Retail round-up: Results 2014

The value you get from an online retailer is hard to beat. By 2017, 60% of all retail sales are expected to involve the internet for either research or purchase and that puts discretionary retailers in a very precarious position.

Online retailing has already killed Borders, Blockbuster and Colorado, but the pressure is only likely to increase in all but a few areas (most notably the big grocers such as Woolworths as we explain in Supermarket superwars – Part 2, also published today).

The founding Kindl family of women's fashion retailer Noni B recently accepted a takeover offer that valued the company at a tenth of what it was worth just seven years ago. When a family that's been involved in retail for decades sells out at that kind of price it's not just because the industry is going through a rough patch. The retail landscape has changed – and there's no going back.

Harvey Norman

The biggest problem traditional retailers face compared to the online upstarts are their large fixed costs to rent and maintain their stores. Coupled with thin margins, they mean that even a slight fall in sales can have a large impact on profits.

However, the reverse is also true, and a small uptick in same-store sales – 3% for the year to 30 June in Harvey Norman's case – will flow quickly and efficiently to the bottom line. This operating leverage is why the company's net profit rose an impressive 49% to $212m. That's a great result, but it's still around half what the company earned in 2007.

Cash flow was redirected from opening new stores to paying off debt which we think is sensible, and the company's net debt as a portion of equity fell from 28% to 22%. It was also good to see more given back to shareholders with the company increasing its final dividend by 77% to 8 cents per share.

Without providing specific guidance, management expects a good year ahead due to a strong housing market driving sales of whitegoods and small appliances, though it won't be easy with JB HI-FI broadening its offering to also include whitegoods (see JB Hi-Fi: Result 2014 from 12 Aug 14 (Avoid – $17.47)). The stock is up 15% since Go Harvey, go on 15 Jan 14 (Sell – $3.27) and we think the current price-earnings ratio of 19 leaves little margin of safety. SELL

Super Retail

Super Retail Group, the owner of SuperCheap Auto, BCF, Ray's Outdoors and Rebel Sport, had a reasonable result for the year to 30 June, but will need to do better if it's to justify its lofty share price.

Net profit increased 6% to $108m on sales that rose 5% to $2.1bn due to the rollout of new stores and same-store sales growth of roughly 2% from the company's two largest divisions: Auto and Sports.

Most disconcerting was that net debt increased 16% to $383m 'to fund capex and net inventory investment' which is more than we're comfortable seeing in a cyclical specialty retailer. The company is continuing its aggressive store roll-out, but given the increased competition from online alternatives and little in the way of a sustainable competitive advantage, success is no guarantee.

Super Retail's share price is up 8% since Super Retail Group vs. The Reject Shop from 1 Jul 14 (Avoid – $8.55) and represents about 17 times earnings and 85% of sales. This doesn't compensate investors adequately for the risks and we recommend you AVOID.

Pacific Brands

Brands are often a source of above average profitability – but not always, as Pacific Brands' latest result shows. The company reported a net loss of $225m due to a string of write-offs and restructuring costs.

Sales of Bonds and Sheridan were strong in the year to June, rising 20% and 16% respectively, but overall sales only increased 4% to $1.3bn due to the continued decline of its smaller brands. New chief executive David Bortolussi (previously the company's chief financial and operating officer since 2009) will have his work cut out.

Warren Buffett has said 'should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks'. With this in mind, it was encouraging to see Pacific Brands announce the sale of its Workwear division, which includes the brands Hard Yakka and KingGee, to Wesfarmers for $180m, or roughly 12 times earnings. We explained in What would you pay for Pacific Brands? on 22 Apr 14 (Hold – $0.54) that the division has abysmal profitability, so this was a great price for a dying business.

Pacific Brands' share price is little changed since 22 Apr 14 (Hold – $0.54) and we're sticking with HOLD.

Scentre

If Pacific Brands' result tells us anything it's that the retail game is becoming increasingly competitive. When retailers come under pressure, landlords like Westfield Corporation and Scentre Group find it difficult to increase rents.

So it's no surprise that Scentre, the collection of Australian and New Zealand shopping centres previously owned by Westfield Group and Westfield Retail Trust, has had a slow start following the restructure (see Westfield restructure approved from 20 Jun 14). However, occupancy at its 47 shopping centres was almost perfect at 99.5% for the six months to 30 June.

Specialty sales growth was a modest 3% and comparable net operating income increased 2% (see Note 1). Westfield Retail Trust was slugged with an additional $6.8bn of debt during the restructure and the company's gearing ratio of 38% is currently above management's long-term target of 30–35%.

For the six months to 31 December, management expects funds from operations of 11 cents per security, with a distribution of 10.2 cents.

The share price has risen 10% since Westfield Corp. and Scentre list on ASX from 2 Jul 14 (Hold – $3.19) and the stock now trades at a 26% premium to net tangible assets. That's a high price for such a slow growing property group, with a development pipeline less than half that of Westfield Corporation. SELL.

Westfield

After being freed from its low-growth Australasian shopping centres, Westfield Corporation's first result as a purely international retail property owner was a good one. Though occupancy is lower than Scentre's at 94% for Westfield's 40 shopping centres in the UK and US, specialty sales grew 4% to lift comparable net operating income 5% (see Note 1).

The company has $2.6bn of new centres under construction including the Westfield World Trade Centre site in New York. The $4.5bn future development pipeline is also on track and Westfield is increasing its ownership of Westfield Milan – soon to be Europe's largest shopping centre when completed in 2015 – from 50% to 75%.

For the six months to 31 December, management expects funds from operations of 19 cents per security, with a distribution of 12.3 cents.

The stock has risen 8% since Westfield Corp. and Scentre list on ASX from 2 Jul 14 (Hold – $7.15) and we recommend you HOLD.

David Jones

The $4 a share cash bid for David Jones by the South African Woolworths (unrelated to Australia's Woolworths) was almost derailed when billionaire Solomon Lew revealed he had amassed a 10% stake in David Jones and threatened to block the deal.

Lew was a minority shareholder in fashion retailer Country Road, while Woolworths controlled the company with its 88% share. Wanting to sell out, Lew used his newly acquired David Jones stake as leverage to get a better deal. The controversial strategy ultimately worked, with Woolworths agreeing to a $213m, or $17 a share, bid for Country Road in addition to the David Jones offer.

Nonetheless, it was a great deal for the rest of David Jones' shareholders considering the retailer hasn't increased revenues or earnings in more than five years and faces an onslaught from online competition. Almost 90% of shareholders, representing 97% of its shares, backed the proposal and the stock was delisted in July. As a result, we're CEASING COVERAGE.

Note 1: Westfield Corporation and Scentre only announced partial half-year results following the restructure. For further details please see their investor presentations, found here and here respectively and the security holder booklet found here.

Note 2: Our model Growth and Income portfolios hold shares in Woolworths. Our model Income portfolio holds shares in Westfield Corporation.