Myer: Result 2016

The number ‘seven' is lucky (or so some say). For Myer you'd hope so, because the company has now reported six straight years of declining earnings.

Myer's slick managing director Richard Umbers plans to interrupt the trend. Reporting the company's 2016 results yesterday, he promised that underlying net profit would grow this year. For what it's worth we believe him, although that particular number is pretty easily to manipulate.

We weren't expecting miracles in 2016 and the result was acceptable rather than exceptional. Helped by an extra week in the year, Myer's sales grew 3% to $3.3bn while underlying net profit fell 11% to $69m (see Table 1). Profit was in line with the company's guidance but don't put too much faith in that number; net after-tax implementation costs associated with the New Myer strategy of $9m knocked the bottom line down to $60m. Expect more implementation costs in 2017.

As expected, the gross margin fell 1.6% to 38.7% as Myer introduced more concession stores (sales up 22%) and de-emphasised private label brands (sales down 7%). While management has said it is being more efficient in rostering staff, we can't help thinking its costs should be rising rather than falling at this point in the turnaround. Instead the company's cost of doing business fell 0.9% to 32.5%.

Return to dividends

Myer's strong cash flow was a key reason for recommending the stock in Is Myer still a pariah? in November 2015. Thankfully Myer didn't disappoint here, with excellent operating cash flow of $149m and free cash flow of $98m. Another of the milestones we were looking for was delivered, with a return to dividends during the year. A fully franked final dividend of 3 cents was declared.

The apparent delay to Myer's capital expenditure program, however, has been a little surprising. After promising to spend $100m-120m in 2016, it spent just $59m in the period. Management explained that the cash figure didn't include capital already committed, and that the program would ramp up in 2017. Net debt of $102m is therefore likely to rise from here.

Included in the 2016 capital expenditure program were refurbishments of the Werribee store, which opened in July, and the Warringah store, which will open in November. Both will be tailored to local demographics, with the Warringah ‘premium' store the first to showcase the New Myer strategy. Refurbishments will also commence at a further seven (lucky?) stores in 2017, including the Sydney and Melbourne flagship stores.

As we explained in Is Myer still a pariah?, the New Myer strategy was as much about where it won't spend money as where it will. To that end, the company announced that it will close the Logan store in Brisbane in 2018 and will not proceed with the Darwin store it announced in 2012.

Selling space contracting

It's all about focusing on areas where Myer can earn the greatest return. With its selling space contracting, sales per square metre rose 5.6% in 2016.

As we said in March, though, in Myer: Moribund no more, reducing selling space is a low-quality way of improving sales density. What we're really hoping for is decent sales growth.

Sales growth was in fact the weakest element of Myer's result. Same-store sales rose 2.9% for the year to 30 July, which seems like a reasonable result given the headwind of a warm winter. Yet, David Jones grew same-store sales by 7% over the year to 26 June.

What's particularly concerning is that Myer had a very weak July. Management blamed it on the election and clearance activity – which makes some sense – and it's just one month after all. But it's concerning that the focus for 2016 was on introducing ‘wanted' brands and – just at the time shoppers should be getting excited about the changes – sales dipped.

The first quarter of 2017 looks like another difficult one. The corresponding quarter was a strong period and this year the company will need to clear aged inventory from winter. These are short-term concerns, yes, but same-store sales growth below 3% will make the turnaround much tougher.

Slow start to 2017

With a slow start to the year – and the refurbishment program proving potentially disruptive – 2017 is unlikely to be a stellar year. Of course, a lot will depend on Christmas. But at this stage it looks like the decent profit growth we were expecting might be less than 10%.

The good thing is you're not paying for high expectations. The market isn't counting on a significant turnaround so if Myer manages to produce anything better than 5–10% profit growth over the next few years then the stock looks good value below our Buy price. As it stands, Myer is trading on a 2017 forecast enterprise value to earnings before interest, tax, depreciation and amortisation multiple of 5.8 and a price-earnings ratio of 14. The stock is not expensive.

All that said, this remains a speculative recommendation. Success depends on management being able to turn around a business that has been a perennial underperformer. There's a reasonable chance of a decent return from here but our Buy price needs to incorporate the risks.

The market remains sceptical about Myer's turnaround but there's some chance it will surprise on the upside – just not in 2017. We'll upgrade again if Myer falls much below our $1.25 buy price, but for now the stock remains a HOLD.