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Morningstar | Premier Investments’ Core Brands Challenged, While European Economies Provide Tailwind for Smiggle

Shares in no-moat-rated Premier Investments are screening as expensive, trading at an 18% premium to our unchanged AUD 14.50 per share fair value estimate. We continue to credit Smiggle with successfully rolling out stores in Europe and even entering two further countries in 2020, beyond those already confirmed by management. However, we think the company’s core brands, largely operating in a highly contested Australian fashion retail market, will face gradually declining sales over the next decade. At the current share price, the market is either overestimating the pace and scope of the Smiggle expansion, or underestimating the structural headwinds faced by the company’s core fashion brands, excluding Peter Alexander.

Smiggle has established beachheads in the United Kingdom and Northern Ireland, and its first store in the Netherlands will open in late 2018. Belgium has been flagged as the likely next cab. We expect Premier Investments to eventually also introduce the brand to Germany and France, two large and lucrative European markets. They neighbour Belgium and the Netherlands, and future distribution infrastructure could potentially be shared across the region. By fiscal 2027, we forecast store counts in Germany and France to match the footprint in the United Kingdom, Smiggle’s largest market today. We expect the Smiggle expansion to benefit from a benign macroeconomic environment, at least in the near term. The International Monetary Fund expects the economies of the European Union to increase GDP by 2.5% in 2018 and 2.1% in 2019, and unemployment remains low. This strong growth, in conjunction with declining sales in the lower-margin core apparel brands, is the primary driver of a 350-basis-point jump in our forecast for group operating margin, to 15.5% by fiscal 2027.

In Australia, clothing retailing picked up in the five months to May 2018. According to the Australian Bureau of Statistics, clothing retailing grew by 2.6% in the first five months of second-half fiscal 2018, compared with only 1.6% in the first half. This tracks with our expectation of recovering core brand sales in the second half of fiscal 2018. We estimate core brand sales to decline by 2.3% in fiscal 2018, less than the 2.7% reduction seen in the first half. The influx of international fashion retailers to Australia, along with online competition, has resulted in sales growth of Premier’s core brands underperforming the overall Australian fashion market for several years. We estimate that the Australian clothing market grew at a compound annual rate of 5% over the past five years, while Premier’s core brand sales were flat. We forecast this trend to continue, with core brand sales, currently accounting for 55% of group sales, to decline by 2% on average over the next decade. Bucking the trend, sleepwear specialist Peter Alexander is growing strongly, including by 15% in the first half of fiscal 2018. We forecast this growth rate to persist into fiscal 2020, from where we expect it to slow to 7% in the longer term.

Further troubling traditional Australian retailers is the structural decline in foot traffic to shopping centres, resulting from the migration of consumers to the online channel. Premier identified this trend relatively early, focusing on building its e-commerce capabilities, and is continuing to invest in online technology. Some 10% of Premier’s retail sales are already conducted online, and operating margins in this channel are higher than the group’s average of around 12%. The operating margin could further benefit from rationalisation of the core brands footprint, in addition to negotiating better lease terms. Premier’s six apparel brands combined represent the largest specialty apparel retailer in many of Australia’s shopping malls, providing management with a large bargaining chip at those locations.