Tag Archives: Consumer Discretionary

article 3 months old

Blackmores Endures Setback, Long-Term Health Intact

Health product manufacturer Blackmores had a very weak September quarter and does not expect to match its FY16 performance in FY17.

-Affected by de-stocking at retailers and exporters changing acquisition channels
-Leveraged to long-term demand for Australian health products in China
-Potential challenges remain in selling via cross border e-commerce


By Eva Brocklehurst

Health product manufacturer Blackmores ((BKL)) sustained a weak September quarter, with sales down 8.1% and net profit down 46.6%. The latter was the element that disappointed many brokers as it signalled significant operational de-leveraging. Sales momentum is becoming more positive and a better second quarter is expected but the company does not expect to match the FY16 performance, suggesting profit will be lower in FY17.

The Australian business endured a tough quarter, Morgans acknowledges, because of the slowing in the wholesale market, impacted by de-stocking at retailers and some exporters changing the channels through which they acquire products. The notable crunch to EBITDA (earnings before interest, tax, depreciation and amortisation) and net profit is a result of the company's high fixed cost base, the broker observes. The EBITDA margin fell sharply, to 13.3% versus 21.5%.

Importantly, management said that de-stocking is now easing and its major customers are placing orders while the company is taking costs out of the business. Morgans downgrades FY17 and FY18 net profit by 29% and 20% respectively.

Over the medium term, the broker considers the stock well positioned given its strong brand, market leadership and rapidly expanding international operations, as well as leverage to the increased awareness of health, an aging population and the rise of the wealthy Chinese middle class. Recent corporate activity in the sector by the Chinese demonstrates the strong future demand potential in this market, in the broker's view.

CLSA is in no doubt the regulatory headwinds in China will continue and reduces its earnings per share estimates significantly. The broker, not one of the eight monitored daily on the FNArena database has a Sell rating and $85 target for the stock. CLSA asserts a change in exporter procurement strategies through late FY16 contributed to a significant build up in domestic inventory and now de-stocking has caused a sharp contraction in first quarter profit which will weigh heavily on FY17 sales.

The broker expects Blackmores to still face material challenges in selling products via cross-border e-commerce after China's period of grace ends in May 2017. Blackmores has no products registered and, while management noted strong growth in direct sales in China, CLSA envisages material risks to this channel should the company fail to gain product registration. Exporters that take on inventory risk are also likely to be more cautious.

Opaque distribution channels and mixed feedback from channel checks on system inventory mean Ord Minnett is inclined to edge its recommendation down to Accumulate from Buy, cutting the target to $120 from $150.

The broker prefers to await a sustained sales recovery in the industry before becoming more positive but still envisages Blackmores as a very well-run business for the longer term, leveraged to an attractive and growing category. The longer-term thematic of Chinese consumer demand for Australian products remains intact, as long as the exchange rate does not appreciate significantly.

Goldman Sachs was surprised by the extent of the deterioration in the quarter and negative operating leverage and also draws attention to the opacity of the selling channels, which means that quantifying the amount of excess inventory is challenging. From its channel checks with re-sellers as well as industry data, the broker concludes that inventory levels are improving, but still remain too high.

Goldman envisages limited opportunity for a sustained turnaround in revenue at this juncture as there is regulatory uncertainty related to obtaining product registration for the free trade zone, ongoing price discounting and a muted consumer response to recently launched products. Goldman Sachs, not one of the eight monitored daily on the database, believes it too early to become more constructive and retains a Neutral rating and $95 target.

Credit Suisse is another broker that considers the long-term growth prospects are undiminished. Blackmores has also had some success in setting up its own, nascent export division and selling direct to China. This is now a $17m business representing about 10% of group sales. Investors have been nervous over price discounting but recently the broker has observed fewer promotions and price discounting in both Australian retailers and also Chinese e-commerce platforms.

Credit Suisse's long-term investment view remains underpinned by a $200m revenue opportunity in Chinese retail stores. This is a US$9-10bn channel in the Chinese vitamins/supplements category and Blackmores has a fairly negligible presence because of onerous registration requirements.

China's new 'orange hat' registration process should allow the company to register a far larger range of Chinese-compliant products through this channel. The opportunity accounts for around $25/share in Credit Suisse's valuation.

Blackmores has indicated it is still waiting for further clarification from the Chinese administration on the new 'orange hat' registration process. The broker observes, while the draft legislation is quite detailed and yet to be finalised, Blackmores is continuing to take active steps to build its Chinese presence. More recently it has been adding to its sales/marketing force and opening new sales offices.

There are two Buy ratings and one Hold on the database. The consensus target is $118.33, suggesting 4.7% upside to the last share price. Targets range from $110 (Morgans) to $125 (Credit Suisse).

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article 3 months old

Hard Yards Still Ahead For Woolworths

Woolworths delivered improvement in supermarket sales in the September quarter but brokers believe the hard yards remain ahead of the business.

-Questions raised over the sustainability of revitalised sales and the competitive response
-Supermarket turnaround expected to take longer and cost more
-Is there room for both Big W and Target?

By Eva Brocklehurst

Woolworths ((WOW)) delivered an improvement in Australian supermarket sales in the September quarter, a commendable development brokers believe, as it provides some indication that the company's efforts to turn the business around are delivering results.

Yet Macquarie observes the industry is full of suggestions that the market is becoming aggressive, which raises a question regarding how much of a free kick Coles ((WES)) has received previously while Woolworths was working through its other problems. On the other hand, the broker notes this also raises a question about the sustainability of revitalised sales for Woolworths.

Like-for-like sales grew 0.7% in supermarkets, and Deutsche Bank estimates Woolworths may have had better growth on this front than Coles during the quarter. The broker suggests the building blocks are in place for gradual improvement over coming quarters but suspects the market may be too optimistic about FY17 margins.

While price investment and more effective use of loyalty points to drive increased share from existing customers has worked, Macquarie has doubts about the cost and what this strategy will induce from the competition. The broker believes the market is pricing in an aspirational recovery in Australian food retailing that is unlikely. While a stock undertaking a turnaround could be expected to trade ahead of fundamentals, the valuation process demonstrates how much is factored in at the current share price.

Morgan Stanley also suspects the market has prematurely priced in a turnaround and this turnaround is being hampered by the significant level of price and promotional investment required to drive top line growth. The broker notes items per basket remain weak, which implies customers are choosing to cherry pick specials. Until there is a clear path to over 2% like-for-like sales growth, with a sustainable level of investment, the broker believes a turnaround is some way off.

Morgan Stanley expects Aldi will continue to obtain a greater share of the consumer's wallet and this will put continued pressure items per basket. Moreover, as as investors increasingly focus on the first half results, the broker expects Woolworths shares to de-rate. Morgan Stanley forecasts a first half EBIT (earnings before interest and tax) margin for food at 4.28%.

UBS acknowledges that on face value, like-for-like sales in grocery have turned up, but retains a Sell rating on the basis that earnings risk still exists for FY17. The broker expects a competitive response from Coles and Aldi, with the risk that pricing intensity rises and a price war ensues. The broker continues to expect Woolworths will lose share in food & liquor as intensity steps up at Coles, share loss slows for the Metcash ((MTS)) IGA chain and double digit sales growth continues at Aldi.

UBS assesses the sustainable medium-term EBIT margin for Australian food & liquor is 5% or less and Australia remains one of the most profitable grocery markets globally. This signals there is downside risk to EBIT margins for Woolworths, given a need to re-invest to regain like-for-like momentum. Woolworths is a good company, in the broker's opinion, but it will take longer and cost more to turn around.

Outside of the supermarkets, Macquarie notes Big W is guiding to losses again in FY17 and concludes that there is a strong probability that there is only room for either Big W or Target plus Kmart in the discount department store segment. The latter two are owned by Wesfarmers. At best, the broker suggests both Big W and Target may take longer than expected to find a base.

Credit Suisse, too, believes the risks at Big W increase to the downside in FY17 because of the impact of changes to range and a deteriorating trading environment. Big W reported like-for-like sales declined 5.7% in the quarter. Credit Suisse forecasts Big W will return to profit in FY18 as its range stabilises and results in a reduction in the cost of goods.

UBS assesses the Australian department store EBIT pool has declined over the past five years, driven by Big W and Target, and the sector's performance is largely a matter of shifting between players, ie a fixed-sum game. While its estimates imply this profit pool will grow at around 12% over the next four years, UBS accepts this may prove optimistic. The main risk is heightened competitive activity from international players such as Uniqlo, H&M and Zara.

On FNArena's database there are three Hold and three Sell ratings. The consensus target is $22.16, suggesting 5.7% downside to the last share price. Targets range from $19.10 (UBS) to $24.79 (Morgans).

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article 3 months old

Soft Quarter Signalling More Weakness For Wesfarmers

Brokers raise the spectre of whether soft September quarter sales numbers for Wesfarmers, particularly at Coles, are a sign of more weakness to come.

-Main negative is the deceleration of sales growth at Coles as Woolworths steps up price investment
-Sales growth at Coles now more difficult to obtain and expected to be modest
-Resources business seen doing the heavy lifting for Wesfarmers at present
-Uncertainties also prevail in the fashion, hardware and resources


By Eva Brocklehurst

Brokers raise the spectre of whether soft September quarter sales numbers for Wesfarmers ((WES)) are a sign of more weakness to come. Sales were weak across the main divisions. Food and liquor grew 1.8%, which represents the worst growth in several years. Bunnings slowed to 5.5%, as a result of clearance activity at former competitor Masters and a softer market, which are acknowledged to be temporary factors. Target's like-for-like sales slumped 22% while Kmart was encouraging, growing sales 8.2%.

The main negative was the deceleration in sales growth at Coles supermarkets. Management suggested this was driven by slower market growth as well as intense competition. Deutsche Bank warns there are risks in calling one quarter a trend, but believes competitor Woolworths ((WOW)) is improving in an environment where deflation is constraining market growth, while Aldi continues to gain share.

The broker does not believe there was a sharp market-wide decline in consumption volumes, but looking at the three consecutive quarterly declines in like-for-like growth, suggests this does coincide with the improvements Woolworths has made, even if it just means Woolworths is now “less bad”.

Overall, the broker contends that the sustained run at Coles has been supported by a strong top line, which has enabled the supermarket to provide incremental value for customers and grow or, at the least, preserve margins. Sales growth is now likely to be difficult to obtain, which could undermine this value loop that has been crucial to the success of Coles. With Coles being the main driver of Deutsche Bank's valuation the broker's rating is downgraded to Sell from Hold.

Cash generation is sound for Wesfarmers overall, Ord Minnett asserts. Bunnings is able to continue to generate a strong return on capital through continued earnings growth and capital recycling. The value focus and cost reductions at Coles are expected to position it well to address a challenging competitive backdrop. Still, the broker expects only modest earnings growth in the near term.

Industrial and resources divisions are improving, although this carries some risk and weighs on the price/earnings multiple in Ord Minnett's calculations. While accepting that blaming the weather is a weak stance, Macquarie's recent channel checks confirm the comments from Wesfarmers that a cold and wet spring has adversely affected apparel, home improvement and supermarket sales.

Resources business is doing the heavy lifting for Wesfarmers at present but it, too, was affected by weather, with total production down 11.8% on the prior quarter. The lower production will delay the benefit of higher coking coal prices but the company is expecting to break even in the first half. The first half is lining up as a tough period the broker believes, with risks to earnings increasing, but the longer-term proposition of strong balance sheet, earnings growth and dividend yield remain intact.

Macquarie is one of the more optimistic regarding Coles, doubting the supermarket has ceded share at this stage, although acknowledging it will need to to do more to offset the increased aggression in the market in recent months.

The broker does not envisage Coles straying from a long-held strategy of leading the market on value, which implies price leadership will not be given up lightly, although it could be at the cost to margins over the medium term. Macquarie forecasting a 10 basis points EBIT (earnings before interest and tax) decline in food and liquor over FY17 and slower comparable store sales growth of 2.3%.

Target's turnaround remains uncertain as brokers note the chain exists in a tough fashion segment. Credit Suisse expects around a 10% re-basing of sales in FY17 and, if Target successfully moves more towards an EDLP (Every Day Low Prices) model, the sale price offset could feasibly be around a three percentage point fall in markdown and supplier costs over time.

Credit Suisse would like to scrutinise the Woolworths and Metcash ((MTS)) results to determine the extent to which the slowdown in Coles was competitively driven. Pricing behaviour in food appears rational, given that Woolworths has dropped a significant profit into rectifying a poor price position. That said, the risk is that Coles moves its focus to near-term profit requirements.

Based on a circa 10% decline in fuel volume, the Coles convenience business has probably dropped 5-10% in value due to the acquisition of Shell's business by Vitol, the broker estimates. A reduction in the decline in gross margin offsets the earning impact of lower sales volumes in Coles in Credit Suisse forecasts for FY17.

Morgan Stanley reduces profit forecast for Coles by 12% and, while the non-food retailing business have also slowed, these are less of a concern given strong market positions. The broker reduces margin estimates significantly, estimating 4.6% for FY17 margins versus Woolworths at 4.4%.

The main question for UBS is what Coles does in the face of the heightened competition, considering it is driving the structural shift in the industry, as well as the impact slower sales will have on margins. The broker forecasts Coles to grow market share at 12 basis points per annum over FY16-20, yet also considers it increasingly challenging for Wesfarmers to maintain current rates of momentum in both Coles and Kmart into FY17. UBS believes Wesfarmers is fairly priced at current levels, given uncertainty over housing (Bunnings), grocery (potential price war) and the resources business.

The consensus target for Wesfarmers on FNArena's database is $41.59, signalling 1.8% in upside to the last share price. Targets range from $38.00 (Deutsche Bank) to $45.00 (Ord Minnett). The dividend yield on FY17 and FY18 forecasts is 5.0% and 5.2% respectively. There is one Buy rating (Macquarie), five Hold, and two Sell.

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article 3 months old

Soft Sales For Super Retail But Profits Line Up

Sales for Super Retail were soft in the September quarter as the company continues to take action to address problematic parts of its leisure, automotive and sports businesses.

-Encouraging signs in new format RAYS stores performance
-Sales activity affected by inventory clearances by the Masters chain
-Competition from Bapcor in automotive and new entrants in sports a challenge


By Eva Brocklehurst

Sales over the first quarter of FY17 were softer than expected for Super Retail ((SUL)) but this was countered by cost controls and the company assures the market profits are lining up with budget. Sales in automotive and leisure slowed while sports division sales accelerated. Results continue to be distorted by the closure or re-vamp of Ray's Outdoors stores and associated inventory clearance.

Macquarie observes, while still early days, the performance of the new format RAYS stores is encouraging. Three are also 14 new BCF stores, including 11 converted Ray's stores, expected to open. The performance of BCF in the upcoming summer period will be a key swing factor in the results, the broker asserts.

Definitive action taken on the Ray's Outdoors business and Infinite Sports, as well as improved margins for BCF, underpin Macquarie's FY17 forecasts. Deutsche Bank agrees comparables can be volatile over any given period and this needs to be viewed in conjunction with gross margin to gauge performance. The only gross margin commentary provided related to sports and Ray's and both were stated to be higher.

As group profit appears in line with expectations, Deutsche Bank views this as a positive signal. Comparable sales growth of 4% in the quarter was ahead of the broker's estimates. Automotive like-for-like growth was 2.5%, leisure 6% and sports 4.5%. Capex guidance is reduced to $110m from $115m.

UBS makes minor change to its estimates and suggests the company is on track to meet earnings per share growth of 23%, underpinned by EBIT (earnings before interest and tax) margin growth across the business. The broker forecasts 11% growth in 3-year compound earnings per share, with upside via the successful execution of the turnaround in leisure.

UBS suspects the market is ascribing a very low valuation to the leisure business and considers this overly pessimistic. Investor sentiment should improve as management continues to execute a turnaround. Over the medium term, the growth story remains intact, driven by continued momentum in automotive and sport, margin recovery in leisure and strengthening cash flow.

Tool sales have been affected by clearance activities from the closure of the Masters hardware chain, which Citi expects may persist over the final 10 weeks of the first half. Opportunities in the second half should be created once all the inventory clears and the Masters stores close. The broker is unconcerned about the current volatility, as clearance activity ahead of the closure of 36 Ray's Outdoors stores is proceeding as planned.

Moreover, the new RAYS format continues to show traction, Citi observes, with the segment reporting improvements in average transaction value and gross margins. Gross margins in the sports segment were tracking ahead of the same period last year, signifying better full-price sales and less discounting.

The liquidation of stock at Masters stores may have been highlighted as an impediment by the company but Credit Suisse believes it worth noting that Bapcor ((BAP)) has strengthened its trading in the quarter, reporting like-for-like sales growth of 5.2%.

Super Retail used to be a straight forward growth story, the broker asserts, but now the strengthening position of Bapcor is likely to create a stronger competitor for the automotive division. Also, the entry of Decathlon and JD Sports to the Australian sports retail market is suspected to fundamentally challenge the profitability of the sector and be a new challenge for Rebel Sport and Amart.

Morgan Stanley believes the company is on track to deliver growth of 20% in earnings per share during FY17 despite a weaker top line. The investment case still holds up for the broker as it centres on strong like-for-like sales growth across automotive and sports as these formats take market share.

Ord Minnett understands Ray’s Outdoors, Workout World and Infinite Retail have detracted from the performance of the business and progress is being made to address two of these problematic segments. The broker notes the new RAYS business is performing better and Infinite Retail contracts have been resolved, so both these initiatives should support growth in FY17. More generally, the business retains growth prospects and valuation support underlines an Accumulate recommendation for Ord Minnett.

There are four Buy ratings, two Hold and two Sell on FNArena's database. The consensus target is $10.84, suggesting 4.0% upside to the last share price. Targets range from $9.77 (Credit Suisse) to $11.50 (Deutsche Bank, Ord Minnett). The dividend yield on FY17 and FY18 estimates is 4.6% and 5.0% respectively.

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article 3 months old

Coca-Cola Amatil Refreshes Growth Strategy

Coca-Cola Amatil has refreshed its strategy with a focus on still beverages, expanding categories in beer and coffee and growing its business in Indonesia.

-Structural headwinds in Australia while macro environment in Indonesia is challenging
-Shift to incidence pricing for concentrates aligns company more with The Coca-Cola Co
-Focus in Indonesia turns away from Coke towards still drinks and tea


By Eva Brocklehurst

Coca-Cola Amatil's ((CCL)) has refreshed its strategy with a focus on still beverages, expanding categories in beer and coffee and growing its business in Indonesia. Brokers welcome the extra detail on earnings targets and the drivers for its various drink businesses. Low single-digit EBIT (earnings before interest and tax) growth in Australia & New Zealand is forecast and double digit growth in Indonesia, PNG & Fiji. A 10% long-term (2023) EBIT margin in Indonesia/PNG is expected.

UBS retains more muted forecasts, reflecting a view that structural headwinds abound in Australia and the macro environment in Indonesia remains challenging. The broker notes there is a $50m restructuring charge and $75m in additional capex in 2017, amid expectations of a 2-3% increase in the cost of goods sold in Australia because of higher sugar and electricity prices, and a negative impact from US dollar forward contracts. From all that, UBS believes the stock is not cheap and retains a Neutral rating.

Citi is encouraged by the company's adaptation to the fact that the Indonesian market is more likely to be driven by tea and other still beverages instead of the company's flagship brand. Coca-Cola does not resonate with Indonesian consumers yet growth in GDP per capita and relatively young population have made the country appealing for some time for the Coca-Cola bottler. Citi believes the upside is now more significant as Amatil is placing less focus on cola and has an improving distribution capability. Citi retains a Buy rating and believes the company is well placed to achieve its earnings targets.

The company has announced a shift to incidence pricing, where concentrate prices differ depending on factors such as revenue, carton sizes and sales channels, rather than simply pricing by the litres sold. Coca-Cola Amatil will move to incidence pricing during 2017 when paying for concentrate. Brokers observe this should align the company more with The Coca-Cola Co, enabling revenue growth irrespective of pack size. Incidence pricing is commonplace among Coca-Cola bottlers around the world.

Deutsche Bank agrees the move to incidence pricing better aligns objectives with the parent company but retains some concerns that Amatil's share of the system profit pool could contract as the market moves towards smaller serving sizes. The broker cuts its rating to Hold from Buy as the share price has outperformed since the half year results.

The company was always going to have to find additional areas to reduce costs in order to hit its targets, Deutsche Bank asserts, given the difficult trends in certain categories. The original cost reductions of $100m over three years are expected to be achieved ahead of schedule in 2016 with a further $100m identified, mostly from the supply chain. Management highlights that incremental cost savings will be reinvested and not result in margin expansion.

Ord Minnett leaves its Australian EBIT forecasts unchanged, given they already imply no EBIT growth in 2017. Structural pressures are expected to create ongoing headwinds for the company, which in the broker's view creates a risk to guidance for the medium term. Consumption per capita of carbonated soft drinks in Australia is falling at an accelerating rate as the consumer's focus shifts to healthier lifestyles.

Competition is also increasing, via rising promotional intensity, particularly in grocery. Taxation is another area of concern, through the prospective container deposit scheme in NSW. The broker believes initiatives to address the structural product and channel challenges facing Australian beverages are sound, yet the size of the task is significant and the revenue outlook remains subdued.

Morgan Stanley has more confidence in the earnings outlook and in the growth businesses since the update. In Indonesia, the company has notably shifted its focus from the Coke brand more towards Sprite and Fanta and its non-carbonated drinks. The Indonesian operating environment is still difficult but the broker notes inflation has eased to 3-4% and the rupiah has stabilised.

The alcohol division looks set to be driven by the move to craft production in the Australian beer market and there are clear opportunities to take share and leverage the distribution network, in Morgan Stanley's opinion. The Grinders coffee business is envisaged benefitting from product innovation.

Macquarie maintains an Underperform rating despite a supportive balance sheet and dividend. While management is executing well, there are complications to the outlook, such as the container deposit scheme and incidence based pricing in Australia, which limit growth and create uncertainty for the broker.

There is a view that Amatil can better withstand the impact of a container deposit scheme given its premium price position but Macquarie has little doubt it will impact to some degree. In recent research the broker estimated the impact to group earnings would be 1-6% , assuming NSW, Queensland and Western Australia all adopt the program.

Positives taken from the strategy briefing are the ongoing opportunities to offset headwinds through cost re-allocation and maintenance of long-term guidance. Yet, Macquarie suspects strong volume declines in carbonated drinks are unlikely to abate in the short term and could be exacerbated by the implementation of a container deposit scheme and, possibly, incidence based pricing.

On FNArena's database the consensus target is $9.68, suggesting 2.1% upside to the last share price.Targets range from $7.90 (UBS) to $10.80 (Citi). The dividend yield on 2016 and 2017 forecasts is 4.8% and 4.9% respectively. There are two Buy ratings, four Hold and two Sell.

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article 3 months old

Treasure Chest: Are AP Eagers And Automotive Holdings Offering Value?

Moelis believes the downside from the ASIC review has now been factored into AP Eagers and Automotive Holdings.

By Eva Brocklehurst

AP Eagers ((APE)) and Automotive Holdings ((AHE)) have experienced a sharp decline in share prices, with market concerns centring on a review by ASIC (Australian Securities and Investments Commission) into motor dealer finance income.

ASIC's review of add-on insurance products released in September contained a proposal for a 20% cap on dealership commissions. The sale of these products previously attracted higher margins. Moelis expects the impact of an add-on insurance cap of 20% on such commissions is likely to be offset by management initiatives for a net impact of negative 1% of EBIT (earnings before interest and tax) for both companies.

ASIC has not stated anything publicly, but in terms of the expected outcomes of the finance review to be announced later in the year, using a 1.5% cap on flex commissions Moelis expects the gross EBIT impact will be in the order of 20% and 14% for Automotive Holdings and AP Eagers respectively.

With some downside mitigation by management, the broker would not rule out a net 10% negative EBIT impact for Automotive Holdings and a 5% negative impact for AP Eagers from a cap on flex commissions.

The broker understands dealers receive finance income from several sources, including around $600 in origination fees per car, a volume bonus paid by the financier and a flex commission, which is around a 70% share in the upside from writing interest rates above a base rate of 5%. The latter area is where ASIC is expected to intervene with a cap on commissions.

The broker notes there are some independent players in the market that are over-earning on flex commissions and these dealerships are likely to be the ones most affected by a 1.5% cap. The large listed dealerships are expected to pick up volumes from these independents.

Moelis also understands both companies have strategies in place to mitigate some of the downside, including lower levels of discounting in the sale price of vehicles, different remuneration structures with the financier and reduced sales staff remuneration.

To achieve an earnings-per-share neutral impact, Automotive Holdings would need to increase market penetration to 53% from its current 42% and AP Eagers to 43% from 38%.

Even adjusting for the impact of these caps on commissions the broker believes AP Eagers' core business is trading below a market multiple. Given the company can deliver a FY15-25 compound growth rate in earnings per share of over 10%, after adjusting for the impact of finance and insurance commission caps, the broker believes the business deserve to trade at a premium to the market.

Automotive Holdings looks cheap too. With increased exposure to Western Australia and lower growth potential through consolidation, Moelis believes the stock deserves to trade at around a 5% discount to AP Eagers' current multiple.

The broker believes the downside is now factored in and, while not including the impact of the ASIC review in earnings estimates, includes it in its valuation of the stocks. On this basis the broker moves to a Buy rating for both, with a $13.30 and $4.80 target for AP Eagers and Automotive Holdings respectively.

Moelis also notes the opening of the first Carzoos store by AP Eagers last month and is impressed with the location. The broker is increasingly confident in the concept.

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article 3 months old

McPherson’s Eyes Off China

McPherson's has redoubled its focus on health & beauty brands and has China in its sights. Moelis initiates coverage of the stock.

-Health & beauty brands identified for campaign to Australian and Chinese consumers
-Moelis speculates household consumables may be divested
-Success in China could lead to stock re-rating


By Eva Brocklehurst

McPherson's Ltd ((MCP)) has undergone a significant transformation over recent years and Moelis observes the company's strategy is now about its key divisions in health & beauty and household appliances.

The broker likes the yield and growth story and initiates coverage with a Buy rating and $1.35 target, on an estimated 31% total return. FY17 is considered to be the first full year post the transformation and there is a renewed focus on lowering the company's exposure to the grocery channel.

Moelis bases its view on EBITDA margins (earnings before interest tax depreciation and amortisation) expanding to 10% in FY17, because of gross profit margin expansion in the health & beauty division and the effect of measures taken to offset the negative impact of a fall in the Australian dollar.

Moreover, a new CEO could mean divestments are on the agenda, as there is a clear strategy to grow the company's own health & beauty brands. McPherson's has identified seven A'kin units and five Dr LeWinn's “hero” units which appeal to both the Australian and Chinese consumer and launched a WeChat campaign to introduce the products.

Moelis does not factor in sales from new international markets but notes the new CEO, Laurie McAllister, was managing director of Sanofi Australia & New Zealand and has extensive experience in the consumer health care segment.

The broker suspects the company may divest its household consumables division which would lead to improved quality in earnings. With a focus on health & beauty and overseas expansion, particularly China, the broker considers BWX ((BWX)), which has the Sukin brand, and NZX-listed Trilogy International are the most comparable companies.

The broker believes McPherson's should trade on a discount to these companies given its home appliances and consumables divisions and the early stage of its expansion overseas. If the natural skin care market continues to grow and the brands gain traction overseas the stock could re-rate to more of a market multiple, in the broker's view.

A fully franked 9c per share dividend is forecast for FY17, which represent a 65% pay-out ratio and 63% of estimated free cash flow. The broker estimates health & beauty revenue will decline in FY17 by 23% because of around $25m in from Swisspers, Moosehead and Maseur brands being moved to the household consumables division. The latter division should therefore benefit from this to the same degree.

Health & beauty will also be negatively impacted by McPherson's not retaining the distribution contract for Dolce & Gabbana fragrances post October 31 2016 because of the Procer & Gamble/Coty merger. In home appliances, the broker estimate revenue will decline by 5.5% because of the impact of the closure of Masters, which is estimated to provide around 10% of revenue. McPherson's currently has a tender with The Good Guys for a range of built-in ovens, increasing the division's range of products and number of retailers.

McPherson's has closed its impulse merchandising business following the decisions by a major Australian grocery retailer to cease its impulse merchandising program. This has led to one-off costs but will release $2m in working capital and should marginally improve overall earnings in FY17, Moelis believes.

Prior to 2012 McPherson's was largely involved in the grocery channel and in its printing business. The printing has been de-merged since than and the exposure to grocery decreased. The company divested the remaining 49% of its housewares division in March this year.

The proportion of purchases in US dollars has fallen to 65% from 85% in FY14 and management expects this to continue to decline. Management has also now taken the view that where customers do not accept price increases and margins are inadequate, it will exit the contracts. This has been the case with some private label and the impulse merchandising division.

In terms of China, Moelis notes Dr LeWinn's and A'kin are not as well known as Sukin or Trilogy and, therefore, the company's strategy is to partner with Daigou sellers, rather than going direct to the consumer. Daigou businesses are shopping agents that purchase items for residents in mainland China which are unavailable or hard to obtain otherwise.

By using Daigou, McPherson's does not need to adhere to the recent Chinese regulation that requires foreign manufactured products to be registered by May 2017. Nevertheless, if the company decides to sell direct to the Chinese consumer via a flagship store it will need to register its products and this may be the case if the uptake of its brands in China is successful. McPherson's has expansion plans for New Zealand and Singapore as well and has appointed distributors in South Korea and the UK.

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article 3 months old

Leading Brands Perform For Premier Investments

Retail network Premier Investments continues to perform well although brokers note some tough comparables will be cycled in the current half year.

-Smiggle and Peter Alexander lead the sales outlook for FY17
-Youth brands underwhelmed in FY16 because of holiday mismatch
-FX translation headwinds buffetting Smiggle UK roll out


By Eva Brocklehurst

Fashion retail network Premier Investments ((PMV)) is shaping up to perform well in FY17 as it rolls out further stores for its fun stationery and sleep wear brands, Smiggle and Peter Alexander.

Mature brands under performed in FY16, with sales overall declining. Still, management has signalled that trading picked up in June and July and it finished the year with a clean inventory position.

The second half was understandably weak, brokers agree, given it included a warm start to winter, the unfavourable timing of Easter and the federal election, with negative performances from Dotti, Jay Jays and Portmans.

The half year featured a misalignment of school holidays and, as a result, management suggests its youth brands were particularly affected. Brokers observe this is borne out by the fact there was no sales growth in Jay Jays, Dotti or Portmans over the second half.

The macro outlook does not support above-trend sales growth in FY17 and the company is cycling strong like-for-like comparables. That said, UBS considers the outlook is still reasonable and forecasts first half sales growth of 1.6% and FY17 2.5%.

The broker expects the benefits of direct sourcing in core brands and an increased skew towards Smiggle and Peter Alexander will lift gross margins to 67.5% from 63.9% over the next decade.

UBS expects 750 Smiggle stores will be rolled out including new regions yet to be announced. Should Smiggle increase its footprint to 1500 stores over the long term the broker's valuation would increase by 39% to $23.15.

Earnings in FY16 beat Macquarie's estimates but this was largely because of cost reductions. The broker remains a supporter of the Smiggle roll-out internationally but highlights FX translation headwinds currently buffeting Smiggle UK. Management has found there has been no impact from the Brexit decision on its stores, which have been trading modestly better post Brexit.

Lower tariffs and an increase in direct sourcing from factories helped gross margins, Citi observes, but with the reduction in hedged FX rates for FY17, gross margins are expected to decline by 70 basis points. The broker retains a Sell rating and believes, while growth in Smiggle is strong, this is factored into the share price.

Credit Suisse believes the market is too bullish about FY17 and not taking into consideration the company will be cycling a “perfect” Christmas. The broker does not take into its calculations the upside based on potential new markets being developed in Smiggle but believes the lower guidance for the number of new stores being opened for Smiggle in the UK does not appear to be anything other than prudence.

The UK business is expected to be marginally loss making and move to significant profitability from FY18. Growth appears to be behind industry comparables in the clothing stores, although the broker acknowledges the underperformance of Premier Investments may reflect a skew to youth brands in its portfolios.

Store development over the next three years for Peter Alexander is expected to take the number of stores to 115-120. Beyond that Credit Suisse suspects there would be few premium locations in Australasia. The company has stated it intends to open 5-7 stores per annum through to 2019 with 3-5 being refurbished.

The broker notes Jay Jays sales were down 1% and below forecasts but comments from the company suggest a reduction in promotional sales events has been successful in lifting profitability.

Results were below Deutsche Bank's estimates but the company's confidence in its Smiggle roll-out and its initiatives in turning around brands and supply chain suggest meaningful growth and margin uplift will be forthcoming.

The broker adjusts earnings estimates to reflect the lower store count at Smiggle. Premier Investments has reiterated the view that the UK could sustain 200 stores, which would represent $200m in revenue over the next five years.

FNArena's database shows four Hold and two Sell ratings. The consensus target is $15.07, suggesting 5.8% in downside to the last share price. Targets range from $13.80 (Citi) to $16.60 (UBS).

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article 3 months old

Mixed Views As JB Hi-Fi Takes On The Good Guys

JB Hi-Fi will acquire The Good Guys in a highly anticipated move expected to make the group the dominant player in the white goods and electrical retailing sector.

-Synergies forecast at $15-20m over three years are lighter than expected
-Potential for increased scale and buying power impresses brokers
-Risks in the unwinding of The Good Guys joint venture stores and combining business cultures


By Eva Brocklehurst

In a well-anticipated deal, JB Hi-Fi ((JBH)) has announced the acquisition of white goods and electrical retailer The Good Guys for $870m. The combined group is expected to become a dominant player in an industry brokers believe remains rational and sales momentum strong. That said, there is some unease regarding the risks of successfully coupling the two businesses.

Deutsche Bank was pleased that the price was based on trailing earnings and JB Hi-Fi did not stump up payments for growth that the vendor was simply expecting. JB Hi-Fi has guided to sales and earnings at The Good Guys in FY17 to be in line with FY16. The acquisition will be funded by $394m in a fully underwritten, pro-rata, accelerated, renounceable entitlement offer, with the balance through debt facilities.

The broker is concerned that the housing tailwind may have eased by the time the business is fully integrated. While the company intends to integrate over a period - outlining $15-20m in synergies to be achieved over three years - which lessens execution risk, Deutsche Bank believes this reduces the actual synergies entailed.

UBS estimates around 8% of JB Hi-Fi's sales are linked directly to housing and the share price has a 56% correlation with approvals. The broker expects housing to be supportive over 2016 before slowing in 2017.

Several brokers upgraded on the news, UBS raised its rating to Buy from Neutral, assuming in its forecasts a three-year compound sales growth rate of 3% and synergies of $17m by FY19. The broker expects the acquisition will provide upside risk to forecasts via synergy upside and a more rational market, given over the past 12 months the top four players have consolidated into two (with the demise of Dick Smith and now this merger). Harvey Norman ((HVN)) is the other player.

The deal impresses Morgans by virtue of the earnings accretion and power of the combined group's increased scale. While acknowledging the risks associated with the unwinding of The Good Guys' joint venture stores, the broker believes JB Hi-Fi management has appropriately allowed for the challenges. JB Hi-Fi's store footprint will increase by 52%.

The Good Guys consolidated 55 of its JV stores by July 1 and 30 partners have retired while the remaining 25 have stayed on as store managers. Based on a relatively undemanding FY18 price/earnings ratio over 10% upside to the price target, Morgans upgrades to Add from Hold.

Morgan Stanley takes a similar stance to Deutsche Bank, sticking with its Equal-weight rating, believing the critical issue of integrating two very different retail cultures will have its challenges. The broker observes The Good Guys to be a high cost, high service retailer compared with JB Hi-Fi's, low cost, low service model. The broker also remains concerned about the performance of The Good Guys following the joint venture partner's transition as well as the longer-term outlook for the business.

Morgan Stanley estimates 12% accretion to FY18 earnings per share should the acquisition proceed. JB Hi-Fi has advised that for the year to August 2016, comparable sales growth slowed to 7.7% from 9.5% in July and has suggested that the closure of Dick Smith will positively impact sales during the first half.

Citi believes the acquisition has been made at a fair multiple for a rare opportunity to consolidate the industry, yet the synergy target appears light. The broker had forecast around $40m in synergies. The lack of organic sales and earnings growth in FY17 estimates for The Good Guys may surprise on the downside, the broker believes, as the transition to corporatised stores is likely to be a headwind.

The company may look to extract further synergies if the operating environment deteriorates, the broker acknowledges, with the ability to consolidate support offices and generate cost savings. Both businesses are considered to be trading at or near their peak in terms of sales and growth. Still, the acquisition has been factored into the share price for several months, Citi concludes, and sticks with a Sell rating.

Credit Suisse views the transaction, with the brands to be run independently, as a portfolio acquisition, with the value being in the growth option and shared capability over the longer term. While the grouping is likely to offer supply chain and systems synergies over time, and be complementary with product access and promotional buying opportunities, the broker is concerned about the financial assumptions underlying the integrating of the joint venture operations.

This concern is in respect of the base EBIT (earnings before interest and tax) for the Good Guys. The broker notes large increases in EBIT in FY15 and FY16 and then flat guidance in FY17, with no disclosure of leases and low fixed assets in the balance sheet.

The deal is logical in terms of strategy, Goldman Sachs believes, and the enhanced scale should provide opportunities to improve buying terms. The broker, not one of the eight monitored daily on the FNArena database, does not incorporate the acquisition or capital raising into earnings forecasts at this stage and retains a Neutral rating.

Ord Minnett is one of the upgraders, moving to Accumulate from Hold. The broker believes the acquisition provides valuation support for JB Hi-Fi, and while there are execution risks, remains confident the process can be well managed, with the maintenance of separate head offices and cultures. Moreover, operating performance in both the second half of FY16 and into FY17 as been strong, delivering sales growth and EBIT margin expansion.

FNArena's database shows three Buy, two Hold and two Sell ratings. The consensus target is $29.51, suggesting 2.3% upside to the last share price. This compares with $27.50 ahead of the announcement. Targets range from $25.21 (Credit Suisse) to $32.55 (Morgans).

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article 3 months old

Brokers Modestly Positive On Myer Outlook

Brokers expect Myer's upcoming FY16 results will reveal a contraction in margins but they remain modestly positive about sales growth and momentum of the New Myer strategy.

-Like-for-like sales growth needs to be seen as sustainable to generate investor confidence
-Reduction in private labels and concessions playing a greater part in the store's footprint
-Re-opening of Warringah Mall store to showcase New Myer strategy


By Eva Brocklehurst

Competitive and structural pressures may be buffetting Myer ((MYR)) but the department store is progressing with its “New Myer” strategy. The company will re-open its Warringah Mall store in October, showcasing an increased emphasis on concessions amid a more boutique footprint. The company's upcoming FY16 results are likely to reveal a contraction in margins but brokers are modestly positive about sales growth and the likelihood momentum will continue.

Citi expects profit to be slightly above guidance, with net profit guided at $66-72m. The broker expects gross margins will have declined by 140 basis points in the second half, largely because of the exit of private labels. A warmer start to winter is one of the risks the broker acknowledges, noting stock clearances emerged a week earlier than in the prior year.

Myer has expanded its floor space allocated to concessions and sales in these segments are expected rise accordingly. Progress is being made on costs and Citi forecasts cash costs to fall 130 basis points, through savings at head office, procurement benefits and lower wage inflation. The stock has flatlined since the third quarter sales result in May and the broker accepts, in order to generate further investor confidence, like-for-like sales growth will need to be seen as sustainable.

While competitive pressures are continuing unabated, Deutsche Bank still believes the new initiatives and the retail environment are broadly supportive of Myer. FY16 gross margins probably were under pressure from FX movements and inventory clearance in the winter, and the mix-shift to concessions

This broker also expects margins to decline but EBIT (earnings before interest and tax) margins should hold up better than gross margins because costs are being held down. Sales growth remains positive but Deutsche Bank believes that at some point costs will start growing again. New initiatives are observed as providing some support and consumer demand remains reasonable.

Of interest to Ord Minnett is the extent to which like-for-like sales growth continues. The broker will also monitor the implementation of the New Myer strategy. Sales growth is expected to remain strong in the fourth quarter at around 3.8%, with a greater part being played by concessions amid store closures and targeted investments in key stores.

The broker flags the fact that the growth in concessions, with reduced private labels, and lower costs via productivity changes and procurement, will change the shape of the profit and loss statement. Ord Minnett forecasts gross margins to fall 186 basis points to 38.5%.

The main issues for the broker are sustainability of sales growth, the change in product mix and the competitive intensity arising from both incumbents and new entrants. Ord Minnett would also look for any disclosure of a relationship with UK department store John Lewis.

Credit Suisse believes Myer's strategy is being under-appreciated by the market. The re-opening of Warringah Mall store is expected to deliver $5m in incremental EBIT. The store has been closed since January and refurbishment is part of the re-development of the mall.

Structural headwinds are well documented for department stores and the broker expects the format to continue to decline as a segment of retailing. Nevertheless, Myer is undertaking improvements from a very low base and, with a largely fixed cost base, it is considered highly leveraged to even a moderate improvement in sales revenue.

FNArena's database shows three Buy and four Hold ratings. The consensus target is $1.33, suggesting 3.2% upside to the last share price. Targets range from $1.16 (Macquarie) to $1.56 (Credit Suisse). The dividend yield on FY16 and FY17 forecasts is 4.7% and 4.5% respectively.

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