The
Reject Shop (TRS) 3
Sep 2013
Rationale:
TRS offers one of the most exciting long investment prospects in the Australian listed equity market today. Effectively we have a business which is half way through its proposed business growth cycle (currently c.290 stores in operation with a plan to expand to c.400+ stores) currently undergoing accelerated growth due to a market opportunity (i.e. the failure of competitor Retail Adventures). The success of the current expansion will not be clear until c. FY15 so this investment is an assessment of:
- TRS’s historic ability to return on and profitably run existing businesses;
- TRS’s historic ability to roll out stores and ensure they become profitable over a reasonable period of time; and
- Our expectation of the market conditions surrounding the competitive discount retail space where TRS’s business plays
The current
security price at c.$17 prices the success of the expansion at historic margins
and dividend payout at an equity return of c. 8% (pre-tax) - see valuation section. Thus there is a real
risk that if the discount retail market deteriorates over the next 2-3 years,
TRS’s security will be re-rated downwards.
The risk around this investment is limited to achieving clarity on the performance of TRS over the first half of the financial year (evidently this is due to the seasonality of the returns of the business. Given that the first quarter of FY14 has already passed we should be able to achieve a fair understanding of how the final phase of the accelerated growth strategy is performing. A correct forecasting of the FY14 expansion performance should result in partial re-rating of TRS following the FY14 half yearly results.
Longer term, we need to attempt to understand whether the c.320 store business model is sustainable in the competitive retail sector TRS is a participant of. A large component of this will be management’s ability to select appropriate sites (particularly so as not to cannibalise other store performance), run stores profitably and achieve economies of scale through the larger business model. Based on the historic ability of management to run the TRS business it seems that they have been able to achieve strong ROE and run stores profitably, particularly through the challenging trading conditions of the most recent 5 years. Thus based on management’s proven ability to profitably grow TRS, I would establish that this is a positive increasing the probability of success of the larger business model with the unknown being the behaviour of differing markets where new stores are being opened (although to the extent the company can provide historic trading data, say from Retail Adventures, or the extent to which we can examine the new sites and assess the local market dynamics of each store (maybe by going on a site visit?), a better understanding can be established and this risk reduced).
Key Metrics:
Traded Performance
12
Month Security Price and Volume
Valuation and Historic Performance
The
following historic financial data has been extracted from TRS’s annual reports
and results presentations. The data evidences the strong seasonality of TRS
cashflows, with most income being derived during H1 of each financial year.
Further we note that TRS maintains a conservative capital structure, paying
down debt when feasible. It is difficult to extract the pure performance of
underlying stores as TRS continued to increase stores over the period analysed,
however, the effect of more aggressive store number growth is evident from the
FY13 results with lower NPAT and operating cashflows.
The TRS
Board policy to pay out approximately 50% of Annual NPAT in dividends to
shareholders does not quite hold true according to the calculations performed
over the period analysed, however it seems to be an appropriate amount to
distribute in order to allow the business to operate efficiently given the lack
of cash trapped in the business at the end of each annual period.
A high
level valuation calculation was performed adopting similar assumptions to those
observed over the historic period from 2008 to 2013. It has identified that on
a conservative base case the market is approximately pricing an equity return
of c. 8%p.a. at the current share price.
Market Opinions (Restricted to available
research)
Wilson HTM
Date: 22 Aug 2013
Position: Hold
12 Month Target: $18.68
Notes:
- Business is attractive in light of store-roll outs and benefits from industry consolidation
- In near term execution risk around the high volume of store roll outs over a short period of time (40+ stores over FY13 and FY14 versus previous role out of c. 20 stores over the same period)
- 41 stores opened over FY13. 43 stores confirmed for FY14 (34 over the first half and 9 over the second half)
- Development of satellite distribution centre in WA with estimated commencement in June 2014
- Risk: execution risk around new store openings particularly in light of macro retail environment; logistics and product supply management given aggressive increase in stores
- Catalysts of change: industry consolidation; sourcing initiatives to improve speed and costs
- Expect occupancy costs to decrease over FY14 given that there are more than 50 lease renewals due (management has flagged the potential for some store closures over FY14)
- Target of 400 stores (not including larger stores – the smaller store footprint will be revisited in 2015
- 17 stores opened over the first half of 2013 largely covered opening costs while the 24 opened over the second half of FY13 did not cover opening or indirect costs
- Costs of doing business increased, wage inflation ate into margins, new staff were hired for new store roll outs, electricity costs increased significantly
- Management estimates that c. half of the (84) new stores in both FY13 and FY14 were previous Retail Adventure sites (Sam’s warehouse (99 stores), Chickenfeed bargain stores (39 stores), Go-Lo/ Crazy Clark’s (275 stores))
Macquarie Equities Research
Date: 21 Aug 2013
Position: Neutral
12 Month Target: $17.90
Notes:
- FY13 and FY14 is all about new store rollout and market share changes. Commentary suggests that there is still scope for more stores in FY2014
- By the end of FY14 TRS will have increased its store base by c.50% in just over 3 years. If successful this will place in a strong position in FY15+ allowing TRS to leverage off operational efficiencies and drive future growth
- The accelerated store opening program provides TRS with by far the strongest growth profile of the specialty retailers over the next two or three years. TRS is a strong medium term outlook proposition.
- It will be well into FY15 and probably FY16 before store operating efficiencies can be achieved and key metrics brought back towards targeted levels.
- Opportunity to refine the store portfolio and exit less desirable stores
- Risk as cost base increases and supply chain, IT and management expand
- Financial risk has been reduced following the recent equity capital raising
- Modest increase in debt is expected over FY14
- FX hedge in place to minimise the effect of lower AUDUSD
- MRE assume 49 store openings over FY14
Credit Suisse
Date: 21 Aug 2013
Position: Underperform
12 Month Target: $13.70
Notes:
- FY13 result produced lower than expected sales revenue and a fall in gross margin in 2h13
- Possibility that large number of changes in the store network disrupted merchandising plans
- CS seem to be strictly following their valuation outputs rather than examining the market dynamics around a potential TRS re-rating
Montgomery Fund
Date: 26 Aug 2013
Notes:
- In the coming years this is a business with bright prospects
- Looking at the Australia Discount Retail and then Retail Adventures administration, this has created a short term opportunity to expand at a low cost. Further there is an opportunity to capture market share and grow the business by around 30% in 2 years
- 67m of incremental capital have been invested in what has historically been a high return business on incremental capital (40m on capex fixtures and fittings IT and DC infrastructure; 20m inventory; 7m on additional management to manage growth / expansion
- Expect short term pressure on profitability as they absorb expansion costs and train staff. Longer term the business momentum is impressive. If management are able to manage the expansion plans as proposed Montgomery Fund expects very strong ROE from 2015+
Additionally Notes
- Competitors – Kmart, Homeart, Big W, Target Australia
- 20 January 2009, Directors placed Australian Discount retail into voluntary administration – biggest retail collapse for 5 years in over 5 years.
- 23 March 2009 Australian Discount Retail was sold to Retail Adventures (owned by Australian millionaire Jan Cameron)
- 27 October 2012 Retail Adventures was placed into administration - Jan Cameron will continue to run the viable portion/s of the business under a licence from the administrators with the intention of buying back the business after a restructuring – only brands expected to survive are Crazy Clarke’s and Sam’s Warehouse
