Many of the shopping giants are suffering considerable pain, a state of affairs that might not be ending any time soon.
ARE we hearing the full story when it comes to retail stocks? Or being lulled by financial market patois into visions of a cyclical recovery that may never arrive?
We hear a lot about soft patches, we hear the oft-parroted catch-cries of "challenging" and "tough retail environment". But one gets the eerie feeling that we are not being availed of the full story. What if this retail predicament were a little more structural than the analysts were forecasting? David Jones shares got hammered 20per cent in a day last week on conceding an earnings downgrade. Country Road confessed to lower guidance on Monday. JB Hi-Fi, Harvey Norman, Myer, Noni B, Billabong you name it if it's in retail, its share price has seen better days.
A stress test is in order then. How much pain can a retailer bare?
The plight of David Jones has been well telegraphed. The usual suspects: rising interest rates, rising saving rates, a sluggish east coast consumer economy, poor sales, and floods and cyclones were to blame. The chief Paul Zahra even blamed falling earnings on the spectre of the carbon tax.
Let's look at Zahra's arch-rival, Myer, for a case study. Last year, Myer notched up sales of $3.284 billion. Its gross profit for the year came in at $1.301 billion, for a gross profit margin of 39.6per cent. Earnings before interest and tax (EBIT) were $271 million, or 21per cent of gross profit.
As almost everything that lies between gross profit and EBIT are fixed costs, we can assume that if sales were to fall by 21 per cent, there would be no EBIT left.
Sales are falling. For the first half, they were down 3.6 per cent on the previous corresponding period. And by the third quarter sales update in May, it was evident the soft trend had persisted, with sales on a like-for-like basis tracking 3.1 per cent lower. The point of this is that Bernie Brookes and his team at Myer have already done a sterling job stripping the costs out of the business. They've sold the buildings and leased them back, they've snipped staff costs. Short of actually lugging the entire inventory out of the leased properties and creating an echo chamber a dance party venue perhaps there is not a lot more cost to come out. So the future of Myer relies on rising sales.
The concern over sales holds for every retailer. For its part, David Jones has just forecast that its fourth quarter sales would fall 11per cent. That's a fair leg down. Is it really just cyclical? Or are we talking the internet here, the great unspoken?
Extrapolating further on Myer, there's $420 million-odd in debt, which it has just started to pay down. Let's say $400 million at 7 per cent interest and there is $28 million in interest a year. That means when Myer gets to EBIT of $28 million, that is the year it goes bust. This is entirely hypothetical, of course. On the current trajectory, the game might be over in five years. But there is time. There is cash.
This perspective is a rather alarmist way of looking at things and, it must be said, at odds with mainstream forecasting. Take, for instance, the venerable numbers of Goldman Sachs. Goldman should know a lot more than others, as it was involved in the float and is therefore close to the business. Looking then at a Goldman report on Myer from March this year, the broker said total sales growth rates had improved since January but "remain negative".
"Importantly, we do NOT believe that recent weakness in sales or earnings represent a structural change in Myer's operations or industry positioning." The report was emphatic. Nothing structural. It was all cyclical downturn stuff.
Country Road conceded on Monday that sales were down 10.9per cent on a comparable store basis in fiscal 2011. We know people are increasingly shopping online. Australian retailers, as a class, have lagged behind some overseas counterparts.
As the Australian dollar has shot up, lowering dramatically their cost of goods, retailers have held their fewer, fatter-margin customers but not passed on the falling costs. What happens when the Australian dollar goes down again?
Frequently Asked Questions about this Article…
What's going on with Australian retail stocks right now?
Many major Australian retailers (David Jones, Country Road, JB Hi‑Fi, Harvey Norman, Myer, Noni B, Billabong and others) have seen sharp share price falls as sales weaken. The article describes broad pain across the sector, with companies cutting guidance or reporting lower sales and investors debating whether the weakness is cyclical or something more structural.
Why did David Jones shares drop so sharply and what did the company forecast?
David Jones shares fell about 20% in a day after the company conceded an earnings downgrade. The retailer also forecast that its fourth quarter sales would fall around 11%, which signalled a significant near‑term sales decline to investors.
How vulnerable is Myer if sales keep falling?
Myer reported $3.284 billion in sales and $1.301 billion in gross profit (a 39.6% gross margin). Its EBIT was $271 million (about 21% of gross profit). Because much of the cost base is fixed, the article notes that a roughly 21% fall in sales would eliminate EBIT. Management has already cut costs (sale and leaseback of buildings, staff reductions), so future recovery largely depends on rising sales.
Have retailers already cut costs enough — is there more room to save?
The article argues many retailers have already stripped out obvious costs (for example, Myer sold buildings and reduced staff). That leaves limited scope for further meaningful fixed‑cost reductions, so most retailers will need higher sales to restore profits rather than relying on more cost cutting.
How do debt and interest costs affect the risk profile of retail companies?
Higher interest and existing debt can squeeze retailers' margins. The piece gives a hypothetical on Myer: if it had $400 million of debt at a 7% interest rate, that would be about $28 million of annual interest — the level at which EBIT could be swamped by interest expenses. The author stresses this is illustrative but highlights how debt and interest amplify downside risk for retailers with weak sales.
Is the retail slowdown cyclical or a structural change like more online shopping?
There is debate. Some analysts (for example, a Goldman Sachs report cited) call the weakness cyclical and not structural. The article, however, raises the possibility that part of the problem is structural — notably growing online shopping and shifting customer behaviour — which could mean the weak retail environment persists beyond a normal cycle.
How have a strong Australian dollar and online shopping affected retailers' margins and pricing?
A stronger Australian dollar has lowered the cost of imported goods for retailers, enabling fatter margins. The article notes many retailers kept these margin gains instead of passing savings to customers. That raises the question of how margins and pricing will respond when the Australian dollar falls again and when online competition continues to grow.
What should everyday investors watch when evaluating retail stocks?
Pay attention to trends in like‑for‑like sales and company sales guidance, profit margins, fixed cost structure, debt levels and interest expense, and signs of structural change such as online sales growth. Also monitor broader factors mentioned in the article — interest rates, household saving rates, regional consumer conditions (eg. east‑coast weakness), and one‑off events like floods or cyclones — which can all affect retail performance.
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