Purchase of Myer Holdings Limited (MYR)

For clients that have selected the “Blend” AEQ option we will be replacing Leighton with Myer. Due to Leighton being subject to a 3 for 8 offer from major shareholder Hochtief at $22-50 cash per share which we have accepted, the purchase of Myer across all client portfolios is not expected to be fully completed until late next month when the proceeds from the Hochtief offer is paid.

Myer is Australia’s largest department store group with total sales of over $3.1 billion in FY13 and a network 66 stores in prime retail locations across Australia complimented by their recently enhanced online, digital and mobile platforms.

We like Myer because:

• The company has managed margins, operating cash flow and the balance sheet well during tough retail conditions over the last few years whilst also making significant capital investments;
• The company is expected to benefit from an improvement in retail sales growth rates flowing from record low interest rates and increased consumer confidence;
• It’s private label penetration is expected to continue increasing in coming years which should help support margins;
• It has a clearly defined corporate strategy for driving growth with management making solid progress on execution of the 5 point plan;
• Myer One loyalty program has 5m members which generate circa 70% of group sales via repeat business. Valuable customer data allows more targeted marketing and offers to these important customers;
• A vast store network supports the Omni-channel strategy as consumers value the buy online, pick-up in store option. A greater focus on optimising the store network rather than simply adding new stores should see improved free cash flow generation going forward.

The Primary Risks to our Positive View on the Company are:

• While Myer is a well run business it is facing ongoing competition from the discount department stores, international entrants and online providers which has seen department stores lose market share over the past decade. Competition in the mid-tier retail segment is intense;
• Lower interest rates fail to simulate retail sales due to factors such as rising unemployment levels, cut backs in government spending and/or unwinding of the mining investment boom, which combined with ongoing labour and occupancy cost pressures result in further margin compression;
• A falling A$ increases inventory costs putting pressure on margins. Further gains from lower shrinkage and own-brand penetration will likely also be more difficult going forward and cause gross margin growth to be more constrained;
• Omni-channel distribution model fails to gain significant traction as a proportion of total sales.

While retailing remains challenging, we believe the cycle is slowly improving albeit at a far slower pace than during previous periods of interest rate cuts. Investors may thus require some patience, but with the stock offering a very attractive dividend yield (consensus FY15 forecast c.7% before franking), they are being paid to wait for conditions to improve.

Disclaimer

EP Financial Services Ltd

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