brands and sharing the the benefits with retailers is the sensible way to go. Marking to market the inventory, land, vines and plant generates a tangible asset value north of $5.50 for CLSA, and there is also the prospect that some of the value of these assets may be realised.

UBS welcomes the necessary reduction in overheads, capacity and brands. The broker also welcomes the commitment to forecasts, but does not expect the company will deliver. With the FY14 earnings likely to miss guidance, the broker thinks this will be the catalyst to clear the decks. A large problem for Treasury Wine, according to UBS, is the fact that two dominant customers continue to grow their own private label brands. The pricing power of Treasury Wine's commercial, and potentially premium, brands is being weakened. UBS is optimistic about Asia as well as Europe but thinks turning around the Americas is a difficult proposition. The Sell rating is retained. The main risk to this recommendation, UBS acknowledges, is corporate activity - or that the turnaround proves the sceptics wrong.

On the FNArena database there is one Buy rating, two Hold and five Sell. The consensus target is $3.71, suggesting 6.0% downside to the last share price. The targets range from $3.15 (Credit Suisse) to $3.90 (Macquarie) with one outlier, Merrills at $5.50.
 

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article 3 months old

More Capital Return From Wesfarmers?

- Wesfarmers now out of Insurance
- $3bn to spend
- Acquisition or capital management?
- Regulatory approval pending


By Greg Peel

The new management of Wesfarmers’ ((WES)) insurance business looked to be performing well, suggests BA-Merrill Lynch, and there were positive plans to grow the underwriting business through Coles. But the broker acknowledges that volatility in the insurance game is elevated. Insurance delivered $20m in earnings for WES in FY11 but only $5m in FY12. The broker thus understands the logic in divesting of the business.

WES sold its underwriting business to Insurance Australia Group ((IAG)) in December, pending regulatory approval (the ACCC has approved but NZCC approval awaits), immediately leading the market to assume the company would also divest of its insurance broking business. An IPO was touted, but WES has saved itself the trouble and cost with its announcement yesterday that the broking business is to be sold to US-based Arthur J. Gallagher & Co, subject to approval. This time approval needs to be forthcoming from the FIRB as well as the ACCC and the equivalent New Zealand bodies. The approval process could take several months.

Credit Suisse believes approval is likely to be given, although most brokers have elected not to adjust their forecasts until this becomes more clear.

The insurance broking business will be sold for $1.16bn and a pre-tax profit of $310-335m is expected. As to whether or not this price is a good one depends on which broker one takes a starting valuation from, which is dependent on that broker’s earnings forecasts. Suffice to say the price represents a multiple that is either at, or a bit above, Wesfarmers’ group multiple and either consistent with, or a bit better than, recent comparable local insurance sector sales, being those of Austbrokers ((AUB)) and Steadfast ((SDF)).

On that basis, both JP Morgan and CIMB would have liked more of a control premium while four other FNArena database brokers and Morgan Stanley suggest a favourable price.

But there’s little benefit in quibbling about price. Let’s just say it will do. And there’s not much point pining for lost earnings as the loss of business will be only modestly dilutive while the proceeds sit in cash. But they will not sit in cash for long, and that is the important element. The two sales combined – underwriting and broking – will generate around $3bn.

What will Wesfarmers do with the money?

The first thing to do is to pay down debt, not that the group is highly geared to begin with. WES cannot actually pay down too much debt given most of it cannot be retired for at least two years. WES could then pursue capital management, as it did last year via a 50c special dividend, or pursue an acquisition. Balance sheet strength means the company could re-gear its balance sheet and maintain its A- rating from S&P while still having $4.5m to spend on an acquisition, notes CIMB. WES could comfortably fund a $5bn acquisition without compromising the balance sheet on Morgan Stanley’s estimates while UBS suggests up to $7bn.

Brokers are mostly looking at the decision between capital management or acquisition as indeed an either/or proposition. But neither is without its obstacles.

A share buyback is unlikely while the stock trades on a 20x multiple. There would be little earnings accretion gained in paying up. And given Wesfarmers’ franking credit balance is actually negative, a dividend payout ratio above 100% is also unlikely in CIMB’s view. A capital return is the most likely choice if distribution is WES’ preference, CIMB believes.

Yet the announcement of the special dividend did not ultimately prove particularly popular with retail investors at the FY13 result, notes CIMB, which is surprising given for the last few years one would not want to be caught standing between a retail investor and yield. In this instance shareholders appear to be more keen on future earnings growth potential. The big miners and energy companies may be increasing their yields but only because they see no value in further growth at present. Wesfarmers, already a conglomerate of disparate businesses, could surely find a growth opportunity somewhere.

This is not a stroll in the park either. Macquarie believes WES is eager to redeploy capital into another acquisition (Coles has worked out rather well) but the group’s track record would imply WES is not going to buy a business just for the sake of it. Deutsche Bank suggests that given stretched valuations across listed assets, it will be difficult for WES to generate an immediate return above its weighted cost of capital on any acquisition, unless synergies are sufficiently attractive.

Wesfarmers currently owns all of Coles, Bunnings, Kmart and Target. Anywhere the group could find any synergies among similar businesses would never get past the ACCC, one presumes. Insurance has now been cast out, leaving the group’s industrial divisions and coal. The industrial divisions are challenged due to the slowing resources market and operational factors, notes JP Morgan. So even a “cheap” acquisition in this sector would likely not go over well with investors. That leaves coal.

CIMB believes the group’s decision is one of either one of returning capital or buying a metallurgical (coking) coal asset “at the bottom of the cycle”. WES has previously discussed a desire to evaluate acquisitions that offer economies of scale or downstream benefits, much like the coal reserve extension in January.

Credit Suisse, on the other hand, is not even entertaining the acquisition option. The “focus remains capital management,” the broker declares. Unlike other brokers, CS is not hanging around to wait to see what the regulators decide.

The broker is now basing its forecasts on the distribution of proceeds from the two transactions to shareholders through a combination of special dividends and capital returns. Specials of 46c and 21c will be paid in FY14 and FY15 respectively along with capital returns of $1,338m and $0.783bn. Throw in ordinary dividends, and shareholder returns will represent 10.0% and 8.9%. Credit Suisse seems rather definitive. Unlike other brokers, who are mostly waiting to see what happens.

Macquarie is nevertheless continuing to forecast a special dividend of 50c in the first half of FY15 although the broker notes that the group retains significant capital for deployment into acquisitions or further capital returns.

Despite the potential on offer from Wesfarmers’ divestments, not one FNArena broker can afford the stock a Buy or equivalent rating at the current trading price. The insurance businesses were sold at around a 12x PE but the group trades at over 20x. Coles and Bunnings are quality assets, suggests Citi, but the other 33% of enterprise value in the group is cyclical in nature. Multiples of over 20x are mostly afforded either to defensive high cash flow stocks or stocks with strong earnings growth trajectories.

There are four Hold and four Sell or equivalent ratings for WES on the FNArena database. Target prices range from $38.00 (Deutsche) to $45.00 (Credit Suisse) for a consensus target of $40.50, 4% below the current trading price.
 

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article 3 months old

Break-Out For JB Hi-Fi

By Michael Gable 

The Dow Jones was down 167 points last night on higher than average volumes. This is after the 160 point drop from the night before. The volatility is in stark contrast to the last few days of last week where the market almost appeared to switch off and do nothing at all. Although we are still cautious on the overall market here, there is still the possibility to uncover opportunities in the top 200. The sell-off in tech stocks is fairly broad based, and that is a good thing. Many companies are overvalued because investors piled in on the future promise of revenue. However, some tech companies have been generating solid earnings for years now – earnings growth that has kept pace with the market’s lofty expectations. As a result, these companies will soon present themselves as buying opportunities. We will continue to monitor the quality names being caught up in the sell-off and will advise when we believe they are going to bounce back.

JB Hi-Fi
 


We looked at JB Hi-Fi ((JBH)) on 11 February and noted how cheap and attractive the business was looking. We also noted that there was good support around $17.50 but it was unclear at the time whether it would hold. We wrote that “if JBH can get through $19, then we may have some further upside. Otherwise a breach of the January low could see JBH fall into support around $14.50.” In the last two months we have seen it test that $17.50 two more times and hold it. It has now therefore finally cracked that $19 level. As a result, JBH has become a buying opportunity and in our opinion it should head back into the low $20’s.
 

Content included in this article is not by association the view of FNArena (see our disclaimer).
 
Michael Gable is managing Director of  Fairmont Equities (www.fairmontequities.com)

Michael assists investors to achieve their goals by providing advice ranging from short term trading to longer term portfolio management, deals in all ASX listed securities and specialises in covered call writing to help long term investors protect their share portfolios and generate additional income.

Michael is RG146 Accredited and holds the following formal qualifications:

• Bachelor of Engineering, Hons. (University of Sydney) 
• Bachelor of Commerce (University of Sydney) 
• Diploma of Mortgage Lending (Finsia) 
• Diploma of Financial Services [Financial Planning] (Finsia) 
• Completion of ASX Accredited Derivatives Adviser Levels 1 & 2

Disclaimer

Michael Gable is an Authorised Representative (No. 376892) and Fairmont Equities Pty Ltd is a Corporate Authorised Representative (No. 444397) of Novus Capital Limited (AFS Licence No. 238168). The information contained in this report is general information only and is copy write to Fairmont Equities. Fairmont Equities reserves all intellectual property rights. This report should not be interpreted as one that provides personal financial or investment advice. Any examples presented are for illustration purposes only. Past performance is not a reliable indicator of future performance. No person, persons or organisation should invest monies or take action on the reliance of the material contained in this report, but instead should satisfy themselves independently (whether by expert advice or others) of the appropriateness of any such action. Fairmont Equities, it directors and/or officers accept no responsibility for the accuracy, completeness or timeliness of the information contained in the report.

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article 3 months old

Weekly Broker Wrap: Myer/DJs, Oz Confidence & Consumption and EUR/USD

-Myer/DJs value less likely
-Delay in Oz credit growth
-Oz consumption lifting in 2014
-Taza key for Oil Search
-EUR/USD strength continues
 

By Eva Brocklehurst

A deal between Myer ((MYR)) and David Jones ((DJS)) is becoming harder to envisage, according to Deutsche Bank. David Jones shares have outperformed by over 20% since the proposal was made public and consensus estimates for Myer have fallen after the first half result. Press speculation has indicated Myer may borrow up to $500m to introduce a cash component to the transaction in order to overcome the widening gap between the two share prices. Deutsche Bank's analysis suggests a cash and scrip structure is unlikely to be more compelling and would result in a merged entity which would be too highly geared. The broker reminds the market that one of the original advantages of a merger was an appropriately geared balance sheet. A cash and scrip deal is expected to lead to a more highly leveraged entity and wouldn't enhance the value accretion of the deal.

***

Credit Suisse has looked at the relationship between business confidence and credit in Australia. Credit growth has typically lagged GDP growth as it was relatively insensitive to the cash rate, but in recent years it has decoupled. Credit Suisse observes that where there's been a sustained or sizeable decline in business confidence, such as in the early 1990s and the period after 2008, it has led to a much longer period of subdued credit growth. What this means is the longer and deeper the fall in confidence and, subsequently, reduced credit growth, the longer it takes for credit to then respond to improving business confidence.

UBS expects Australian consumption to lift in 2014, still below trend at a 3.0% annual pace but up from 2.0% seen in 2013. Areas where the most significant rise in consumption has already occurred are insurance and financial services, clothing, cigarettes, hotels and eating out. Recreation is also witnessing a spending recovery. The areas where consumption slowed most significantly in 2013 were cars, health, transport and communications. The strongest themes UBS sees emerging are increased housing-related consumption, and a casting aside of the more cautious spending approach to entertainment, recreation, hotels, eating out and alcohol. Longer term, the broker has compared consumption patterns with the 1990s and 2000s and notes that households are spending significantly more on a range of services such as utilities, finance, insurance and health, and significantly less on alcohol, furnishings, household goods, transport, recreation and communication.

***

Morgan Stanley has been to Kurdistan to review the Oil Search ((OSH)) operations at Taza. The second appraisal well is being drilled and this well, Taza-2, will also test deeper formations known to be oil bearing in other parts of the country. Morgan Stanley's unrisked valuation calculates Taza as worth between 55c and $3.30 a share, depending on the ultimate resource size.

***

The euro has appreciated against the US dollar substantially over the past year and Commonwealth Bank strategists believe this state of play will continue for a while yet. The eurozone is running a large current account surplus, equivalent to 2.3% of GDP. Despite a narrowing of the US deficit to 1.9% of GDP it remains a stark contrast to the eurozone. The real eurozone-US two-year bond spread is very supportive of the EUR/USD appreciation as well. Eurozone inflation, while declining to 0.5% in March, is supporting higher real yields.

Eurozone exporters are under-hedged, according to the evidence the strategists have garnered. They suspect there's a "buy euro on the dips" mentality among these exporters and there is more EUR/USD buying to come, consistent with the eurozone's large trade surplus. Despite the move towards more normal monetary policy in the US the anticipated appreciation of the US dollar has not materialised. The strategists believe this is due to the persistence of negative US real rates, as the US dollar is influenced by the real Fed funds rate. The US current account deficit has improved but it's still a deficit and that, combined with negative real US short-end yields, does not encourage currency appreciation. In other words, net inflows into the US economy are not sufficient enough to strengthen the currency.

There are other reasons too. The People's Bank of China has been actively recycling accumulated US dollar reserves into euros in keeping with a diversification strategy, as it endeavours to lift the US dollar rate against its own currency. Eurozone banks have also been repatriating capital for a number of years as they reduce offshore assets and increase capital adequacy ratios. Moreover, European equities are performing well and the strategists believe this will stay the case while the European Central Bank maintains rates at record lows. The strategists are increasingly of the belief that US dollar strength will be delayed until the real Fed funds rate turns positive in late 2016.
 

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article 3 months old

Kathmandu’s Growth Potential Global And Online

-Online focus for global growth
-Strong margins impress brokers
-Small format success
 

By Eva Brocklehurst

Kathmandu ((KMD)) has achieved success where many have ventured but few have made the grade. The outdoor clothing specialist is now planning to ratchet up its global network, commencing online. The success of smaller format stores has extended the product reach and, while growth in the company's mature business is limited beyond three years or so, management thinks international expansion will provide the long-term opportunities.

Moelis has a Buy rating with a $4.00 target but expects the near-term prospects for sustained share price upside are limited, given the rally over the past year. It's the international penetration that holds promise, according to the broker, given scope for a further re-rating of fundamentals. Management has conducted "testing" that shows Kathmandu is already in the top 10 global brands for outdoor adventure gear, with product sold in 40 countries. Both North America and Europe are considered realistic targets for growth, which will be facilitated by the international shipping network. Moelis observes the company's strategy will entail building an increased online presence in targeted regions, then to subsequently open cornerstone stores once a level of brand recognition has been reached.

Deutsche Bank found a lot to like in the latest results, noting the first half demonstrated the superior position of the brand and the resilience of the outdoor category. The broker was impressed with the like-for-like growth in Australia and New Zealand as well as the underlying gross margins. The company is structurally better placed than its peers, with brand ownership, no exposure to "fast fashion" and an online presence that can enhance offshore distribution, in Deutsche Bank's opinion. Online is currently around 5% of sales. Deutsche Bank retains a Buy rating and NZ$3.85 target.

Australia was the star performer in the first half and, in the light of the poor performance of the company's competitors, Credit Suisse thinks this is telling of both Kathmandu's market share growth and the resilience in the outdoor area in general. Gross margin expansion also impressed the broker, with product traction resulting in less discounting than the store had anticipated. Credit Suisse has upgraded gross profit margin assumptions to 64.3% over the medium to longer term, to take into account the higher-margin online representation.

Credit Suisse had downgraded numbers recently, assuming the macro landscape in Australia and an unfavourable current mix would affect the stock. The broker has had to eat humble pie in this regard, noting Kathmandu's product and growing profile in Australia is offsetting this. Of particular note was the ability to absorb a meaningful headwind in the strengthening of the NZ dollar against the Australian dollar. Long-term valuation has signaled a need to upgrade the rating. Consequently, Credit Suisse has upgraded to Neutral from Underperform. The target is NZ$3.75.

The company's growth in the home market of New Zealand was respectable too, with revenue growth of 5.6% in the first half. Credit Suisse highlights that the first half is a small part of overall earnings, as Easter and winter sales remain the key to profitability. Credit Suisse is a little cautious about the company taking on a crowded global marketplace in online outdoor gear. Having said that, the broker considers Kathmandu is sufficiently capable of driving reasonable sales from this platform.

Macquarie finds the outdoor market attractive and thinks there's upside for the stock from optimising the stores. The broker has a Buy rating and $3.70 target. One area of notable weakness was the UK footprint which, while small, dragged on the overall results. Sales declined with the store portfolio reconfiguration, and gross margin contraction reflected clearance activity. This business has downsized to four flagship stores and Macquarie observes Kathmandu is now looking to leverage online marketplaces such as Amazon, Next and eBay.

Kathmandu is trading on a FY15 earnings multiple of 13.2 times, which Deutsche Bank observes is a discount to the peer group average of 14.5 times. The company has maintained its target for 15 new stores in FY14 and upgraded its overall target to 180 from 170 in Australia and New Zealand. Kathmandu is weighting the majority of store openings to the second half, having opened four in Australia and one in New Zealand in the first half.

The FNArena database shows two Buy or equivalent and one Hold rating for KMD.
 

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article 3 months old

Weekly Broker Wrap: Exports, Jobs, Transport, Bank Credit And Retail

-Export boom on the way?
-SMEs still critical to jobs growth
-Subdued growth weighs on transport
-Baby boomers affecting bank credit
-Durable goods retailer prospects better
 

By Eva Brocklehurst

What is the prognosis for Australia's economy? Will it manage to revive without relying on mining investment? These are the questions economists at Citi are asking. It's not just whether demand outside of mining will generate enough investment to offset mining's decline but whether the timing of the transition can be coordinated as well. If not, there's a substantial amount of volatility ahead.

Can the fall in mining capex and loss of income from a deterioration in the terms of trade be offset by enough strength in housing construction, non-mining business investment, consumer spending and net exports? Citi calculates that major project capex across coal, iron ore and gas is likely to halve which implies a fall in mining investment by 2018 of around 4% of GDP from the peak of 7.6% of GDP in FY13. Timing is uncertain, but Citi analysts suggest the fall could be most marked after FY15, as LNG projects are set to hold up the level of capex this year.  Unlike investment booms in other areas, the analysts note the mining boom produces a ramp-up in exports as the production phase gets underway. The Bureau of Resource and Energy Economics is the benchmark for exports forecasts and its data suggests that mining and energy exports will increase the contribution to GDP through to FY18, the bulk of the increase being in the next two to three years.

The cumulative drag on real GDP from mining investment is likely to be at the bureau's largest in the next two years. So, with declining investment broadly matched by a positive contribution from net exports, the real pace of growth is likely to be determined by non-mining domestic activity. Thanks to stimulatory monetary policy, Citi thinks there will be a sufficiently robust rally in housing and consumer spending to achieve growth close to trend in 2014-2016 and possibly enable growth to strengthen even more in later years, with the help of recovery in non-mining business investment and a lift in spending on infrastructure. Citi acknowledges this number crunching looks suspiciously stable, with GDP forecasts close to trend, but emphasises that growth is more stable already, in terms of the trade downturn, compared with previous cycles, because of better policy and institutional reforms. All in all, an investment boom being replaced by an export boom means that domestic demand does not need to do all the heavy lifting in rebalancing the economy.

Where will the jobs come from? That's what UBS asks. The analysts looked at the sectors of the economy which have created the recent improvement in the job market. Around 80% are in public-dominated sectors, with some gains in manufacturing, construction, finance and real estate which were countered by weakness in retail, accommodation and food. Most of the private sector jobs over the same period came from mining related areas, reflecting strength in professional, technical and scientific jobs. From analysis of the labour hire and job advertisement data, the broker identifies an ongoing reality that the majority of jobs are in small and medium-sized enterprises and this is where the growth is likely to come from. It's not from large business, where there tends to be highly publicised job losses that mislead in terms of the proportion of jobs being churned in the economy.

The public sector is not expected to contribute such a level of job improvement in the near term but a lower Australian dollar should benefit those sectors such as tourism education and domestic manufacturing, according to UBS. Manufacturing performance has already recovered a little and tourist arrivals have risen 8-9% over the past year. Relatively labour-intensive and interest-rate sensitive sectors of the economy - retail, wholesale trade and construction - are also likely to reveal a jobs recovery. The key sectors which could, in the current environment, plausibly contribute jobs include retail, wholesale trading, accommodation and food, construction and general services. Those most likely to be shedding jobs include manufacturing, mining and related areas.

Goldman Sachs has recently revised Australian dollar forecasts and incorporated this into assumptions about the transport sector. Factoring in a lower Australian dollar has meant downgrades for airlines - Qantas ((QAN)) and Virgin Australia ((VAH)) - and upgrades for US dollar reporting stocks such as Brambles (((BXB)) and Recall ((REC)). This is also broadly neutral for Asciano ((AIO)), Aurizon ((AZJ)) and Toll Holdings ((TOL)), which are more exposed to Asian currency movements. Domestic economic growth is expected to stay relatively subdued over the next 12 months. The analysts believe the non-mining economy will need to accelerate to 3.75% by the end of the year just to meet a 2.0% GDP growth forecast, given the drag from mining investment. This weak outlook is expected to weigh on volume in the domestic transport sector, particularly for Asciano and Toll. Asciano remains the broker's preferred pick for the sector. A transition to positive free cash flow in FY15 and progress on cost of capital should help drive a re-rating, in Goldman's view.

BA-Merrill Lynch observes the demographic that supported the growth of bank balance sheets for the 20 years to 2010 is fading. Unless banks can convince retirees to dramatically increase debt levels the broker thinks household credit will struggle to grow at anything beyond nominal GDP on a sustainable basis. Smaller consumer loan books suggest ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) are best placed to confront this structural challenge, although near-term business credit growth also appears cyclically weak.

The broker emphasises this is not the end of the housing rebound, rather that medium term growth will be slower and historical rates unlikely to be repeated. The broker also views the rise of investors in housing as a natural response to demographic change, although this contributed to a substantial rise in household gearing. As the pre-retirement 45-64 age group increased so did investor housing and overall debt. Now this demographic is approaching retirement and recent data suggests the 55-plus group reduced gearing from 2010-12. While Westpac's ((WBC)) greater investor mortgage exposure offers some appeal near term, Merrills thinks it is unlikely to offer substantial upside relative to peers.

Retailers have had mixed fortunes recently, with several finding it hard to balance top line growth with margin preservation. Either way, Merrills thinks the household/durable goods retailers have better growth prospects than department stores and apparel merchants. Why does the broker like the former? First there's industry consolidation. In the last three years store numbers outside of the three majors - JB Hi-Fi ((JBH)), Dick Smith Holdings ((DSH)) and Harvey Norman ((HVN)) have declined by 33% which provides a more favourable market dynamic for the majors. The broker also believes household goods face less competition from online than soft goods and the penetration of online sales will begin to plateau at levels below other developed countries. The level of store saturation in Australia in consumer electronics and appliances is behind global peers and this supports continued store roll out, to some extent, Merrills adds. The preferred stock is JB Hi-Fi , which the broker thinks has the ability to grow earnings by over 35% in the next three years, self-fund capex and maintain a dividend pay-out ratio of 60-65%.
 

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article 3 months old

Automotive Holdings Lifts The Bar On Scale And Diversity

-Strong long-term earnings potential
-Strategically sound deals
-Higher margins, improved logistics likely
 

By Eva Brocklehurst

Automotive Holdings ((AHE)) has made two substantial acquisitions with a strong rationale to increase scale and diversity. Hence, the deals have been welcomed by brokers. The company will acquire Sydney-based Scott's Refrigerated Freightways for $116m and Bradstreet Motor Group for $68m, funded by debt and an equity placement of $115m. Management has also confirmed approaches by prospective buyers for the Cov retail stores in Western Australia but discussions are preliminary. Morgan Stanley observes such a sale would be well received by the market as it would divest a non-core business.

Both the new businesses have higher operating margins than existing AHE operations, with Scott's providing increased flexibility in road transport. Scott's will take over the remainder of JAT Refrigerated Road Services it doesn't own to incorporate that into the acquisition. Scott's will provide a truly national cold storage business and AHE will become the largest cold transport and storage provider in Australia. Bradstreet will provide 13 automotive dealerships in NSW, countering the overweight representation of Western Australia. After the acquisitions AHE will have net debt of 17.1% of assets and around $70m in undrawn facilities. 

Morgan Stanley thinks Scott's will add network scale and long-term earnings growth. AHE has identified $4m in synergies from cold storage, supplier terms and other savings. This provides a strong cornerstone in cold chain logistics with scope to grow, the broker contends. Morgan Stanley expects the combined logistics division to reach $1bn in revenue in FY15. This would warrant a significant premium to AHE's trading multiple if the company can execute the strategy well. The Bradstreet dealership increases the company's share of favoured brands and also provides a new market in Newcastle. Morgan Stanley believes AHE is a compelling investment and has upgraded to Overweight with a target of $4.50, expecting earnings growth of above 20% from FY15. The company's market share is expected to rise to over 10% of the automotive retail market in the medium term, from around 5% currently.

BA-Merrill Lynch likes the Bradstreet deal, as AHE continues to consolidate a fragmented market and drive scale benefits. There is significant further opportunity for margin expansion and the broker believes the industry is less cyclical than the market fears. This is a straight forward acquisition. Merrills is less impressed with the Scott's acquisition, given disappointments in the past with the Harris acquisition, but acknowledges the scale benefits of a larger network. Management alluded to trading continuing in line with expectations. This reassures Merrills, given the soft car sales numbers from some quarters. The broker expects the combined acquisitions will be 12% earnings accretive from FY15.

The deals make strategic sense to CIMB. The broker is conscious that the Scott's deal increases the company's exposure to the underperforming cold storage and transport business. Nevertheless, there is potential for increased efficiencies. CIMB's analysis suggests the Bradstreet acquisition adds the same accretion to earnings per share as does Scott's, despite being almost half the price. Scott's higher skew to road transport compared with AHE's existing business means there's less subcontracting and the diversity of customers and freight types reduces seasonality and exposure to climatic events. All these are positives in CIMB's view. The broker has run a bull case scenario to incorporate the targeted synergies into FY15 forecasts. This implies FY15 earnings accretion of 11.5% and on that basis AHE would be trading at 10.1 times FY15 price/earnings. CIMB has not incorporated the acquisitions into forecasts but, if so, this would increase the valuation to $5.11. The broker retains a $4.66 target.

UBS notes both acquisitions are yet to be finalised but, also taking the opportunity to reflect the impact on estimates, expects FY15-16 earnings will be lifted by 10.7-14.8%. UBS expects higher margins will be derived from the increased scale in transport and cold storage and this should improve returns for AHE's logistics division. The expansion in automotive dealerships reflects the company's long-term strategy of diversification in order to provide a more stable earnings platform. In FY13 Bradstreet generated $449m in revenue with an earnings margin of 3.5%.

It's all positive from a strategic and financial aspect, according to Deutsche Bank. The multiples paid are also reasonable and the broker thinks the Scott's acquisition could be the catalyst for improving the company's underperforming logistics business. The broker lauds AHE's record in obtaining value upside from automotive acquisitions as the industry is well suited for consolidation.

As for the logistics business, the experience has been less than impressive, Deutsche Bank concedes, but not altogether poor. Since the acquisition of Harris in 2011 and the loss-making Toll Holdings ((TOL)) assets in 2012, cold logistics have increased earnings by 50% but incremental earnings generated returns on invested capital of just 10%. Far from attractive, Deutsche Bank observes. In AHE's defence, the company has pursued a strategy of expanding and upgrading facilities across the country and this is only partially complete. Deutsche Bank believes the benefits from Harris and Toll and potential benefits from Scott's will take time to realise but will be enhanced by the network breadth offered by Scott's.

On FNArena's database the stock has five Buy ratings and two Hold. The consensus target is $4.36, suggesting 15.7% upside to the last share price. On FY14 forecasts the dividend yield is 5.7%. On FY15 it's 6.3%.
 

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