The DJs cost advantage

Several years of intense focus by Mark McInnes on the detail of his business is showing up in the impressive performance of David Jones in conditions that remain challenging. Despite modest sales growth the group's continuously improving productivity is driving strong growth in profits.

In some respects the David Jones' result is not dissimilar to Myer's result last week. It wasn't achieved as a result of buoyant conditions and surging sales but by the continuous improvement on costs and margins that has been one of the hallmarks of McInnes' very successful tenure as chief executive.

Sales were up only 2.3 per cent but profits 10.2 per cent, with the gross profit margin up 50 basis points to 40 per cent and David Jones' retail margin – its earnings before interest and tax as a proportion of sales – rising 90 basis points to 13.5 per cent. That is a number, supported by record earnings and gross profit margins, that puts DJs up there with the best of the international department store operators.

That performance flows from a lot of small initiatives – arrangements with suppliers, choice of ranges, the increased emphasis on exclusive brands and a hard-nosed focus on costs generally. McInnes talks about the culmination a five-year plan to improve DJs' costs of doing business.

The consistency, quality and resilience of DJs' performance through a difficult period for retailers generally, and department stores in particular, is supported by a very clean balance sheet, with only about $70 million of net debt in a $1 billion balance sheet.

The robust nature of DJs' model has enabled McInnes, generally conservative in his forecasts, to reaffirm guidance of growth in after-tax earnings of between five and 10 per cent for both the second half and full year, although he did say the group remained very cautious about cycling the impacts of the massive federal government stimulus package in the fourth quarter of last year.

For the top end of the guidance range to be achieved, he said, the retail recovery would need to be in full swing, which both DJs and others believe is unlikely. DJs generally bases its macro economic outlook on assessments by Access Economics, which doesn't expect a full recovery in retail conditions until 2012.

What's interesting about DJs relative to Myer was that whereas Myer had very strong first quarter sales growth but a second quarter where sales flat-lined (Myer's moment of truth, March 11), David Jones was able to increase sales by about 2.4 per cent in the second quarter (DJs dials it up, February 9).

McInnes referred to the very competitive environment and heavy promotional activity by retailers during the half – which included the highly visible float of Myer. It would appear that DJs' positioning has protected it from the intense battle going on between former stable mates Myer and Target at the more price-sensitive end of the market. Myer, and Big W, may also be more affected by the apparent resurgence of Kmart.

The other factor in DJs performance and outlook that would give McInnes confidence relates to the decision he made in 2005 to buy back his group's key retail sites for $414 million, extricating DJs from a complex sale and leaseback deal it struck with Deutsche Bank in 2000 and giving him control and flexibility as to how the key Sydney and Bourke Street sites were presented.

Stage one of the Bourke Street redevelopment was completed last year, with the entire project – which will enable DJs to counter the massive reconstruction of Myer's flagship store – scheduled to be completed in the first quarter of next financial year. That ought to generate some momentum in the group's sales and because, unlike Myer, DJs doesn't face lease payments, ought to flow through fully to its bottom line.

Myer is looking to its Bourke Street rebuild and a pipeline of new stores to inject some growth into consistently stagnant sales. McInnes has two new stores of his own scheduled to open late this year and early next year. He also has a de-risked financial services business that continues to grow solidly.

The retail environment remains volatile and tricky, but DJs has demonstrated in the past two years that despite its market positioning, or perhaps because of it, it is able to respond to tough conditions and continue to churn out good and high quality numbers.

The rekindled competitiveness between DJs and Myer, for both customers and the market's approbation, hasn't hurt either, and indeed appears to be generating energy and ambition within both. McInness, however, doesn't have Target and Kmart snapping at his heels and dividing his attention.