Do these strong performers belong in an SMSF?

Financial journalist and commentator on 3AW and Sky Business
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The difficulties just seem to keep mounting for Australian retailers.

There is the high Australian dollar, which is seeing business sucked offshore by overseas websites. Research firm IBISWorld expects Australian online shopping turnover to grow by 5.1% a year over the next five years (some of it on Australian websites), although this is coming off a low base: NAB estimates that online retail represents only 5% of the local industry’s total business.

There is the high cost of doing business in Australia, including some of the highest rents in the world – Westfield’s Pitt Street Mall in Sydney CBD is ranked as the second most-expensive retail location in the world – and some of the steepest staff costs in the world, especially on weekends and public holidays.

There is the flurry of big-name overseas competitors that have opened in Australia in recent years, including GAP, Costco, Banana Republic, Zara and Topshop.

And then there is the persistent conservatism of Australian consumers – despite solid wages growth, stabilising house prices and official interest rates that have shed 1.25 percentage points since last Christmas.

Given the fact that Australia’s economy – despite a clear bifurcation between the resources sector and the rest of the economy – is growing at a rate that the rest of Australia’s OECD peer group of nations can only envy, it is this “glass-half-empty” attitude among Australia’s shoppers that is proving to be the retailers’ number one problem.

On the latest Australian Bureau of Statistics figures, retail trade was flat in October after rising by 0.5% in September and 0.3% in August. Annual spending growth fell in October from 3.5% to 3.1%.

No wonder the Christmas-New Year sales period is so eagerly awaited by the nation’s shopkeepers!

Winners and losers

Since the GFC hit, the retail sector has largely struggled, but there have been pockets of success.

Discount variety retailer The Reject Shop (TRS) has been a standout, generating a total return of about 7.7% a year over the last five years. The Reject Shop has a business model that suits the times, and has expanded its store network significantly through the GFC. In 2013 the company will augment its expansion by taking over the leases for a number of stores of the failed discount variety retailer, Retail Adventures.

The share price has moved from $12.30 five years ago to $15.14 – via a peak of $18.40 in October 2010 and a trough of $9.12 in September 2011.

At the other end of the retail business, luxury goods retailer Oroton (ORL) has also been a stellar performer, generating a total return of about 21.7% a year over the past five years, and 10.8% a year over the last three years. Oroton’s share price has moved nicely from $3.90 at the end of 2007 to $6.95 at present.

Super Retail Group (SUL) – owner of Supercheap Auto, sports retailer Rebel Group and outdoor activities chain BCF (Boating, Camping and Fishing) chain – has also kicked some big goals under pressure, generating a total return of 24.3% a year for the past five years and 29% a year over the past three years.

In contrast, retail icons such as JB Hi-Fi (JBH) and Harvey Norman (HVN) have struggled, going backwards in total return over both three and five years (Harvey Norman is down a stomach-churning 19% a year over five years and 20.4% a year over three years.) It is in this pair’s electronic appliances business specialities – and furniture and bedding for Harvey Norman – that consumer reluctance to spend is most noticeable, although JB Hi-Fi, for example is a far more efficient operator than most of its overseas peers.

The yields

On yield grounds – which concerns SMSFs most pressingly – some stocks in the sector are attractive at first glance, but earnings risk (and thus dividend risk) is very high in this area. For example, JB Hi-Fi is expected by market consensus to pay 65.4 cents a share in dividends in the 2013 financial year, rising to 68.3 cents a share in FY2014.

At $10.24, that prices JBH on a prospective FY2013 nominal yield of 6.35%, and 6.67% for FY2014.

That is starting to get into attractive territory for an SMSF because the FY2013 nominal yield converts to 7.71% for a fund still accumulation, and 9% for a fund in pension mode (and paying no tax.)

The FY2014 yield converts to 8.1% for a fund in accumulation mode and 9.5% on a pension income stream.

Oroton, too, has a hefty 8.16% nominal yield projected by the market consensus for FY2013 on the expected dividend of 56.7 cents, which is expected to fall to 41.1 cents in FY2014, generating, at a share price of $6.95, a yield of 5.91%.

The risks

Why Oroton’s projections are all over the place – and why that 8.16% yield should be looked at askance – is that on 30 June 2013, Oroton will lose its exclusive licence agreement with Ralph Lauren Corporation, under which Oroton has distributed Ralph Lauren products in Australia and New Zealand for almost 25 years.

The Ralph Lauren licence (which the parent company is taking back) represents 32 of Oroton’s 92 stores, 45% of its sales, and 35% of net profit. The sharemarket showed what it thought of the deal by stripping 25% off the value of the company when it returned to trading after the announcement in August.

It is not as if Oroton is going to subside into oblivion: the company says it will use the freed-up capital to expand its own brand into Asia, and look at opportunities from which it was barred while working with Ralph Lauren. Chief executive Sally Macdonald is considered one of Australia’s best retail minds, and the company is arguably the most successful online operator of Australia’s listed retailers, generating more than 10% of total sales through this channel.

The bottom line

The problem for an SMSF is that the earnings risk is too high – both at Oroton and JB Hi-Fi – for a fund to try to pick up on these yields. And sadly, neither The Reject Shop nor Super Retail Group, although gun performers, are exactly stand-out yield plays: TRS’ expected FY2013 dividend equates to a yield of 2.76%, and while the FY2014 expectation is better, at 4.3% it is not stellar. Likewise, Super Retail is presently priced at a 3.93% yield in FY2013 and 4.71% in FY2014.

The headwinds assailing the retailing sector are not going away: and investors would be gambling to pile in before the effect of the critical Christmas-New Year season on the tills is seen. Sadly, retail is not a sector where SMSFs can invest for yield and sleep at night.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.

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