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Investors who have digested the steady diet of warning bells about the ASX Retail Sector would do well to study the Full Year 2013 earnings report from New Zealand based specialty retailer Kathmandu Holdings Ltd (KMD).  Released on 24 September, here are some of the highlights:

•    Sales increased 10.6%

•    Gross profit margins increased 10.3%

•    NPAT (Net Profit After Tax) increased 22.6%

•    Same store sales increased 1.8% (+5.6% accounting for currency exchange rates)

•    EPS (Earnings per Share) rose from $0.172 to $0.219

•    Dividends per share rose from $0.10 to $0.12

•    Operating cash flow increased from $32.5m to $45.7m

•    Total stores increased from 120 to 136

•    Kathmandu Summit Club Loyalty members rose over the one million mark, well ahead of the forecast for one million in 2015

All this achieved in the midst of a purportedly weak retail market and an unseasonably warm winter. 

Kathmandu designs and sells outdoor clothing and equipment throughout Australia, New Zealand, and the UK.  The company has been trading on the ASX since 2009.  KMD’s stock price has defied the odds year over year.  Here is a one year chart of KMD compared to the ASX Consumer Discretionary Index, the XDJ:

To top it off the company announced the addition of another 15 stores in FY 2014 towards its eventual goal of 170 stores.  Kathmandu’s online presence is growing as well with a new platform and a 55% year over year increase in online sales which now represents 4% of total revenue.  The company continues its focus on quality design and additional product offerings, now up from around 3,500 different lines to 5,000.  Management outlook for 2014 calls for continued cost controls and is decidedly bullish, providing economic conditions do not deteriorate.  

The key elements of KMD’s success appear to include brick and mortar store expansion; a ramping up of its online presence; ongoing cost controls; a rewards program for loyal members; and more and better product lines.  Might there be other retailers out there following similar steps?  What do analysts think?

The following table lists analyst recommendations from Thomson/First Call for KMD and four other retailers with some similarities to KMD.  Here is the table:

Company

CodeStrong Buy/BuyHoldUnderperform/sell
Super Retail GroupSUL1/3 43/1
David Jones LtdDJS2/136/2
Myer HoldingsMYR2/082/2
Kathmandu HoldingsKMD3/310/0
Oroton Group LtdORL0/051/3

 

Kathmandu is the exception to the prevailing bearish sentiment on retailers. 

Analysts are sceptical about the prospects for the retail heavy weights as well, with a total of seven Underperform/Sell recommendations on Woolworths (WOW) and five for Wesfarmers (WES).

A common theme voiced by sceptics is that low consumer sentiment leads to decreased discretionary spending.  While statistics can often mislead, some figures bear highlighting. Notably, a 4% increase in total consumption For the June Quarter, but just 1.9% growth in retail spending.  In addition, Australians increased overseas expenditures by 15%. The latest Westpac Melbourne Institute Index of Consumer Sentiment was 4.7% higher than a month ago.

Connecting the dots would seem to suggest Australians are in fact spending, but not in traditional areas.  Yet if you look back at the share price movement chart for KMD you’ll notice the XDJ has been in an upward trend year over year, now up 40%.  Clearly there are stocks out there investors favor.  Let’s revisit the stocks from the above table, this time focusing on some performance and growth measures:

Code

Mrk CapShare Price52 Wk % ChngDiv Yld1 Yr Avg Ann Total Shrldr Rtrn3 Yr Ann Total Shrldr RtrnFP/E2 Yr Erngd Growth Forecast2 Yr Div Growth Forecast
SUL$2.6b$13.22+70% 3.1%  75.2% 34.4% 17.17 21.7% 13.2%
DJS$1.6b$2.97+18% 5.6% 25.5% -9.8% 15.63 4% 0.8%
MYR$1.6b$2.68+53%  6.4% 63.5% -3.1%12.18 0.7% -2.8%
KMD$607m$3.03+120%3%  130.6% 33.8%11.65 -8.1% -6.4%
ORL$236.3m$5.78-17% 8.6%  -11% -4% 16.5  47.6% -18.2%

                         

Let’s begin with the second most impressive performance after KMD – shares of Super Retail Group Ltd. (SUL).  The company is four times as large as Kathmandu and is more broadly diversified but competes directly with KMD with its outdoor apparel and equipment product lines.  Its operating segments include Auto, Leisure, and Sports.  Like Kathmandu, Super Retail Group has strong brands; eight to be exact, all well known in Australia and New Zealand.  The company also has operations in China.  

The company’s business model is similar to KMD’s – focus on products to enhance the leisure experience of its customers.  Super Retail Group management attributes part of its success in a challenging retail environment to its core belief that customers will continue to spend to support their passion for leisure even while spending less on other discretionary items.  SUL’s CEO, Peter Birtles envisages opening an additional 120 to 130 stores.  In another similarity to KMD, Super Retail Group is spending money to increase its multi-channel distribution strategy.  All eight of SUL’s brands already have online shopping platforms.

The stock price screams success as over two years SUL has outperformed Kathmandu.  Here is the chart:

On 21 August the company released its Full Year 2013 earnings.  Here are some of the highlights:

•    Sales increased 22.1% (the eighth consecutive annual increase)

•    NPAT rose 22.6%

•    EPS rose from $0.464 to $0.523 (the eighth consecutive annual increase)

•    Dividends per share increased 18.8% from $0.10 to $0.12

•    Operating cash flow increased $89.8m

Sceptics might attribute the results to the company’s Auto segment; since auto repair is often non-discretionary.  Sceptics are wrong on this one as the combined revenue from Leisure and Sport of $1.2 billion outpaced the $789 million generated from the Auto segment.  In addition, the largest percentage revenue increase came from the Sports Group – 52.8%.  

While the share prices of leisure retailers KMD and SUL are up substantially year over year, the biggest surprise in the table is the 53% spike for Myer Holdings (MYR) along with the more modest 18% rise in the share price of fellow department store retailer David Jones (DJS).

According to the ABS, department store sales in July dropped 7.9% while sales of household goods were up 1.8%.  Obviously investors see something positive in both Myers and David Jones.  Even over a two year period, the share prices of both companies are up, although just barely for David Jones.  Here is a two year price chart:

Both of these companies reported Full Year 2013 results recently and both fell short.

Myer came first on 12 September, with a series of down, down, and more down results.  Here are some of the lowlights:

•    NPAT dropped 8.7%

•    Revenues increased 0.8%

•    EPS dropped from $0.237 a year ago to $0.216

•    Dividends per share dropped from $0.19 to $0.18

•    On a positive note, operating cash flow increased from S179.9m to $225.5m

Credit Suisse and Deutsche Bank are alone among Australia’s analysts with a BUY and an OUTPERFORM rating, with both citing Myer’s strong cash generation as reasons for the recommendations.

Deutsche Bank, Credit Suisse, JP Morgan, BA Merrill-Lynch, Citi, and CIMB Securities all have UNDERPERFORM, UNDERWEIGHT, or SELL ratings on DJS.  The company reported FY 2013 results on 25 September and everything was down. NPAT, revenue, EPS, dividends per share, operating cash flow – all down.

So why would anyone invest in either of these two department store stocks?

Myer actually showed an increase in gross operating profit and gross margins but costs overwhelmed them.  Management stated that it is following its five point transition plan and it is costing money.  The company is investing in improving its omni-channel distribution, growing its online presence.  Management reported page views and average monthly visits to its online platform have doubled year over year.  Myer has invested in a new order management system and has a loyalty program to support its omni-channel distribution efforts.  Three new stores were added in FY 2013 and the company is investing in store refurbishments.  

David Jones is also working to transition itself to meet future challenges.  The company recently launched a high-end “village-format” fashion outlet.  David Jones is also investing in omni-channel distribution with an online platform intended to tie the physical stores into its online site.

In addition, the CEO is looking for opportunities to maximise the company’s real estate holdings.  Apparently the company is interested in making use of the air rights above the David Jones store in Sydney.

In short, both these department stores may be down, but both are working mightily to keep from being “out.”

The final company is specialty fashion retailer, the Oroton Group Ltd (ORL) – the only stock in the table whose share price has declined year over year.  The company operates “boutique” style shops across Australia, New Zealand, Singapore, Malaysia, and China.  Oroton’s specialty is leather goods but also offers other high end fashion accessories under its own brand and, formerly, under the Ralph Lauren brand.  On 16 August 2012 Oroton announced its licensing arrangement with Ralph Lauren would cease as of 13 June 2013, and the share price plunged; it has yet to recover.  Here is a 2 year chart showing the fall:

The company has replaced Ralph Lauren with a 51% interest in a 10 year licensing agreement with US based clothing retailer Brooks Brothers.  Brooks Brothers already does about AUD$1 million in sales here in Australia through online sales, without a single store.  The joint venture will start opening stores next year and launch a local Australian online shopping platform.  Management of both companies is estimating the deal could generate AUD$50 million in revenue within five years.  Brooks Brothers is highly respected and has seen 22 years of continuous growth, due in part to its highly successful online efforts.

Brooks Brothers is an iconic brand in the US, having been in business since 1818.  It was revolutionary at the time, being the first clothier to offer ready-to-wear goods.  This deal makes Oroton Group one to watch.

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