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Ross Bird

Head of Equities Strategy
18 October 2011
Changing consumer attitude and spending
platform to challenge the role of the traditional
discretionary retailer
The retailing industry is undergoing many
challenges and changes, both locally and globally.
High levels of sovereign debt and the need for
balance sheet adjustment in many countries
suggests further headline buffeting of local
consumer confidence. Relatively high levels of
household debt locally, rising utility charges, a high
A$ and changing purchasing technology platforms
create conservative and innovative post-GFC
shoppers. These are very different to their carefree
predecessors who believed they could rely upon
rising asset wealth to underpin the active use of
credit card expenditure and housing backed debt
for investment purposes.
From a pre-GFC peak in May 2007, the Consumer
Discretionary index is down 62%. The current level
is a mere 6% above the post-GFC trough reached
in March 2009 where the index was 68% below its
peak. Contrast with the Consumer Staples index
with a peak to trough decline of 37% and currently
19% below peak... far more stable and defensive
in nature, but not entirely immune from general
economic slowing and investor caution.
This Special Report will focus largely upon the
Discretionary side. On one level, the large
“cyclical” decline since 2007 may suggest a “straw
hats in winter” opportunity to increase exposure to
the sector, but this strategy is complicated by
significant structural changes, namely the Internet
as a platform for retail spending and changing
attitudes of households to spending and saving
which may dominate consumer behaviour for some
years to come.
The Australian economy remains the envy of many
developed nations, with strong terms of trade and
forecasts for GDP growth over the next two years
superior to advanced economies. Global events of
recent years still affected our collective psyche,
manifesting in many aspects of daily life, none
more-so than how we deploy disposable income.
Consumer spending trends from an historical
perspective are cyclical in nature and closely linked
to general economic activity, interest rates,
employment trends and consumer confidence. It
must be remembered Australia enjoyed a relatively
long and prosperous period of economic growth,
our last recession in 1990–91 and hence historical
measurement over the last 20 years is within a
setting of generally favorable conditions. We see
many examples of forward projections in bricks
and mortar retailing based on average 20 year or
less trends and caution this may not be entirely
applicable for times ahead.
Retailing is an ever evolving industry, successful
retailers are constantly updating and fine-tuning
the shopping experience to retain and grow
patronage. Many previously successful retailers
failing to evolve their formula have lost relevance,
or over-geared balance sheets on the cusp of a
cyclical downturn, only to find themselves in the
hands of administrators.
In many respects, current operating conditions for
discretionary retailers are unprecedented. Consider
the following challenges and economic settings.
3 High household debt as a proportion to income:
Prosperous times encouraged consumers to use
and be comfortable with debt, to enhance their
lifestyles via spending while rising housing
prices covered the expanding liability. While the
GFC did not affect Australia as much as other
developed nations, Australian house prices have
been less robust over the past year (chart 4).
Combined with weaker equity markets, this
prompted households to adopt a more
conservative approach to debt levels
(deleveraging) as seen in charts 1 & 2 and
predominantly amongst younger to middle age
Bricks and Mortar
Retailing
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Special Report
Continued on page 2
18 October 2011 2
Chart 4: Dwelling prices
Excluding apartments; measured as areas outside capital cities in New
South Wales, Queensland, South Australia, Victoria and Western Australia.
Sources: RBA; RP Data-Rismark

Chart 2 shows households steadily increased
savings as a percentage of income, particularly
after the GFC, to the current 10.5%, net of
depreciation. While this is high for recent times, it
is not out of kilter with levels of the 1980’s.
As housing prices “consolidate” and home
affordability gradually improves via wages growth,
household debt as a proportion of disposable
income may decline back to around the 100 – 120%
level. At the current savings rate, this would take
approximately 3 to 5 years to achieve. While
forecasts are merely that, this scenario suggests an
ongoing modest outlook for discretionary consumer
spending over the medium term as households
maintain an increased level of saving.
3 Employment levels (hours worked) stabilising
after strong post-GFC growth. While we have a
very positive outlook for capital investment,
particularly in the resources sector, job
losses in manufacturing and retailing are
offsetting jobs growth in resource-related
sectors. This will continue to impact the rate
of retail sales growth.
During the 1990’s as the economy grew strongly,
the unemployment rate fell from a recession
induced high of 11% and continued to decline to
the 4% level before the GFC, contributing to overall
income growth in turn fuelling retail sales growth.
Such impetus is unlikely to persist given
unemployment has likely bottomed
(tech savvy) consumers (chart 3). Prior to the last
recession in 1990 – 91, household debt was
approximately 45% of disposable income. It
recent years it rose to around 160%. The
flattening of this trend as evident in Chart 1
suggests a degree of retracement in coming
years as caution drives higher household savings
rates.
Chart 1: Household debt to disposable income

Source: RBA B21 Household Finances – Selected
Ratios, September 2011
Source: RBA B21 Household Finances – Selected Ratios, September 2011
Chart 2: Household saving ratio*
* Net of depreciation
Source: ABS
Chart 3: Change in median savings ratios
Source: HILDA Release 9.0
In many respects, current operating conditions for discretionary retailers are unprecedented.
Consider the following challenges and economic settings.
! High household debt as a proportion to income: Prosperous times encouraged
consumers to use and be comfortable with debt, to enhance their lifestyles via spending
while rising housing prices covered the expanding liability. While the GFC did not affect
Australia as much as other developed nations, Australian house prices have been less
robust over the past year (chart 4). Combined with weaker equity markets, this prompted
households to adopt a more conservative approach to debt levels (deleveraging) as seen
in charts 1 & 2 and predominantly amongst younger to middle age (tech savvy)
consumers (chart 3). Prior to the last recession in 1990 – 91, household debt was
approximately 45% of disposable income. It recent years it rose to around 160%. The
flattening of this trend as evident in Chart 1 suggests a degree of retracement in coming
years as caution drives higher household savings rates.
Chart 1
Household debt to disposable income
0
20
40
60
80
100
120
140
160
180
M
a
r
-
7
7
M
a
r
-
7
9
M
a
r
-
8
1
M
a
r
-
8
3
M
a
r
-
8
5
M
a
r
-
8
7
M
a
r
-
8
9
M
a
r
-
9
1
M
a
r
-
9
3
M
a
r
-
9
5
M
a
r
-
9
7
M
a
r
-
9
9
M
a
r
-
0
1
M
a
r
-
0
3
M
a
r
-
0
5
M
a
r
-
0
7
M
a
r
-
0
9
M
a
r
-
1
1
%

o
f

i
n
c
o
m
e
Total debt Housing debt Other personal debt

Source: 88A 821 Pousehold llnances - SelecLed 8aLlos, SepLember 2011






In many respects, current operating conditions for discretionary retailers are unprecedented.
Consider the following challenges and economic settings.
! High household debt as a proportion to income: Prosperous times encouraged
consumers to use and be comfortable with debt, to enhance their lifestyles via spending
while rising housing prices covered the expanding liability. While the GFC did not affect
Australia as much as other developed nations, Australian house prices have been less
robust over the past year (chart 4). Combined with weaker equity markets, this prompted
households to adopt a more conservative approach to debt levels (deleveraging) as seen
in charts 1 & 2 and predominantly amongst younger to middle age (tech savvy)
consumers (chart 3). Prior to the last recession in 1990 – 91, household debt was
approximately 45% of disposable income. It recent years it rose to around 160%. The
flattening of this trend as evident in Chart 1 suggests a degree of retracement in coming
years as caution drives higher household savings rates.
Chart 1
Household debt to disposable income
0
20
40
60
80
100
120
140
160
180
M
a
r
-
7
7
M
a
r
-
7
9
M
a
r
-
8
1
M
a
r
-
8
3
M
a
r
-
8
5
M
a
r
-
8
7
M
a
r
-
8
9
M
a
r
-
9
1
M
a
r
-
9
3
M
a
r
-
9
5
M
a
r
-
9
7
M
a
r
-
9
9
M
a
r
-
0
1
M
a
r
-
0
3
M
a
r
-
0
5
M
a
r
-
0
7
M
a
r
-
0
9
M
a
r
-
1
1
%

o
f

i
n
c
o
m
e
Total debt Housing debt Other personal debt

Source: 88A 821 Pousehold llnances - SelecLed 8aLlos, SepLember 2011






Chart 2

Chart 3



Chart 2

Chart 3



Chart 4

Chart 2 shows households steadily increased savings as a percentage of income,
particularly after the GFC, to the current 10.5%, net of depreciation. While this is high
for recent times, it is not out of kilter with levels of the 1980’s.
As housing prices “consolidate” and home affordability gradually improves via wages
growth, household debt as a proportion of disposable income may decline back to around
the 100 – 120% level. At the current savings rate, this would take approximately 3 to 5
years to achieve. While forecasts are merely that, this scenario suggests an ongoing
modest outlook for discretionary consumer spending over the medium term as
households maintain an increased level of saving.
! Employment levels (hours worked) stabilising after strong post-GFC growth. While
we have a very positive outlook for capital investment, particularly in the resources
sector, job losses in manufacturing and retailing are offsetting jobs growth in resource-
related sectors. This will continue to impact the rate of retail sales growth.
During the 1990’s as the economy grew strongly, the unemployment rate fell from a
recession induced high of 11% and continued to decline to the 4% level before the GFC,
contributing to overall income growth in turn fuelling retail sales growth. Such impetus is
unlikely to persist given unemployment has likely bottomed



18 October 2011 3
Chart 5: Retail sales growth
* Percentage change over year to latest three months
Source: ABS
Chart 6: Labour force
Source: ABS
3 Global events impacting consumer confidence.
Sovereign risk among the European PIIGS
nations, the US economy losing its AAA credit
rating, stockmarket volatility and other factors
such as rising social unrest sapped the
confidence of the Australian consumer and so
willingness to spend. Rising utility costs and
uncertainties over household finances due to the
proposed carbon tax compound this effect. While
these factors contribute to the rise in the
household savings ratio (chart 2), it also impacts
consumer confidence, normally closely correlated
with retail sales. The sharp reduction in the
Melbourne Institute / Westpac Consumer
Confidence index this year reflects these issues.
Another factor inhibiting spending is current
interest rate settings, which the RBA describes
as “mildly restrictive” and are designed to keep a
lid on underlying inflation.
Chart 7: Consumer sentiment
Source: Melbourne Institute and Westpac
3 The high A$ impacting spending habits.
Commodity prices and interest rate differentials
are the chief drivers of the A$. While it declined
in recent weeks following a decline in daily
traded commodity prices, it remains at historical
highs. Its strength coincides with the growing
familiarisation, acceptance and use of the
internet as a legitimate means of purchasing
durable goods, particularly from overseas.
Normally lower prices for imported goods would
be favorable for bricks and mortar retailers such
as Harvey Norman and to a lesser extent Myer
and David Jones, but the discovery by consumers
of a lower cost means of acquiring imported
goods via the internet turns a retailing opportunity
into an obstacle for these established retailers.
On the one hand, establishing an online store may
cannibalise traditional business, but not
establishing an online presence risks ceding
market share to early mover, online competitors.
3 The exact level of online sales is not clear, nor the
level and timeframe to which it may grow and
eventually level out at. Online spending is believed
to be 6–8% of current retail spending, with the
Productivity Commission forecasting growth of
10–15% pa over the next three years. This high rate
implies bricks and mortar retailers will continue to
lose market share to online sales. Growth in online
sales is particularly strong in books, CD’s & DVD’s,
electrical, sporting goods, clothing, toys and
cosmetics; differentiating discretionary areas from
the food- driven Consumer Staples sector.
One additional effect of the high A$ is a rise in
offshore travel and hence offshore rather than
domestic holiday spending. So total consumer
spending is not as weak as retail spending data
would suggest, but offshore spend does not support
Chart S

Chart 6

! Global events impacting consumer confidence. Sovereign risk among the European
PIIGS nations, the US economy losing its AAA credit rating, stockmarket volatility and
other factors such as rising social unrest sapped the confidence of the Australian
consumer and so willingness to spend. Rising utility costs and uncertainties over
household finances due to the proposed carbon tax compound this effect. While these
Chart S

Chart 6

! Global events impacting consumer confidence. Sovereign risk among the European
PIIGS nations, the US economy losing its AAA credit rating, stockmarket volatility and
other factors such as rising social unrest sapped the confidence of the Australian
consumer and so willingness to spend. Rising utility costs and uncertainties over
household finances due to the proposed carbon tax compound this effect. While these
factors contribute to the rise in the household savings ratio (chart 2), it also impacts
consumer confidence, normally closely correlated with retail sales. The sharp reduction
in the Melbourne Institute / Westpac Consumer Confidence index this year reflects these
issues. Another factor inhibiting spending is current interest rate settings, which the RBA
describes as “mildly restrictive” and are designed to keep a lid on underlying inflation.
Chart 7


! The high A$ impacting spending habits. Commodity prices and interest rate
differentials are the chief drivers of the A$. While it declined in recent weeks following a
decline in daily traded commodity prices, it remains at historical highs. Its strength
coincides with the growing familiarisation, acceptance and use of the internet as a
legitimate means of purchasing durable goods, particularly from overseas. Normally
lower prices for imported goods would be favorable for bricks and mortar retailers such
as Harvey Norman and to a lesser extent Myer and David Jones, but the discovery by
consumers of a lower cost means of acquiring imported goods via the internet turns a
retailing opportunity into an obstacle for these established retailers. On the one hand,
establishing an online store may cannibalise traditional business, but not establishing an
online presence risks ceding market share to early mover, online competitors.

! The exact level of online sales is not clear, nor the level and timeframe to which it may
grow and eventually level out at. Online spending is believed to be 6 – 8% of current
retail spending, with the Productivity Commission forecasting growth of 10 – 15% pa
over the next three years. This high rate implies bricks and mortar retailers will continue
18 October 2011 4
local jobs. Of course the path of the A$ will govern
this trend, with the level of the currency a function
of demand for commodities and of interest rates in
Australia relative to global rates.
Overall, consumption of goods at a growth rate of
1.75% over the past year lags services at 4.0%
(chart 10). Maybe we’re becoming less material and
instead enjoying that well earned overseas break
with family and friends.
Chart 8: A$ against US$, Euro and Yen
* ECU per A$ until 31 December 1998
Source: Thomson Reuters; WM/Reuters
Chart 9: Short term resident departures
overseas up 11.3% year on year while arrivals
have fallen by 2.5%.
Chart 10: Consumption growth rate of goods
trailing services over the past year.
* Excludes housing
Sources: ABS; RBA
Bricks and Mortar Stocks
Few investors need to be told Australia’s strongest
‘bricks and mortar’ businesses are the supermarket
giants, Woolworths (WOW) and Coles, the latter
part of listed conglomerate Wesfarmers (WES).
Both WOW and WES also own discount
department stores which are significantly lower
quality businesses than supermarkets but
constitute a relatively small proportion of total
group earnings. Both stocks carry positive
recommendations at current prices, and we draw
attention to attractive fully franked dividend yields
of around 5% from WOW and 6% from WES at the
time of writing.
In terms of business quality our preferred bricks and
mortar specialty retailers are Super Retail Group
(SUL), Premier Investments (PMV) and JB Hi-Fi
(JBH). Of these PMV and JBH have positive
recommendations. The business models of leisure
equipment retailer Kathmandu (KMD), Harvey
Norman (HVN) and travel agent Flight Centre
(FLT) potentially are under greater threat resulting
in greater valuation uncertainty and so greater
investment risk.
Department stores David Jones (DJS) and Myer
(MYR) also face significant structural headwinds
but have been sufficiently sold down to be in
positive recommendation territory.
Supermarkets
Woolworths (WOW) – Accumulate
Wesfarmers (WES) – Accumulate
Supermarkets have little to fear from online
competition. Online competition, where the retailer
is cut out of the transaction – the customer dealing
directly with the manufacturer or a consolidator – is
unlikely to occur or become meaningful. The sheer
volume of grocery lines and relative low prices will
protect supermarkets from online competition.
Fresh produce including fruit, vegetables, meat,
seafood, dairy and bakery also precludes online
competition. Both major operators – Woolworths
and Coles already have an online shopping
capability – customers can order online and choose
between pick-up or delivery service.
Online grocers like CatchOfTheDay and GroceryRun.
com will nibble away but are unlikely to be a cause
of concern. GroceryRun.com will offer
manufacturers a conduit to shift excess or
unwanted stock. Others are targeting lines where
to lose market share to online sales. Growth in online sales is particularly strong in books,
CD’s & DVD’s, electrical, sporting goods, clothing, toys and cosmetics; differentiating
discretionary areas from the food- driven Consumer Staples sector.
One additional effect of the high A$ is a rise in offshore travel and hence offshore rather
than domestic holiday spending. So total consumer spending is not as weak as retail
spending data would suggest, but offshore spend does not support local jobs. Of course
the path of the A$ will govern this trend, with the level of the currency a function of
demand for commodities and of interest rates in Australia relative to global rates.
Overall, consumption of goods at a growth rate of 1.75% over the past year lags services
at 4.0% (chart 10). Maybe we’re becoming less material and instead enjoying that well
earned overseas break with family and friends.
Chart 8





Chart 9 - Short term res|dent departures overseas up 11.3¼ year on year wh||e arr|va|s have fa||en by
2.S¼.


Chart 10 - Consumpt|on growth rate of goods tra|||ng serv|ces over the past year.




Chart 10 - Consumpt|on growth rate of goods tra|||ng serv|ces over the past year.


18 October 2011 5
the use by date is rapidly approaching providing a
service to clear stock at significantly reduced prices.
Liquor sales should be similarly protected. Big box
operations like Woolworths Dan Murphy’s offer a
shopping experience for those so inclined and are
very price competitive. Transport/delivery costs can
quickly add to the delivered price sharply lifting the
online per bottle price and reducing the gap
between big box and online offers.
But Crackawines.com.au, the development of
former COO of Carsales believes up to 25% of all
wines will be sold on the internet by 2016.
Woolworths has an auction capability after
acquiring Langton’s in 2010. Cracka suggests its
two weapons – first the online Dutch auction where
the price falls with each bid and second the access
to extensive wine information – will be winners.
Analyst: Peter Warnes
Discount Department Stores
The move by both majors in this segment –
Woolworths (BIG W) and Wesfarmers (Kmart) and
(Target) to a policy akin to ‘Every Day Low Prices’,
aggressive lowest cost direct sourcing and the
diversified offer provides some protection from
online competition. The continual emphasis on
Everyday Value is gaining traction with customers.
Both also offer incentive programs including Qantas
Frequent Flyer and Fly Buys where benefits can be
monetised. Relatively low priced women’s and
men’s apparel and essentials or necessities like
socks, underwear and homewares are unlikely to
attract meaningful on-line competition. In the
electrical and electronic space competition is
intense from other bricks and mortar retailers
keeping prices low and reducing the gap between
in-store and on-line offers. All operate in house
on-line stores.
Analyst: Peter Warnes
Department Stores
Myer (MYR) – Accumulate
David Jones (DJS) – Accumulate
At current prices there is more upside than downside
risk in both Myer (MYR) and David Jones (DJS),
although due to structural change the level of
uncertainty around calculation of fair value is high.
Consumers’ new-found frugalism is a function of
deleveraging and a reaction to a range of factors
generating uncertainty. This frugality stimulates
growth in online shopping. A recent CBA study
estimates 5.2% of discretionary retailing dollars are
spent online, but growing rapidly with for example
online fashion purchases growing 146% by value
over the last year.
It is difficult to predict the proportion of retail
spending that will move online. In the case of
department stores we expect online increasingly to
marginalise certain categories such as electronic
goods. A temporarily mitigating factor is
department stores’ typical customer is largely not
Generation Y or Z, the most prolific online buyers.
As well as providing dramatically lower start-up
and operating costs for a new retail entrant, the
Internet also improves customer knowledge, helped
by the rise of smartphones. New technology allows
shoppers to photograph a barcode with their
smartphone which immediately finds and prices the
same item at a range of outlets to locate the
cheapest price.
To counter online competition department stores try
to enforce parity or near parity between their
pricing of branded product and online prices where
the brand owner also sells directly online. Stores
could charge the brand owner a “promotional” fee
for carrying and thereby providing exposure for the
brand, which the store could use to reduce the price
of the product. The success of these counter-
measures will reflect the strength of the store
brand relative to the strength of the product brand
and relative to the brand of online aggregation sites
that sell the same product.
Existing consumer awareness of their marque
should give department stores a significant tailwind
when establishing a website presence. Online sales
still will cannibalise store sales, leading to a
contraction in store size and number.
Consumer sentiment and savings rates are at
extreme levels. By definition extreme levels revert.
The rapid rise in online sales is occurring during
weak sentiment and is partly a result of consumers
becoming unusually frugal. But online growth is
only a small part of the explanation for falling sales
in bricks and mortar retail. The higher savings rate
and a shift away from goods to services and
“experiences” in combination with the stronger A$
seem the main reasons. Cases in point include the
strength of Flight Centre’s overseas travel business
and success of Kathmandu. Our view is that fears
of the online threat have reached extreme levels,
leading to over-selling of retail stocks.
18 October 2011 6
We don’t know how retail will look 10 years from
now. Maybe in the long-term department stores
will end up relics, something wrongly predicted for
decades. But before then we’re confident their
sales along with other discretionary retail
segments will improve significantly when consumer
malaise lifts.
Department stores deliver a form of theatre: lavish
displays, glamorous celebrities, and live music. Or
the gentle elegance of soft music and carpets that
soothe and cocoon the shopper. Stores may need to
spend even more on embellishing the shopping
experience to remain relevant, but when the current
fear subsides these features as well as the
attraction of product and brand aggregation will
again draw consumers.
Discretionary Specialty Retail
Household indebtedness and online retail
competition is set to make for a very uncertain
future for the retail sector – especially the
discretionary component, the first to be curtailed
when the household budget is constrained. In
reviewing the stocks within discretionary retail,
many of which are trading near their 52-week lows,
there are only two on which we have positive
recommendations. Our preferred stock, with a
medium-risk rating, is Premier Investments (PMV).
It is targeting strong earnings growth, derived from
a combination of cost cutting and an expansion of
more immature brands. We also see value in JB
Hi-Fi (JBH), but assign it a high-risk rating because
of uncertainty about how online competition will
impact longer-term sales growth.
Harvey Norman (HVN) – Hold
Ten years of rapidly rising house values and access
to cheap debt fuelled strong yearly comparable
sales to FY10. The music stopped suddenly in FY11
with a contraction in retail expenditure, combined
with price deflation of once star product categories
such as flat screen TVs, leading to a sudden
contraction in sales and profits. As we look out over
the next few years, we expect conditions to remain
tough as consumers and retailers adjust to lower
levels of expenditure.
Revenues are highly correlated to the health of the
house market, as new owners seek to update or fit
out newly purchased real estate. The government's
decision to increase the first homeowner's grant in
early 2010 demonstrated this with a sudden surge
in sales. With household debt near maximum
levels, but falling, spending is largely maxed out
and consumers will take a number of years to
slowly get over their credit hangovers.
HVN has been slow to respond to online
competition and is rolling out a new online format
to complement bricks-and-mortar outlets. The aim
is to engage with consumers on any retail platform
and so provide choice, with online orders shipped
via local stores. HVN is one of Australia’s most
recognised brands and we expect it can use this as
leverage when it comes to the online format. Online
retail offers low barriers to entry and we expect
competition from emerging online retail brands to
increase, which will erode the comparable growth
in HVN’s revenues.
Analyst: Tim Montague-Jones
Billabong (BBG) – Hold
The decision by BBG to move vertically down,
integrating wholesale channels with retail outlets,
is in part a strategy to protect brands and provide
greater control within a rapidly evolving retail
market. Control from design to distribution limits
third parties from discounting products to the
detriment of the brand. Brand is BBG's competitive
advantage, built through consumer experience and
trust in both quality and design. Internet
connectivity lowers the barrier to entry for the retail
sector, so the importance of brand will become a
crucial differentiator when it comes to pricing
power, otherwise consumers will gravitate to the
lowest-priced supplier of product.
The timing of BBG’s retail outlet acquisitions was
unfortunate, with higher working capital
requirements draining cashflow. The wet summer
of 2011, combined with tough retail conditions,
conspired to further restrict cashflow, adding to our
concerns about BBG's deteriorating interest cover
from 9x to 4.4x. We retain a Narrow Moat rating for
BBG because we recognise the unique iconic brand
portfolio, but short-term funding issues require a
sizeable discount to our fair value before looking to
build a position.
Lifestyle brands grew in popularity over the past 10
years as young consumers sought to identify
themselves with specific sub-cultures, such as
surfers or skaters. Parents, who largely fund this,
are now likely to reassess the financial merits of
paying such high prices for apparel as they
grapple with the household budget. We expect the
days of rapid revenue growth are gone and forecast
low to mid-digit revenue growth, as offshore
18 October 2011 7
expansion in emerging markets offsets domestic
contraction in demand.
Analyst: Tim Montague-Jones
Premier Investments (PMV) – Accumulate
Brand control becomes increasingly important in a
retail landscape where an online retail store can be
created for little cost. Just Group has developed a
fully integrated retail business model. Brands are
individually designed to target specific
demographics. Designs are sent to partner
manufacturers in China, with products shipped and
pre-packed for specific store requirements. An
integrated business model means consumers must
either go into a Just Group store or to a company-
owned online site to purchase product. Product
control limits third parties from discounting and so
undermining brand value, ensuring acceptable rates
of return.
Household de-leveraging is set to work its way
through the retail industry and low demand will see
some retail stores close. As part of a strategic
review, PMV CEO Mark McInnes is closing 50 of
their 1000 stores and cutting costs, targeting focus
on cost control, online opportunities and on
expanding emerging brands. Realigning the cost
structure will make the business more competitive
and also protect it from a continuation of weak retail
expenditure when compared to the last decade.
Analyst: Tim Montague-Jones
JB Hi-Fi (JBH) – Hold
Entering a mature market dominated by a few
strong retail brand leaders, such as Harvey Norman,
required JBH to create a niche to survive. Success
to date reflects a point of difference, an appeal to a
younger, innovative audience who seek value. JBH
embraces the functionality offered from online and
already records over 800k in weekly visitors. The
development of mobile applications complements
both online and store networks, offering customers
choice for ordering and picking up purchases.

The migration of video and music content online is
eroding traditional sales of DVDs and CDs. JBH is
launching a subscription online service called JB
Hi-Fi Now. This will give customers unlimited
access to stream around 8m music tracks. This
initiative is a low-cost venture and exemplifies an
entrepreneurial spirit and willingness to try new
business lines
While constraints on household expenditure mean
consumers are far more value conscious, JBH is
providing them not only with hardware and
software to access the internet, but is also offering
industry-low prices by utilising scale and a low-cost
business model.
Analyst: Tim Montague-Jones
The Reject Shop (TRS) – Hold
The success of the business model to date has
been attributable to providing consumers with
value, everyday items. Success pushed competitors,
particularly the likes of Kmart, Target and Big W, to
become more competitive in offering value during
growing economic constraint. The unfortunate
flooding of the Queensland distribution centre
severely impacts not only the immediate operations,
but also clouds the impact to sales from competitors.
This inherent risk or uncertainty means we require
a large discount to our fair value before investing.
TRS’s expanding footprint from the eastern seaboard
heartland aims to double the store base from 200
to 400. Retail expansion will drive operating scale
and deliver operating efficiency, enabling profits to
grow. Organic growth will help offset our
expectation of general weakness across retail.
Online competition is less of a threat as it is
uneconomical to send lower-priced items via the
postal system. Average basket size or dollar spend
in store is low, with TRS appealing to impulse
purchasers and shoppers looking for cheaper gifts
during Christmas trading.
Analyst: Tim Montague-Jones
Super Retail Group (SUL) – Hold
SUL has a consistent track-record of impressive
growth. Like Kathmandu the group benefits from
exposure to the strength in the experience/lifestyle
segment of retail through both Leisure Retailing
(LR) and SuperCheapAuto (SCA) chains. LR sells
outdoor goods such as camping and fishing
equipment while SCA caters to the car enthusiast.
Management consistently lifts gross margins
through product mix optimisation, product
innovation and direct product sourcing. It also
demonstrates successful containment of overheads.
Return on equity is strong near 20%.
A considerable proportion of LR product is available
from online retailers and falls squarely in the
category of goods that don’t attract GST or tariffs if
bought from an overseas site. Mitigating this is the
fact SUL’s market comprises enthusiasts who like to
‘touch and feel’ before purchase and get a kick out
of visiting a shop stacked high with a wide range of
18 October 2011 8
gear. SUL’s strong market presence and strength in
supply chain logistics should allow the rapid build
of an online channel.
Analyst: James Cooper
Flight Centre (FLT) – Hold
FLT is a clear beneficiary of the strong A$, which
reduces the cost of holidays abroad and the cost of
offshore shopping. The currency strength was the
main driver behind a 7.5% increase in outbound
travel in FY11. Bricks and mortar travel agents such
as FLT encourage international travel. Such travel is
more expensive and more complicated to organise
benefiting the agent. Assisted by a highly visible
and credible brand this gives FLT a competitive
advantage over online competitors. Travellers
also trust FLT's scale will ensure a good price. But
we nevertheless regard the online threat as
significant. See our FLT report in this YMW issue
for further analysis.
Analyst: Nathan Zaia
Kathmandu Holdings (KMD) – Hold
The quality of the FY1 result in a depressed retail
environment impressed. Management gave no
specific guidance other than to say the FY12
outlook is ‘positive’. Despite any further
deterioration in the global economy or weakening
of the A$ and NZ$, KMD should once again
outperform sector peers.

Although the retail environment continued to
deteriorate during FY11, a key tailwind was the
strong A$ and NZ$ against the US$ and Euro. Aside
from boosting margins, the stronger currency also
encouraged consumers to allocate discretionary
spend to overseas travel. KMD outlets benefit as a
popular stop for many travellers heading overseas.

The RBA noted the consumption of goods rose at
1.75% for the year while the consumption of
services rose 4%. Specific to KMD, the ‘recreation
and culture’ sector of the economy grew at 7%. The
RBA also noted that although the savings rate has
been rising, a possible explanation has been the
shift in consumer preferences from goods to
‘experiences’. Along with the stronger A$, this
bodes well for KMD.
We retain our caution on the longer-term
sustainability of margins and pricing model, given
the competitive industry. We view the online
channel as potentially a major challenge given the
relatively undifferentiated nature of product range
and high margins that will attract competitors.
KMD is a high risk stock, exposed to a cyclical
industry and the fickleness of consumer sentiment
and preferences.
Analyst: James Levien
Bricks and Mortar stock recommendations and trigger prices
Company ASX Code Rec Share Price ($) Fair Value ($)
Business
Risk
1 Yr Fwd
PER (x)
2 Yr Fwd
Div Yield (%)
Buy
Below ($)
Accumulate
Below ($)
Reduce
Above ($)
Sell
Above ($)
Billabong BBG Hold 3.78 3.63 High 9.2 6.6 2.20 3.10 4.15 5.65
David Jones DJS Acc 2.99 3.60 High 11.1 8.2 2.15 3.05 4.15 5.60
Flight Centre FLT Hold 18.55 20.00 High 10.4 4.8 12.00 17.00 23.00 31.00
Harvey Norman HVN Hold 2.24 2.22 High 10.4 5.3 1.35 1.90 2.55 3.45
JB Hi Fi JBH Hold 14.88 17.32 High 11.6 5.4 10.40 14.70 19.90 26.85
Kathmandu KMD Hold 1.76 2.00 High 10.5 4.8 1.20 1.70 2.30 3.10
Myer MYR Acc 2.26 2.70 High 9.5 8.5 1.60 2.30 3.10 4.20
Premier Inv PMV Acc 5.25 6.16 Medium 11.9 6.7 4.30 5.55 6.80 8.30
Super Retail SUL Hold 6.50 6.60 Medium 13.0 4.9 4.60 5.95 7.25 8.90
The Reject Shop TRS Hold 10.39 10.95 High 14.1 5.4 6.55 9.30 12.60 16.95
Wesfarmers WES Acc 31.79 36.90 Medium 13.7 6.3 25.85 33.20 40.60 49.80
Woolworths WOW Acc 24.65 29.05 Low 13.7 5.1 23.25 27.50 30.50 36.30