Throwing cold water on Myer's 'merger of equals'

The Myer interim result was more or less in line with expectations, which is to say it wasn’t exactly the set of numbers off which to launch its merger proposal with David Jones.

The 8.1 per cent decline in earnings had been broadly flagged, with Myer digesting a range of factors that will eventually wash through its numbers.

The impact of its latest enterprise bargaining agreement, the Fair Work Act’s impact on penalty rates, three of its bigger stores under refurbishment, the investment in its online platform and a brittle environment for consumer spending provided the framework for the lower result. Some of those issues will tail off this year, with Bernie Brookes somewhat more optimistic about the 2014-15 year as the refurbishments end and cost pressures stabilise.

With all things relating to department stores being viewed through the lens of the merger proposal, the Myer numbers don’t compare well with those disclosed by David Jones yesterday.

As discussed yesterday (Stronger DJs holds a store of value, March 19), however, superficial comparisons can be deceptive. David Jones’s department store division was cycling a very poor earnings period in the same half of the previous year whereas Myer maintained its earnings in the first half of last year.

Over a two-year period Myer’s performance remains superior. However, both groups have struggled to generate sales and earnings growth in a weak trading environment and against the competition provided by online retailers and the physical invasion of offshore big-brand retailers.

That is why Myer is seeking a structural response via the merger to structural changes in Australian retailing.

There were some tactical influences underlying Myer’s headline numbers. Brookes said today that after some very poor numbers in November last year (partly, he conceded, self-inflicted), Myer’s management had made a decision to invest some of its gross margin gains in protecting its top line, which led to its most successful stocktake sale in a decade.

That enabled Myer to maintain its sales numbers, which grew 0.3 per cent and produced a 1.2 per cent gain on a comparable stores basis. In six of the past seven quarters, Myer has grown its comparable stores’ sales. Gross profit, however, slipped 0.3 per cent as a result.

Brookes believes Myer can restore growth to its gross profit margins in future, with the caveat that some of the drivers of margin growth in the past -- reduced shrinkage and direct sourcing -- will have less impact in the future than they have had in the past.

Within the half and continuing into the second half there has been a continuing investment in Myer’s omni-channel platform. Like David Jones, Myer didn’t provide much detail on its online sales other than to say they had grown strongly. It said that they were expected to double this financial year compared to last and that the online business was expected to break even this year.

Another strand of Myer’s response to the threat posed by the growth of online retailing has been to grow its portfolio of exclusive brands. They generated 20.2 per cent of sales and enabled more direct sourcing and reduced shrinkage. Owning or controlling brands is a way of protecting margins from online competition -- the brands are higher-margin and aren’t accessible to competitors.

The changes to the structure of the sector have also prompted a re-thinking of Myer’s original post-float plans for an aggressive store expansion strategy.

While it has a significant refurbishment program under way, it has closed some stores and cancelled some planned new stores. It is very focused on improving the productivity of its stores by increasing the selling space as a proportion of the stores’ footprints.

With guidance of a flat gross profit margin in the second half and a 4-5 per cent increase in its cost of doing business over the full year -- the cost pressures are expected to start moderating in the final quarter -- Brookes is cautious about the outlook for the second half. However, he is more optimistic about the 2014-15 financial year as the cost growth slows and the impact of his store refurbishments starts to show up.

Without a significant lift in consumer confidence and spending, however, the outlook for department stores generally isn’t bullish. The key to future growth and profitability will be their ability to build a high-margin and high-growth presence online.

If Myer were to achieve its target of generating 10 per cent of its sales online within five years, it would be the equivalent of adding a new Bourke Street flagship store and roughly $300 million of sales to the portfolio.

Sharing the cost of an omni-channel platform and supply chain with David Jones and pulling the $85 million a year of synergies from a merger that Myer estimates would be available would, of course, both strengthen their traditional physical networks and create real scale and earnings leverage online.

However, it was obvious from Paul Zahra’s comments yesterday that, despite now taking the proposal more seriously and hiring external experts,  the David Jones chief executive is far cooler on the concept of the merger than Brookes.