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Friday, 17 March 2017
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BUY, SELL or HOLD (ASX:SUL)

Super Retail Group Limited (SUL) is a specialty retailer with 3 main retail divisions across 627 retail stores across Australia. It also has a retail network in New Zealand, and has international operations and sourcing presence in Asia and across China.

  1. Auto Retailing: Retail and distribution of motor vehicle spare parts and bicycle accessories, tools and equipment over 312 stores.
    • Supercheap Auto (SCA) is a retailer of automotive spare parts, hand tools, power tools, car care, electrical, batteries, and outdoor products with store locations across Australia and New Zealand.
    • Auto Trade Direct (ATD) business supplies auto parts and accessories to auto mechanics from a number of hub stores and directly from its distribution centre and from trade partners.
  1. Leisure Retailing: Retail and distribution of boating, camping, fishing, outdoor equipment and apparel, with 133 BCF and 17 Rays stores
    • Boating Camping Fishing (BCF) offers products such as fishing rod holders, bilge pumps, fish finders, tackle boxes, fishing nets, tents, rope, pegs, cooking equipment, clothing and hiking gear.
    • Rays (formerly Ray’s Outdoors) is an outdoor entertainment and camping leisure retailer having a number of branded product ranges such as Wild Country, Outdoor Expedition and Classic Outdoor.
  1. Sports Retailing Commercial: Retail and distribution of sporting equipment and apparel, with 165 stores. 101 Rebel and 64 Amart stores
    • Rebel Sport is a sporting and leisure goods retailer located various states of Australia.
    • Amart Sports is a retailer of sporting and leisure equipment, apparel and footwear in Australia.
    • Workout World retail provides fitness equipment for both domestic and commercial markets, ensuring the supply of latest designs and technology.

INVESTMENT CASE

Positive

  • Dominant market position – Generally SUL holds number 1 or 2 position in each category in which it operates.
  • Strong brand, range and reputation for customer service.
  • Competitive advantage – Scale and balance sheet strength give an advantage in soft trading conditions.
  • Management is well regarded for improvements in working capital, strong ROC, inventory and supply-chain improvements, growth throughout the cycle and turnaround in Rays.
  • Growth - Management has identified the potential for about 350 SCA stores (from 310), 220 leisure retailing stores (from 150), and 230 sports retailing stores (from 165).

Negative

  • Competition – There are few barriers to entry and competition is strong, particularly from discount department stores such as Kmart and BigW or offshore/online entrants such as Amazon.
  • Cyclical business - Declines in economic activity will dampen demand, particularly in the target lower-to-middle income earning demographic. Offsetting this is that less favourable economic conditions could result in greater attraction for “cheaper” leisure style activities such as camping versus hotels/overseas holidays.
  • Currency exposure – Most products are sources from overseas so a weaker dollar increases input costs. However it also makes an Australian camping trip much more affordable than an overseas holiday.
  • Limited growth options in some divisions such as Automotive, where increased car complexity reduces the “do-it-yourself” car maintenance model.
  • Acquisition/store roll-out risk – New stores or acquisitions may not generate the desired synergies or increased revenue.

RECENT RESULTS

SUL’s results were well-received by analysts and were generally better than expected and of good quality.

Some of the highlights included

  • 1H NAPT was $74.4m, up 26.3% on pcp
  • Total group sales up 6.6%, or 5% on a like-for-like basis
  • Auto sales +6.9%, EBIT +10.1%. Auto is likely to benefit from the closure of Masters
  • Leisure sales +2.9%, EBIT +53.7%. Transformation of Rays, with strong 3.6% lfl sales growth and improved margins. All the loss making stores have been closed and the new format stores look to be showing improved performance.
  • Sports sales +8.5%, EBIT +19.5%. Includes 6.0% lfl sales growth and firmer margins
  • Cash flow was particularly strong and inventory levels fell on average by 3% by store, despite the lower $A and higher purchase costs, due to software and logistics improvements.

Management also said the company had had a solid start to second half, with each division delivering positive like for like sales growth. The group was also planning to open around 12 new stores across group in second half.

This 1H17 included the 26 weeks to 31 December, whereas the previous 1H16 was for the 26 weeks to 26 December 2015, which provided some timing benefits. These timing benefits contributed around $28 million to sales, $7 million to earnings before interest and tax (EBIT) and $45 million to operating cash flow, and will reverse in 2H.

You can review the full presentation here.

FUNDAMENTAL VIEW

The STOCK BOX tells a very positive story. A high measure of earnings quality, which means earnings are largely sustainable, is combined with high and growing ROE of 17.4% and double-digit earnings growth. From a valuation basis, shares are not expensive on any measure, trading at a 24% discount to intrinsic value, a 6% discount to broker target prices and at a low PE relative to the historical range.

SUL even pays a yield of 6% with dividends forecast to grow further so that the yield rises to 8.4% in 3 years.  

The gearing level of 57% might seem high but in fact on other measures of financial health, SUL scores well. For example, while total liabilities to total assets may be high, many of these liabilities are of a longer term nature so aren’t as pressing. With strong cash flow metrics and strong profitability ratios, it scores well on an overall “credit ranking” with a percentile rank of 69 on the average credit measures.

OUR VIEW

One of the things that we’ve been looking for throughout results season is companies that have surprised on the upside because they have begun to deliver on management strategy. In SUL’s case, there were a number of issues weighing on sentiment, including the underperformance of Ray’s Outdoor. There looks to be a clear improvement in this division and the generally strong quality of the latest result has led to a couple of broker upgrades. This is exactly the sort of turnaround story that we are interested in, and in SUL’s case it is combined with strong fundamental backing, most notably high ROE and EPS growth, high and growing dividend, strong financial health and undemanding valuation

We have clearly missed the bottom or turning point in the recovery, and the technical picture is hardly convincing. There is also a clear risk when investing in the retail sector due to highly cyclical nature of earnings and the threat from overseas and online competition. But we think SUL can weather these risks better than most in the space and there is a strong yield and valuation basis to support the share price. Some Members might be concerned about the recent run and may prefer to wait for a more attractive entry point but we’re starting out today with a small holding. One of the biggest dilemmas is deciding whether to add it to the MT Growth Portfolio or the MT Income Portfolio, as it qualifies for both. We’re adding it to the Growth Portfolio but income-focused investors should also think about the additional growth in dividends it is expected to deliver over time.

TECHNICAL VIEW – There isn’t much of a technical basis to support a purchase of SUL. Shares bounced on the results in February and they have continued to strengthen. But as a turnaround company that is starting to deliver on strategy, there could be a lot more to it.

BROKER VIEW

  • Morgans has a Hold recommendation with a target price of 1154c (from 1110c). The 1H results were ahead of the Morgans’ analyst and they particularly liked the margin expansion and sales growth across all divisions. They think SUL represents a reasonable value with an undemanding multiple and the strong growth profile appears achievable
  • Macquarie has an Outperform recommendation with a target price of 1150c (from 1110c). The 1H result was ahead of the Macquarie analyst as well. They note automotive and sports continue to perform strongly while the leisure division is turning around. While there was no specific guidance, there was positive commentary regarding the second half.
  • Citi upgraded to a Buy (from Neutral) recommendation with a target price of 1190c (from 1080c). The analyst thought the result was strong albeit in line with their expectations. While the Q2 trading update was a little underwhelming, the upgrades to estimates are enough for an upgrade. They expect double digit growth for the next three years and think it’s trading at a discount versus the ASX200 ex-resources.
  • UBS has a Buy recommendation with a target price of 1100c. The result was in line with the analyst’s expectations but of good quality, and included the benefits of prior loss-making businesses either being closed or turned around. Auto and Sport saw sales accelerating, while Leisure saw a strong improvement in margins. They think the business is now back on track.
  • Credit Suisse upgraded to a Neutral (from Underperform) recommendation with a target price of 1042c (from 977c). The CS also used the term “back on track”, saying BCF's promotional issues seem to have been addressed and Ray's is no longer a drag on performance.
  • Deutsche Bank has a Buy recommendation with a target price of 1150c. The 1H result was ahead of the analyst’s estimates and they note that the long-awaited working capital improvements and cost savings from the supply chain are beginning to show through. A good start to the year with 4% growth in Auto, 9% in leisure and 2% in sports.
  • Morgan Stanley has an Overweight recommendation with a target price of 1200c (from 1060c). The results were better than the analyst was expecting, with better-than-expected Christmas trading. They think the sports and automotive remain well positioned for growth while the turnaround in leisure is gaining traction. With a dominant market positions and opportunity for further margin expansion due to operating leverage and private label penetration, they think the outlook is strong across all divisions.
  • Ord Minnett has an Accumulate recommendation with a target price of 1150c. The result beat the analyst, with the recent Ray's Outdoor and Infinite Retail acquisitions improving and automotive division remains in steady growth. They haven’t made many changes to forecasts but note that the 2H outlook looks strong across all divisions, with perhaps a temporary slowdown in sports.
  • Bell Potter has a Buy recommendation with a target price of 1225c (from 1170c). The 1H result was well above the analyst’s expectations. The analyst say that following a period of important business investment/restructure, they think SUL has emerged as a stronger & more competitive business that is backed with a more integrated and scalable platform. They don’t think the current valuation is demanding given the strong growth outlook, portfolio of leading retail platforms and healthy fully franked yield. They have upgraded EPS estimates over the next 3 years by around 4%.
 

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