article 3 months old

Super Retail Still Challenged By Restructuring

Australia | May 12 2015

-Margin, competition risks prevail
-Need to restore investor faith
-Success with strategy required


By Eva Brocklehurst

Super Retail ((SUL)) continues to restructure its business with most brokers considering the outlook robust, albeit with some caveats on the back of consumer sentiment, margin compression and exchange rate volatility. Nevertheless, successful execution of the company's strategy is paramount to any re-rating of the stock.

Sales were strong but margins weak in the March quarter and the over-riding outlook is stable, in Citi's view. By addressing its problems and overhauling its supply chain the company should achieve 17% earnings growth in FY16. Half of this relates to action by the company to close the loss-making Fishing Camping Outdoors business and scale back Workout World. Each of the segments may have lower earnings margins in FY16 but this does not worry Citi unduly. The drop may be 50 basis points, but 30 points of this can be explained by higher depreciation associated with investment in systems.

The broker also considers the company is managing its headwinds well, through initiatives such as a lower hedged Australian dollar and negative margin in sports and leisure. Growth opportunities prevail in store numbers, productivity, margin and supply chain costs and, in Citi's opinion, this is a rare combination for a large ASX-listed retailer – having all four areas contributing to growth.

Morgans observes the company is looking better than it has for some time but concedes competitive pressure on margins. The exit from the loss-making businesses and stores means FY16 forecasts should be achieved. That said, Queensland continues to be a major drag, the broker notes, with the region detracting around 1.0% in like-for-like sales growth.

JP Morgan is more conservative about the update and considers downside risks are to the fore, given margin contraction. The broker also maintains there is a risk that the restructure in leisure is insufficient, with the prospect that margins are slow to expand and more restructuring charges are announced. Moreover, expanding businesses such as Workout World, Amart (into NSW and Victoria) and Infinite Retail will weigh on the financial performance. While historically the earnings growth driver, JP Morgan is also concerned that the automobile division, Supercheap Auto, may slow. This adds up to a lack of valuation support and the broker retains an Underpeform rating.

Other brokers are more optimistic. UBS expects trends to improve over the rest of the second half as easier comparables are cycled. The broker considers Super Retail offers a compelling investment given its market position, with over 25% share in the categories in which it operates, and top line growth. That said, UBS acknowledges that execution over the past 12 months has been poor, with earnings forecasts downgraded four times amid a material de-rating in the stock. Further downgrades and/or signs its strategy is not working could spark further de-rating.

Macquarie retains an Outperform rating and believes the various initiatives underway, such as automotive store roll outs and the restructuring of leisure and sports, should drive double digit earnings growth in FY16. The broker observes sales momentum in BCF (boating, camping, fishing) is also improving as the cannibalisation of stores is reduced. Morgan Stanley, too, found the trends encouraging, and expects strong sales momentum should offset the margin weakness. Moreover, the upgrades to the distribution centre should drive future margin expansion. The Amart rollout has affected earnings margins but as these stores mature Morgan Stanley expects margins will strengthen.

Outside of margin issues, there are signs the leisure division has turned a corner and the broker expects like-for-like sales to improve. Vehicle sales softened in the quarter but Super Retail has increased its long-term Supercheap Auto store target to 350 from 325 and this provides confidence in the longer-term growth outlook. While Supercheap Auto remains resilient, Deutsche Bank notes customers are highly price sensitive and this will be a challenge for the company over the next year. Also, Super Retail is deploying a lot of capital to support earnings growth with only a modest outlook while the broker suspects the repositioning of Ray's Outdoors will not be easy.

Deutsche Bank also maintains the company will need to demonstrate that the previous internal issues will not recur. The deterioration in leisure is of concern and points to a highly competitive market with underlying weakness in its customer base. On this basis the broker retains a Hold rating, requiring evidence of stabilisation before becoming more positive.

So what is involved in the restructuring? Restructuring in several areas will cost $27m in FY15, including closure of five Workout World stores by the end of this month. Another five will close by the end of the year, with the business re-styled as a fitness brand and integrated into the Rebel division. The exit of Fishing Camping Outdoors is to plan and all stores will be closed by the end of this month. The savings are being redirected to the Workout World and Ray's Outdoors restructure. The new format at Ray's Outdoors will be trialled in five stores while four will be closed by July 31.

Super Retail has four Buy ratings, two Hold and two Sell on FNArena's database. The consensus target is $9.98, suggesting 0.8% upside to the last share price. The dividend yield on FY15 and FY16 forecasts is 4.0% and 4.5% respectively.

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