A Merry Christmas for Myer and DJs?

Financial journalist and commentator on 3AW and Sky Business
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If it’s Christmas, the advertising blitz is driving us crazy, the weather is warming up, the year is rushing to an end, the family demands are starting to wear a bit thin – and the tills are singing at Myer and David Jones.

Or are they?

The Christmas and New Year sales are the most important time of the year for retailers: traditionally up to 25% of their yearly earnings is generated at this time.

Retailers are counting on Christmas to redress the effects of a constant battering of consumer confidence at the hands of the global economic outlook, cost of living pressures, the pressure to pay down household debt, the lack of the ‘wealth effect’ that flows from rising house prices, rising fuel and electricity prices and general economic uncertainty.

They are also fighting the increasing propensity of Australians to shop online from overseas websites, lured by cheaper prices, unprecedented purchasing power via the high Australian dollar and no GST.

The retailers have some reasons to be optimistic going into Christmas 2012: wages growth is solid, house prices are stabilising, and consumer confidence has picked up. Even more importantly, the Reserve Bank has lopped 1.25 percentage points from official interest rates since last Christmas, meaning that mortgage rates are about one full percentage point lower than at this time last year. This should increase disposable income from last year.

A recent Commonwealth Bank survey projects Australians spending up to $16.2 billion this festive season. With people budgeting on average $475 for presents, according to the survey – down $10 on last year – an estimated $7.8 billion will be spent on presents alone.

And boy, do the retailers need it.

Myer vs David Jones

Take Myer, which had what it described as a “solid” year in the 2011-12 financial year, with sales down 1.3% to $3.1 billion, and net profit down 12.7% to $139.4 million.

Given the tough environment for retail, the company did a magnificent job of extracting more profit from its sales – it lifted gross profit margin by 1.05 percentage points to 41.31%. But Myer – sensibly – didn’t give any earnings guidance for the coming year. Chief executive Bernie Brookes expects the current quarter, which includes the crucial Christmas and Boxing Day sales period, to be “flat”.

Myer’s arch-rival David Jones reported a 4.8% fall in sales for FY2011-12 to $1.87 billion, and a net profit drop of 40% to $101.1 million. David Jones didn’t do as well on the margin front as Myer: its gross profit margin slipped badly to 37.5%, well below the company’s preferred 39.5-40% range.

But department store heavyweights are seeing some tiny chinks of light at the end of the tunnel. In the first quarter of the current financial year, Myer reported a 1% increase in sales, while DJs had its first quarter of sales growth in two years.

Shares struggling

But the simple fact is that the shares have been hammered.

Myer, notoriously, has struggled on the market since its $2.2 billion float in November 2009. Sold through the prospectus at $4.10, Myer shares opened on the market at $3.88 and have never traded above the issue price – the best that shareholders have done is a peak of $3.96 in September 2010. In June this year the stock touched a low of $1.61, but it has at least recovered to $2.18.

Myer has been a good performer this year, but has lost about 8.3% a year over three years.

DJS has managed to keep its head above water in 2012 – starting the year at $2.37, recovering from a June low of $2.12 to be at $2.50 at time of writing – but the stock has lost more than 17% a year over the last three years.

The bottom line for these two corporate icons is that the investment case to hold them in a SMSF is simply not convincing.

Beware the value trap

At $2.18, Myer is trading on an historical yield of 8.71%. For an SMSF in accumulation mode, paying 15% tax, that equates to about 10.6%. If the fund is in pension mode, that yield is about 12.4%.

At $2.50, David Jones is trading on an historical yield of 7%. For an SMSF in accumulation mode, paying 15 per cent tax, that equates to about 8.5%. If the fund is in pension mode, that yield is about 9.9%.

Myer is expected (by the market consensus forecast) to cut its dividend from 19 cents in FY2012 to 18.2 cents in FY2013 and 17.9 cents in FY2014. That would make the yield for FY2013 come to 8.35% (nominal); 10.16% (SMSF accumulation mode); and 11.86% (SMSF pension mode). For FY2014, the yields would be 8.21% (nominal); 10% (accumulation); and 11.7% (pension).

That is undeniably attractive. But it also looks like the classic value trap – where it is the market pessimism (that is, the depressed share price) that is creating the high yields. And in neither stock is the earnings or dividend outlook pointing in the right direction.

David Jones is also expected by the market consensus to lower its dividend, from 17.5 cents a share in FY2012 to 16.8 cents in FY2013 and 16 cents in FY2014. At the current share price, for FY2013 you would be looking at a yield of 6.72% (nominal); 8.18% (SMSF accumulation mode); and 9.54% (SMSF pension mode). For FY2014 the yields would be 6.40% (nominal); 7.79% (accumulation); and 9.09% (pension).

Again, those are attractive yields – but falling earnings and dividends is not the situation you want to see. Myer CEO Bernie Brookes and his DJs counterpart Paul Zahra are fighting the good fight against some pretty strong headwinds, but neither Myer nor David Jones belongs in your fund’s Christmas stocking.

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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