Beware turnaround situations that involve companies overcoming cyclical and structural threats. It takes gifted managers to navigate a weak economy and industry disruption, and Corporate Australia does not have enough of them.
Fairfax Media is an example. Like most in its industry, Fairfax continues to struggle with the migration of advertising from print to online. A sluggish economy, a big headwind for any cyclical business, has compounded the business-transformation challenge.
Department stores face similar problems. As more consumers buy goods online and favour speciality retailers, the department store format worldwide has struggled. An “income recession” among consumers, amid record-low wages growth, compounded the problem.
The share falls in Myer Holdings from its 2009 issue price and in David Jones before it was bought reinforce how much wealth can be destroyed when cyclical and structural forces conspire to crunch companies. Overcoming one of these threats in a hyper-competitive market is hard enough; beating both takes management genius.
Corporate restructures are invariably easier when the economy is improving. Companies have greater leeway to make tough decisions, impair assets and perhaps sacrifice some sales in the pursuit of higher margins. There’s some scope to recover from bad decisions.
I have avoided department stores – and old media for that matter, until earlier this year – for these reasons. Myer, for the most part, has looked overvalued given its challenges, despite its sharply lower price. It was more of a “value trap” than good value.
My view on Myer is changing, principally because I expected improved trading conditions for retailers in the second-half of 2017 – and the market to price in that view in advance. Those such as Myer with strong leverage to improving consumer confidence look well placed to outperform the broader sharemarket.
Investors could be starting to price in a nascent recovery in Myer. The stock fell from almost $3 in April 2013 to $1.10 at the start of 2016. It has rallied to $1.27, much of the gains in November, after topping market expectation with its FY17 first-quarter sales performance and commentary.
Chart 1: Myer HoldingsSource: The Bull
Myer’s sales growth has remained more resilient that some broking firms expected – a good effort in a challenging market. The department store owner maintained its profit guidance and it shares spiked on the news.
I expect some the headwinds facing Myer to ease in the second-half of 2017. There could be an inflexion point for the Australian economy and sharemarket in the next six months, as commodity prices remain elevated (though not as high as current spot prices), housing slowly comes off the boil (without crashing) and wages growth starts to rise.
Do not expect big gains or a bull market to resurface anytime soon. But it looks like the economy, more through good luck than good management, is navigating through a series of significant risks, notwithstanding the threat of a nasty slowdown in apartment construction.
By this time next year, unemployment could be edging lower and income growth inching higher as the labour market improves. If that happens, confidence should slowly improve and consumers might be encouraged to spend more and save less.
That would boost Myer, which is as leveraged to discretionary consumer spending as any retailer. Myer looks well placed to capitalise on any consumer gains, given its work to cut costs, close unprofitable stores, improve inventory and lift the customer experience.
Of course, Myer’s structural threats remain as intense as ever: online retailing; the move away from general department-stores; the rise of foreign retailers in Australia; and a market that has been conditioned to expect heavily discounted items at sales. An expected bigger push from Amazon in Australia is another threat.
From a customer’s perspective, department stores feel like they are starting to find their mojo again. David Jones looks a much-improved business under its new ownership, and I was pleasantly surprised at the product range – and service – recently at Myer.
It was not so long ago that the only way to get served at Myer was to pretend to shop-lift, so bad was its service. An insane decision to cut service staff numbers infuriated customers, missed opportunity to upsell products and damaged department store brands.
As always, the key is valuation. At $1.27, Myer trades on a forecast price-earnings (PE) multiple of 12.7 times FY17 earnings, according to consensus analyst forecasts. That is below the market average and it does not look excessive, despite Myer’s challenged growth prospects.
The market has mixed views on Myer. Three of 10 broking firms that cover the stock have a buy recommendation, five have a hold and two have a sell. A median price target of $1.30 suggest Myer is fair value at the current price.
I believe the market is underestimating Myer’s prospects for FY18. Not excessively so, but enough to put the retailer on the radar of value investors, particularly if its share price weakens after gains in November.
As the market favours large-caps over small-caps in 2017, and growth stocks over income ones, Myer stock could finally have some sustainable upward momentum. If it does not, a takeover by a foreign predator is a possibility.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. The article has been prepared without taking into account your objectives, financial situation or particular needs. Before acting on the information in this article you should consider the appropriateness and accuracy of the information, with regard to your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at December 1, 2016.