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Morningstar | Myer Model Store Visit and Management Discussions Don’t Change our AUD 0.63 FVE

We visited no-moat Myer’s Southland, Victoria, department store and met with CEO John King and other senior management. Following the site tour and our discussions, we retain our AUD 0.63 fair value and earnings estimates. At current prices, shares trade at a discount of around 17% to our intrinsic assessment. The focal points of the company’s longer-term strategy were reiterated and are akin to those of other retailers domestically and abroad. This includes a high-quality product range that is hard for others to replicate by offering either private brands or national brands that are exclusive to Myer; enhanced customer service in store including upgrading stores themselves; and strengthening the online offering. This corresponds with our unchanged investment thesis.

The firm’s near-term attention is clearly on execution during the upcoming key Christmas trading period. To improve execution and ensure consistent in-store merchandising across the fleet, regional general managers inspected Myer’s model store in Southland to replicate its format nationwide.

We also expect to see more marketing, including television advertising, than last year to drive foot traffic. To convert this traffic into more profitable sales, store improvements are focused on shopper convenience. Compared with last Christmas, changes include more staff hours and a new staff incentive scheme to boost service, but also increased product accessibility, especially of higher-margin Myer Exclusive Brands, or MEBs, by making stores easier to navigate--for instance, by zoning related smaller products together, such as men’s underwear, socks, and belts. We expect virtually flat sales and underlying net profit after tax in fiscal 2019.

Over the next 10 years, we expect Myer’s sales to remain flat as the chain continues to lose market share to online players and specialty fashion stores. However, we expect the increased weighting of its offering towards differentiated, higher-margin private label products, as well as greater sales productivity to underpin a recovery in EBIT margins and profits. Over the next decade, we forecast EBIT margins to widen to 3.3% from 1.8% in fiscal 2018.
MEBs currently account for about 20% of fashion sales but could reach 25% in the coming 12 months and 30% in the medium term. In homewares, private label penetration could increase to 50% from around 20% currently, although the category is likely to account for a lesser share of the firm’s sales.
We expect Australian consumers to continuously migrate to the online channel, and the department store sector to gradually reduce floor space as footfall declines. We expect Myer to reduce its floorspace by 25% over the next decade, by closing entire stores, handing back floorspace to landlords, or subletting the space. We are not far from management’s expectations which envisage a store fleet ranging in the mid-50s and handing back a whole floor at some 20 locations with multiple levels. Based on the average-size store, this equates to a footprint reduction of about 20% across the current fleet of 62 stores. We continue to forecast an increase in Myer’s online penetration to 21% by fiscal 2021, in line the management’s aspirational target of lifting online sales to 20% from 8% currently.
Despite the woes the chain had in the recent past, Myer still reigns over about 1% of all total Australian retail spending. We anticipate the sheer size and diversification of Myer’s physical store network, and accompanied footfall, to be a draw card in signing up international brands seeking a presence in Australia that is low risk. Adding more exclusive international brands would assist Myer in differentiating itself in an increasingly competitive market. Australian national brands remain difficult to sell, and we expect their share of Myer’s sales to decrease in the medium term.