Retail icons rated in a bankable kick-along

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.