It is hard to get excited about discretionary retail stocks with so many gloomy reports about Australia’s economy. Consumer confidence remains soft despite record-low interest rates, rising household wealth and better-than-expected job news.
The big problem, of course, is households worried about job security. The Westpac Melbourne Unemployment Expectations Index jumped by 8.5 per cent in April to its highest level since December. Job insecurity is encouraging consumers to save more and spend less.
Another quarter of a per cent rate cut this year high probability after the latest fall in consumer confidence and as a tumbling iron-ore price cuts into Australia’s terms of trade. The trouble is, lower interest rates are having less effect on consumer confidence than in past cycles.
That is a challenging backdrop for Dick Smith Holdings and JB Hi-Fi, as well as other retailers highly leveraged to consumer spending. However, both companies are performing well, look undervalued at the current price, and have strong leverage to any gains in retail sales growth.
Dick Smith had to convince plenty of non-believers when it floated on ASX in December 2013 in a $344 million Initial Public Offering. Critics argued the business, formerly owned by Woolworths, had been brought to the market too quickly by its private-equity owners.
The company has, for the most part, struggled to trade above its $2.20 issue price. It slumped to $1.86 in June last year, rallied to $2.36 in September after a decent full-year result, and has since eased to $2 amid growing concerns for Australia’s economy.
Chart 1: Dick Smith Holdings
Not even a solid half-year result in February could spark a rally. Dick Smith reported first-half net profit of $25.2 million for 2014-15, up 0.8 per cent on the same time last year. Comparable sales rose 2 per cent; stronger growth in Australian sales was offset by weakness in New Zealand due to higher competition.
Judging by recent share-price weakness, Dick Smith spooked the market with news in March of a restructuring that will affect about 80 support jobs and create $8-$12 million in savings. Although the job cuts are part of a long-term plan to improve business efficiency, the market might have questioned whether trading conditions deteriorated more than expected in the first quarter.
JB Hi-Fi has not had the same issues. After sharp falls last year, it has rallied from below $15 in October to $19. The company was oversold at its low, but the market clearly believes it can continue to maintain sales and profit growth in a challenged Australian economy.
Chart 2: JB Hi-Fi
Dick Smith has plenty of work ahead to convince the market the turnaround in its fortunes can be sustained. But that is also an opportunity. Unlike the efficient JB Hi-Fi, Dick Smith still has plenty of scope for efficiency gains. The latest restructuring reduces its cost base and makes it easier for suppliers to deal with the company.
In announcing the restructuring, Dick Smith reaffirmed its guidance of sales growth of about 10 per cent in 2014-15, and after-tax net profit and earnings per share growth of 3-5 per cent. It said: “The growth profile for Dick Smith remains strong, with significant progress made to cement its position as Australasia’s leading consumer electronics retailer.”
Further store openings are a key growth driver. Eleven new stores in the first half of 2014-15 took the total to 385 in Australia and New Zealand. Another nine stores, and Move by Dick Smith locations at Sydney Airport, are planned. The Move by Dick Smith concept, which targets women who see technology products as fashion accessories, has strong growth prospects.
Strong gains in online sales and continuing growth in private-label Dick Smith products, which are getting good traction with customers, are other key initiatives. The goal is lifting private-label sales from 12 per cent of total sales to 15 per cent.
At $2 a share, Dick Smith trades on a prospective Price Earnings (PE) multiple of about 11 times 2014-15 earnings, according to consensus analyst forecasts. Five of seven brokers who cover the stock rate it a buy or strong buy, one has a hold, and one has an underperform. The median price target is $2.40.
Although Dick Smith looks marginally undervalued, the challenge is finding a re-rating catalyst in the next few months. It is hard to see much joy on the economic front as the next Federal Budget in May most likely dents consumer confidence again.
I am looking for signs that Dick Smith is improving the New Zealand operations, finding further efficiency gains and rapidly rolling out the Move by Dick Smith concept, which has terrific potential in Australia and overseas.
My sense is that Dick Smith will get cheaper in the next few months as more bad news on the economy emerges. There is good potential to retest the previous high near $2.40 in the next 12-18 months if the company can show its turnaround is sustainable and there are better signs on jobs, consumer confidence and retail sales.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at April 15, 2015.