Myer’s new chief executive John King is trying an ambitious margin-driven turnaround with one hand tied behind his back because of balance sheet constraints that may prevent the retailer from paying a dividend for at least two years.

Analysts have cautiously endorsed elements of Mr King’s strategy, including exclusive third-party and private-label brands, better customer service and a stronger online offer, saying it is similar to the plans of other bricks and mortar stores under threat from Amazon and structural changes in retailing.

However, analysts have questioned Mr King’s plan to wind back discounting, saying he will struggle to wean shoppers off price-based promotions, and say growth in gross margins from higher private label sales, reduced discounting and better sourcing may not be enough to offset operating deleverage from falling topline sales.

Analysts also say that while Myer’s new lending agreements and relaxed debt covenants have given Australia’s largest department store chain more breathing room, debt repayments and covenants will constrain Mr King’s ability to spend on stores and cut prices.

Myer may also have to write down the value of remaining intangible assets, potentially breaching the new equity covenant, under which shareholders equity must remain above $400 million (compared with $500 million previously).

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Myer shares rebound

However, Mr King is putting his money where his mouth is, buying another 100,00 shares on-market on Thursday for $43,500, taking his stake to 150,000 shares and 2.4 million performance rights.

After falling 4.5 per cent on Wednesday, when Myer announced an impairment-driven bottom line loss of $486 million, Myer shares rebounded more than 18 per cent on Thursday to 49¢ as eight million shares changed hands.

Citigroup analyst Bryan Raymond downgraded his share price target to 36¢ from 43¢ and cut his net profit forecast by 8.6 per cent to just $22.1 million – 32 per cent below Myer’s underlying net profit in 2018.

Mr Raymond said he was cautious about any retailer trying to unwind promotional activity given how accustomed consumers were to buying on promotion.

“The degree of difficulty is very high when attempting to execute a strategy predicated on reduced promotional intensity, exclusivity and customer experience, without sufficient balance sheet flexibility to execute it,” Mr Raymond said.

“Myer has bought some time with the refinancing of debt, receiving 18 months of relief from covenant pressure at the cost of … higher interest rates, (but) we still expect Myer to breach covenants in two years’ time, as the fixed charges covenant resets back to 1.5 times and previously planned store closures do not occur,” he said.

Mr Raymond said the only way to sustainably improve the fixed charges covenant outlook was to grow earnings before interest tax depreciation and amortisation, but this could only be sustainably achieved by growing sales.

Expense of sales

“The strategy outlined by Mr King is somewhat counter to this. The new strategy has a distinct focus on profitability at the expense of sales,” he said.

Deutsche Bank analyst Michael Simotas was also sceptical, cutting his earnings forecasts by 16 per cent and his share price target from 38¢ to 36¢.

“It is positive that banking facilities have been renegotiated but this came with additional cost and restrictions on the dividend,” Mr Simotas said.

“Debt should reduce while dividends are on hold but we are not convinced management can overcome Myer’s perennial challenge of not being able to grow sales without conceding margin or expand margin without losing sales,” he said.

“The strategies … have been tried before and we don’t believe driving exclusive brands or reducing costs will successfully avoid operating deleverage, particularly given the sales hole left by the loss of the Country Road portfolio,” he said.

Mr King revealed on Wednesday the loss of the Country Road brands, which are being pulled out of Myer by Woolworths Holdings, the parent of archrival David Jones, will  cost more than $50 million in sales in 2020. Myer is hoping to plug  the gap with new national and international brands and higher-margin private label brands.

Dividends on hold

JP Morgan analyst Shaun Cousins was more optimistic about the strategy, increasing his share price target from 37¢ to 43¢ a share and lifting his recommendation from underweight to neutral.

“New CEO John King announced a credible strategy with a focus on sales growth led by online, a store network that will be smaller (store size, possibly store network) but more efficiently managed, growing (private label brands) to support gross margins and (cost of doing business) inflation to be managed via an improved organisational structure and better quality spending,” Mr Cousins said.

“This is a strategy that appears more willing to engage with the ‘discount value’ customer and less focused on a more aspirational ‘Eva’ customer (around whom Myer’s previous turnaround plan was based),” he said.

“Execution remains key and we await evidence until we become more upbeat,” he said.

JP Morgan expects dividends to resume in the second half of 2020 as Myer’s fixed charges cover improves.

However, Morningstar analyst Johannes Faul believes dividends may not return until 2022 and was disappointed at the lack of quantifiable near term targets for the store footprint, sales growth and margins.

“Myer is undeniably in a hard spot but management is following a clear strategy to cope with the challenges facing the sector,” said Mr Faul.

Merger speculation persists

Macquarie Equities analyst Quinn Pierson believes sales will continue to fall and cost savings will become harder to achieve, increasing pressure on margins.

However, Mr Pierson believes modest takeover potential may help underpin Myer’s share price.

Speculation persists that Woolworths Holdings may take over Myer and merge it with David Jones, even though Woolworths chief executive Ian Moir, under pressure from his own shareholders over David Jones’ performance, has repeatedly ruled out a merger.

One fund manager said this week Woolworths might change its tune if David Jones’ and Myer’s earnings do not improve.

“It’s not an easy business and eventually it needs to merge with David Jones,” the fund manager said.

“There’s possibly only room for one full line department store to be profitable and a few years of bad results could change a lot of things.”

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