EUR 850.00 For Business Accounts Only

Morningstar | The Warehouse Group’s EBIT Margins Flat as Intense Competition Bites

The Warehouse Group posted 5.2% growth in adjusted net profit after tax, or NPAT, to NZD 39.6 million for the first half of fiscal 2019, tracking slightly ahead of our prior full fiscal year 2019 estimate of 3.9% NPAT growth. Group sales were up 2.7% in the half, slowing significantly in the second quarter as intensified competition and slow Christmas sales took their toll, as we had anticipated. Nevertheless, group sales were better than expected and we increase our full-year sales growth estimate to 2.8% from 1.7% previously. The main driver of our revised expectation is the consumer electronics chain Noel Leeming continuing its strong sales momentum, growing its top line by 7.1% in fiscal 2019, up from 3.1% previously. As a result, we marginally increased our adjusted NPAT estimate to NZD 62 million from NZD 61 million for fiscal 2019, slightly below management’s guidance range of NZD 63-66 million. Beyond fiscal 2019, our sales growth estimates remain virtually unchanged, with forecast average sales growth of 2.3%. The time value of money, together with the slight increase in earnings and lower than expect capital expenditure in fiscal 2019, lift our fair value estimate by 4% to NZD 2.50.

We continue to forecast muted EBIT margin improvement for the group longer term. In contrast with management’s aspirational goal of exiting fiscal 2020 with 7% EBIT margins, we estimate EBIT margins to only widen by 20 basis points to 3.3% in fiscal 2021. Supporting our investment thesis, group EBIT margin expansion proved elusive in the half, as stiff competition during an overall weak retailing sector over the Christmas period weighed down the core Red Sheds’ performance--which account for 77% of group operating profits.

We will cease coverage of the Warehouse Group in April 2019 to focus on larger businesses with greater liquidity that are more suitable for our investor clients. We reiterate our no-moat, high fair value uncertainty, and Standard stewardship ratings.

The New Zealand retailer declared a fully imputed interim dividend of NZD 9 cents per share, representing an 83% payout, but a 10% decrease on the prior half. Management expects the second half is to improve on the previous corresponding period, and expects an increase in adjusted net profit after tax of 7%-12% in fiscal 2019.

The Warehouse, or Red Sheds, segment delivered flat sales growth in the half. Gross profit declined by 0.6% with gross profit margins shrinking by 20 basis points. Cost of doing business remained flat on pcp. The Red Shed business continues to face headwinds particularly in the apparel and outdoor categories which were affected by cooler weather. However, the warmer weather in January resulted in an uptick in seasonal category sales. Online sales at the Red Sheds grew 21% on the prior half, representing 4.9% of total sales.

Consumer electronics retailer Noel Leeming's strong sales growth of 7.4% was a highlight for the half-year result, driven by strong sales in most product categories. Gross profit margin remained stable compared with the pcp, with operating leverage driving a 20 basis points expansion in EBIT margins to 3.6%.

Warehouse Stationery segment recovered from the operational integration issues in the pcp, with gross profit margins improving by 150 basis points. Combined with 3% growth in sales, this resulted in a 6.9% growth in gross profit.

Torpedo7 Group generated a loss of NZD 1.8 million despite a 1.5% increase in sales and 4.5% increase in gross profit. Offsetting was a significant 17.4% increase in operating costs related to the store expansion programme.

Online sales across the group grew strongly by 24% on the pcp, accounting for 7.7% of group sales. Management intends to continuously shift from traditional in-store shopping to an omnichannel mode with ongoing investing in the digital channel.