Reporting season preview: Retail Sector

About the author:

Josephine (Jo) Little
Author name:
By Josephine (Jo) Little
Job title:
Senior Analyst
Date posted:
05 August 2015, 12:24 PM
Sectors Covered:
Consumer Discretionary, Industrials & Developers

We expect a relatively upbeat reporting period from most companies in the consumer discretionary sector given more conducive consumer conditions in the second half and housing still a major tailwind for some.

We identify plenty of strong investment opportunities, but retain a Neutral sector stance given the materially lower AUD will have a meaningful impact on pricing and margins for most retailers from 1H16.

Our predictions for positive earnings surprise this reporting season include: Domino's Pizza (DMP), Adairs (ADH) and Beacon Lighting (BLX).

Candidates for negative surprise include: Automotive Holdings (AHG).

Foreign exchange impact

Given the sharp fall in the AUD, all retailers will have to address their approach to offsetting the cost inflation. Given hedging arrangements, 1H16 will be the first period to see meaningful COGS inflation.

The ultimatum is to lift prices or face severe margin pressure.

Effective pass-through of price increases while consumer confidence remains fragile will be a difficult proposition in our view. The vertically integrated retailers will feel the brunt of the currency hit first but are also arguably best placed to manage the process.

Ultimately, all will be impacted one way or another. Burson Group (BAP) looks best placed to effectively pass the increased costs on to its customers, while Lovisa (LOV) is also well placed given its quantum of offshore earnings (translation benefit) and high GM.

Key picks in retail

In a sector that will be impacted by the falling AUD, we stick with the retailers who are best placed to deal with the cost inflation. We are also mindful of the potential for the strong housing tailwind to ease in the future. Our top picks include:

Adairs (ADH) and Lovisa (LOV)

Lovisa (LOV) and Adairs (ADH) will produce their first results since IPO.

We expect LOV will meet its prospectus forecasts. The stock looks fair value at current levels based on growth projections in existing markets. However, expansion into a major northern hemisphere market would see significant earnings and valuation upside.

We believe ADH's FY15 result will surpass prospectus forecasts, the quantum of which may surprise the market.

Burson Group (BAP)

We see strong upside in this name and clear catalysts ahead (WA expansion, stronger than expected cost synergies from MAH and the base BAP business continuing to trade very well).

Domino's Pizza (DMP)

We believe DMP will exceed its FY15 guidance (32.5% NPAT growth), provide a strong trading update (particularly from ANZ with the GPS tracker to impact) and set growth guidance in line with the street (>20% growth).

We suspect the market will be surprised by how quickly margins ramp up from here. Acquisitions remain the key swing factor which we believe will just be a matter of time. With the above in mind, we see the stock going higher (potentially significantly) over the next six months.

Super Retail Group (SUL)

SUL is an interesting investment proposition currently with the capex intensive period now behind it and the resulting cost benefits yet to be realised. We expect FY15 consensus forecasts to be met.

Most importantly, FY16 consensus forecasts look achievable providing WOW is on track for its expected A$5m EBIT reversal.

While the DCs remain a key operational risk, any early extraction of cost savings in FY16 (eg commencement of multi store deliveries) would result in earnings upside and price outperformance.

More information

Morgans clients can access my full reporting season preview on the consumer discretionary sector, with further detail on changes to my forecasts, trend data and more insights on Adairs. If you are interested in finding out more, please contact your nearest Morgans office.

Disclaimer(s): Analyst may owns shares in some of the companies mentioned.

The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents ("Morgans") do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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