Vita Group: Result 2016

This retailer has enjoyed an impressive ride on Telstra's shoulders, but with the core business firing on all cylinders, future returns may be harder to come by.

Faced with a stagnating business in 2009, telecommunications retailer Vita Group decided to piggyback on Telstra, instead of Apple. Management was optimistic about rolling out Telstra branded stores, whilst simultaneously withdrawing from Next Byte, the independent Apple retailer, but the merit of the strategy was murky at the time. 

Key Points

  • Growth from optimisation 

  • Expanding outside core competence

  • Not a bargain 

It is now crystal clear. The continuation of Vita’s strong results in 2016, led by its Telstra branded stores, provides further validation of the strategy. And with the share price up over 200% over the past 12 months, shareholders aren’t complaining.

Making of a Multi-bagger

It’s hard to say that Vita Group hasn’t been well managed. As Table 1 shows, dramatic improvements have been achieved across all facets of operations.

Telstra stores have inherently better economics than a traditional retailer. It’s one of the most inventory-light models you will find, made possible by selling voice, data, subscriptions and bundled packages from Telstra’s entire product suite. For context, inventory represents just 2% of sales, compared to 14% at JB Hi Fi.

For each dollar that Vita pays in rent, it makes around $11 in gross profit, a level that rivals some of Australia’s best retailers such as Flight Centre.

Table 1: 5 year improvements
Year to June 2011 2016 /(–)
(%)
Telstra stores 50 100 100
Telstra business centres 9 21 133
Total stores 180 ~140 (22)
Sales per store $2.2m $4.6m 109
Gross margin 32.3% 35.8% 11
Opex/sales 28.9% 26.6% (8)
EBITDA margin 3.0% 8.7% 190

But while management has done a good job, a lot has gone right for this business. The total telecommunications market has grown as the number of devices per person has increased, and Vita has captured an increasing proportion of this as market share has migrated to Telstra. We are less sure that these tailwinds will continue to blow as hard for Vita in future.

Is it sustainable?

It’s not often you find a retailer shrinking to greatness. Over 5 years Vita’s store network is around 22% smaller, but its profits are up 5.2 times and its share price is up over 20 times. But with a trailing price-earnings ratio of 23 times, investment success requires a continuation of Vita’s earnings growth.

This is becoming trickier as Vita is now a highly optimised business, suggesting further improvements will be much harder to come by. Consensus expectations are for earnings per share to grow 12% in the 2017 financial year and 11% in 2018. Still decent, but dramatically lower than has been achieved over the past few years.

As an indication of the approaching maturity of its core retail business, a lot of the future growth is expected to come from enterprise, Vita’s new division that sells IT services and support across Vita’s existing channels. Expanding from retailing into IT services is not something you see every day (if ever), and this undoubtedly adds to Vita’s risks. It is a hotly contested market, where many seasoned businesses compete.

Opportunities elsewhere

Table 2: VTG result 2016
Year to June ($m) 2016 2015 /(–)
(%)
Revenue 645 542 19
EBITDA 66 50 31
NPAT 35 25 39
EPS (c) 23.4 17.4 34
DPS (c) 14.0 8.0 75
Franking (%) 100 100 N/a
* Final dividend 8.21 cents, ex date 15 Sep

Vita has produced an exceptional return for its investors, up over 200% in the last 12 months, but that means little today. It is the prospective return that matters.

With such a high valuation and the company moving outside its core area of competence, we suspect future returns will be much lower and we’d prefer to watch from the sidelines for the time being.

It’s still a well-managed business in a decent industry, so we plan to keep our eye on it. However, at prices above $5.20 we recommend you SELL.

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