The Wrap: Retail, BNPL, Oz Dividends

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Weekly Broker Wrap: Discretionary retail unwinding, BNPL regulatory hurdles, special dividends expected

-Snap lockdowns to undermine discretionary retail earnings/share prices
-Proposed EU-based consumer credit regulations may affect growth for Afterpay/Zip Co
-Major rebound in buybacks, special dividends, and return to normal dividend payout ratios on the cards

By Mark Story

Discretionary retail: Lockdowns tarnish second half earnings

Despite the accelerated vaccine roll-out nationally, Jarden sees the real risk of Australia remaining closed for longer, which will likely delay the reopening trade.

To reflect snap lockdowns in NSW and Victoria, partial lockdowns in QLD, WA and the NT, plus a growing cost of doing business pressures (CODB), Jarden has cut FY21 earning per share (EPS) forecasts by an average -5% across a handful of discretionary retailers.

The broker suspects softer trading updates at results in August (ex-food), together with weaker cash flow and comments on rising CODB may put discretionary retailer share prices under pressure. The broker also believes snap lockdowns have materially reduced risk of second half positive earnings surprises.

Most impacted, in Jarden’s view, are electronics/leisure/outdoor retailers, including Super Retail Group ((SUL)), Accent Group ((AX1)), JB Hi-Fi ((JBH)), Harvey Norman ((HVN)), Premier Investments ((PMV)) (locally) and The Reject Shop ((TRS)) of the companies the broker covers.

With the exception of food, Jarden sees lockdowns as a net negative for sales, due in part to insufficient time for consumer behaviour to change. The broker notes without Jobkeeper or rent reductions retailers would bear the full cost without the sales.

Fueling Jarden’s caution of growing pressure points for discretionary retail in FY22 is the cycling of strong demand, which may see sales turn negative for many retailers as trading activity returns closer to trend.

Additional pressure points highlighted by Jarden include the return of promotions as stock availability improves, cost pressures, and household cash flow turns negative.

Meanwhile, Jarden favours companies that should benefit from a global reopening and/or improving long-term return on invested capital (ROIC), including Flight Centre Travel ((FLT)), Premier Investments ((PMV)), Beacon Lighting ((BLX)), Lynch Group ((LGL)) and Domino’s Pizza Enterprises ((DMP)).

With undemanding FY22 consensus forecasts not appearing to appropriately reflect improvements in housing churn and house prices, Citi’s preference within small cap retail remains housing retailers.

The broker highlights Beacon Lighting and Nick Scali ((NCK)) as both emerging from FY21 with stronger balance sheets that can be used to drive shareholder value.

Citi, which has Buys on Beacon (target price $2.21) and Nick Scali (target price $12.05) expects both stocks to benefit from the improving housing cycle. While Beacon will face challenges in cycling the strong comparables from July/August 2020, Citi expects like-for-like sales to continue to grow compared to July/August 2019.

Citi also suspects both its in-house and consensus FY22 expectations for Nick Scali may turn out to be conservative given the elevated order book at end of April 2021, forex tailwinds, and the strong housing cycle.

Citi also has Buy recommendations on Baby Bunting ((BBN)) and Michael Hill International ((MHJ)) with price targets of $6.22 and $0.93 respectively. Given the relatively non-discretionary nature of the category, the broker suspects Baby Bunting could have relatively less downside than other listed retailers, should conditions slow.

Citi also expects Michael Hill to continue to deliver increased sales and margin growth on the back of strategic initiatives, including a loyalty program, omni-channel strategies and digital sales.

Overall, given that covid lockdowns have coincided with many retailers cycling strong comparables from the previous period and a likely reduction in consumers' disposable income, Citi sees downside risk emerging for store-based retailers for July/August 2021 trading updates.

Citi has Neutral ratings on City Chic Collective ((CCX)), Accent Group, and Lovisa Holdings ((LOV)). Due to its greater online exposure, strong sales and earnings growth prospects for the next two years, City Chic remains the broker’s favoured small cap retailer with international exposure.

BNPL: EU regulations could impact Afterpay/Zip Co

UBS believes the recently proposed update to the European Union’s rules on consumer credit, which is expected to provide greater clarity on exactly what consumers are signing up for, has broader implications for Buy Now, Pay Later (BNPL) services.

Proposed EU regulations, which highlight potentially detrimental products due to the high costs they entail, high fees in case of missed payments, plus myriad other concerns are consistent with the broker’s view that regulation of BNPL will increase.

UBS notes the degree of regulation proposed at the early stage of the development of Afterpay’s ((APT)) and Zip Co’s ((Z1P)) businesses in the EU is higher than that imposed in the A&NZ and US markets at an equivalent stage.

As relatively early-stage payment disruptors, UBS reminds investors that both Afterpay and Zip Co are exposed to numerous commercial, regulatory and technological risks. The broker suspects this regulation may impact growth, with more onerous credit checks potentially reducing the sign up to new services.

While the interpretation of unsolicited sale of credit to consumers is unclear, UBS sees a risk this may impact the ability of BNPL services to partner with merchants to actively grow their customer bases through promotions.

As a case in point, the broker highlights that Afterpay unilaterally increases consumer credit limits over time based on repayment behaviour. While the directive currently appears to ban this for credit cards and overdrafts, UBS sees a risk that BNPLs may also be prohibited from doing so.

The broker has Sell ratings for both Afterpay ($42.00 price target) and Zip ($5.60 price target).

Oz dividends: Returns boost for investors

Due to sound capital management activities, Martin Currie Australia expects to see strong growth in the dividend income from high-quality Australian companies.

The equity specialist believes high franking balances and high levels of cash companies are holding, on largely under-geared balance sheets, plus over-provisioning for bad debt levels during covid bodes well for rising earnings and dividends at the August 2021 results.

Equally encouraging, adds Martin Currie, are signs of greater optimism in the outlook statements and a restart in capex spending. Based on its analysis of the strength of Australian corporates, Martin Currie expects to see a flurry of on-market buybacks, off-market buybacks, special dividends, and rebound in dividend payout ratios.

The equity specialist is already witnessing heightened activity from companies such as Boral ((BLD)), which started an on-market buyback scheme in April.

While off-market buybacks were scarce in 2020, Martin Currie expects banks to use this method in 2021 to return their excess regulatory capital to investors, and suspects CommBank ((CBA)) could be the first to move.

Martin Currie also reminds investors that companies with strong earnings during and post-covid, including consumer, non-bank financials and resources sectors may also have the capacity to pay one-off discretionary dividends in addition to the half-yearly dividend schedule.

Given their low debt and substantial cash on their balance sheet, Martin Currie suspects Wesfarmers ((WES)) and JB Hi-Fi ((JBH)) could potentially return capital through either special dividends or an off-market buyback.

The equity specialist expects to see better payout ratios within construction and materials, with companies like CSR ((CSR)), Fletcher Building ((FBU)) and Adbri ((ABC)) already increasing or reinstating dividends in combination with special dividends or buy backs.

In addition to expected off-market buybacks, the lifting of APRA’s restriction of dividends – to less than 50% of statutory profits – should see banks return payout ratio levels to between 60 to 70%.

At the first half 2021 result banks stated their preference for using the surplus capital to reduce share count rather than payout a special dividend. However, Credit Suisse also suspects second half FY21 could signal heightened returns to shareholders.

Credit Suisse is forecasting $6bn of buybacks each for ANZ Bank ((ANZ)), National Australia Bank ((NAB)), and Westpac ((WBC)) and $8bn for CommBank through on-market buybacks spread over two years.

The broker notes there is upside to its buyback forecasts if the banks utilise more of their surplus and/or execute structured off-market buybacks, particularly for Westpac, which has the highest franking balance at $3.5bn.

Due to Westpac’s large franking balance, Credit Suisse assumes the bank is able to distribute a larger amount of capital and franked dividends to shareholders and could potentially buyback 12% of its shares.

Martin Currie Australia is part of Franklin Templeton.

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