Retail icons rated in a bankable kick-along

DEPARTMENT stores Myer and David Jones as well as JB Hi-Fi will benefit the most from an increase in retail sales and consumer confidence triggered by an interest rate cut, according to UBS.

By InvestSMART · 31 Oct 2011

By InvestSMART ·
31 Oct 2011

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DEPARTMENT stores Myer and David Jones as well as JB Hi-Fi will benefit the most from an increase in retail sales and consumer confidence triggered by an interest rate cut, according to UBS.

Analyst Ben Gilbert said if the Reserve Bank of Australia announced an easing in official interest rates tomorrow the new monetary setting would be a positive catalyst for consumer sentiment heading into the key Christmas trading period. It posed potential "upside risk" to discretionary retail earnings for 2011-12.

"The sectors that have generated the greatest outperformance have been household goods and (surprisingly) Woolworths-Wesfarmers, while department store performance has been in line," Mr Gilbert said.

"The outperformance in our view has occurred in anticipation of improving confidence and a consequent retail sales uplift, which have in most instances eventuated following an easing cycle."

He believed Myer had the highest level of operating leverage should retail sales improve ahead of expectations.

"We estimate every 1 per cent sales beat would deliver a 3.2 per cent EBIT upgrade, all else being equal. This compares to David Jones and JB Hi-Fi who generate EBIT leverage 2.2 times and 1.5 times respectively. Myer's superior operating leverage reflects: high fixed-cost base with roughly 46 per cent of cost of doing business fixed on an ex-staff expense basis use of permanent staff and possibly less generous incentive program relative to JB Hi-Fi, and: cost base capable of supporting a much higher level of sales productivity."

Mr Gilbert's report said that on an absolute basis, retailers had delivered outperformance for the three months following eight of the past 12 cuts in the RBA cash rate since 2001. Assuming retail trends picked up into Christmas, he believed Myer and JB Hi-Fi were the top two shares to own.

"Myer offers the greatest level of operating leverage of the discretionary retailers, in our view.

"For the entire discretionary space market expectations remain low, with retailers making up five of the top 10 most shorted stocks, JB Hi-Fi being the most shorted stock in the ASX200. We believe Myer, followed by JB Hi-Fi, offers the most immediate upside from both an earnings and share price perspective should a rate cut occur . . . Tuesday."

In the UBS analysis, Billabong and Pacific Brands were excluded given the high level of offshore earnings for the surfwear company and the more staple nature of Pacific Brand's offering.

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Frequently Asked Questions about this Article…

How would an RBA interest rate cut affect retail stocks like Myer, David Jones and JB Hi‑Fi?

UBS analyst Ben Gilbert says an RBA rate cut would likely boost consumer confidence and retail sales, acting as a positive catalyst into the key Christmas trading period. That could create upside risk to discretionary retail earnings for 2011–12 and particularly benefit department stores and consumer electronics retailers such as Myer, David Jones and JB Hi‑Fi.

Which retailers are expected to benefit most from improving retail sales and consumer confidence?

According to UBS, Myer, David Jones and JB Hi‑Fi stand to benefit the most from an uplift in retail sales and consumer confidence triggered by a rate cut. UBS also noted outperformance in household goods and the Woolworths‑Wesfarmers grouping.

Why does UBS say Myer has superior operating leverage among discretionary retailers?

UBS highlights that Myer has a relatively high fixed‑cost base (around 46% fixed on an ex‑staff basis), greater use of permanent staff and possibly less generous incentive programs versus peers. That cost structure means a small sales beat can generate a larger percentage uplift in earnings, giving Myer stronger operating leverage.

What does EBIT leverage mean for investors, and how do Myer, David Jones and JB Hi‑Fi compare?

EBIT leverage describes how sensitive a retailer's earnings (EBIT) are to changes in sales. UBS estimates every 1% sales beat would boost Myer’s EBIT by about 3.2%, compared with roughly 2.2 times for David Jones and 1.5 times for JB Hi‑Fi—making Myer the most earnings‑sensitive to sales upside.

Have retail stocks historically outperformed after RBA cash rate cuts?

UBS found that retailers delivered outperformance in the three months following eight of the past 12 RBA cash rate cuts since 2001, suggesting retail shares can be responsive to easing cycles.

Why were Billabong and Pacific Brands excluded from UBS’s retail analysis?

UBS excluded Billabong because a high proportion of its earnings are offshore, which makes it less tied to domestic rate moves. Pacific Brands was excluded because its more staple product mix makes it less comparable to discretionary retailers in the UBS analysis.

What are the market sentiment risks for discretionary retail stocks right now?

UBS notes market expectations are low across discretionary retailers: five of the top 10 most shorted ASX stocks are retailers, and JB Hi‑Fi is the most shorted stock in the ASX200. High short interest can amplify volatility but also implies potential upside if sales recover.

If retail trends pick up into Christmas, which retail shares does UBS consider top picks?

UBS suggests that, assuming retail trends improve into the Christmas period, Myer and JB Hi‑Fi offer the most immediate upside from both an earnings and share price perspective should a rate cut occur.