Over the Hill

We've been flirting with Michael Hill International for the past six months but, unlike many of its customers, we've been slow to make a commitment.

Our appreciation of retailing's difficulties has played a big part in that. Competition is fierce and only getting more so with the entry of Amazon to our shores. Competitive advantages are rare, except for a small handful who have entrenched low-cost cultures, and financial risk is often high due to obligations on store leases.

This combination has kept corporate administrators busy with consistent failures like Pumpkin Patch, Dick Smith and Oroton, to name a few. If there's an industry that has a higher incidence of failure than retail, then I'm not aware of it.

But it seems the allure of a higher earnings plateau, brought about through the closure of Michael Hill's loss-making US and Emma and Roe divisions, enticed us (me) towards a superficially cheap business. A big mistake, as superficially cheap retailers rarely make good long-term investments, as the likes of Godfrey's and Oroton have shown.

Mature network

On further reflection, our ardour for Michael Hill has cooled. A big part of what we don't like is where the company sits on the corporate life cycle.

When we imagine what it might look like in ten years, we struggle to see its Australian and New Zealand store footprints being much bigger as they already appear to have reached saturation. That leaves Canada, and any new venture management dream up between now and then, as the only sources of network growth.

Retailers start with just three levers of growth – more stores, higher sales from existing stores and lower costs – and Michael Hill is down to just two. We also think it's been reasonably well run to date, which doesn't leave much low hanging fruit in terms of same-store sales or cost reductions.

Maturity may not be an issue for retailers like JB Hi-Fi, who have the relative scale and efficiency that few others match. But Michael Hill isn't of the same ilk and it competes with many fearsome international peers.

Who knows where our economy is headed either, but it's clear that Canada doesn't provide the diversity we'd like, as it also has a resource-based economy with an expensive, and stalling, property market.

This is not to say that Michael Hill is a basket case. Far from it. In fact, it's looked after its shareholders for decades. It's just that we've grown uncomfortable with the risks, so we've moving on to look for opportunities where we have more conviction. COVERAGE CEASED.

Our Intelligent Investor Equity Income Portfolio is now available as a listed fund trading under ASX code: INIF. Holdings in the fund will mirror our current Equity Income Portfolio and have the same low costs, but you'll be able to buy it on the ASX. You can save yourself the broking commission by applying during the initial offer, which closes on Friday, 8 June, 2018.