Hot Topic NBR Focus: GMO
Hot Topic NBR Focus: GMO
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UPDATED: Warehouse, rated a 'sell', as investors await proof 2015 will show return on investments

Tina Morrison
Tue, 16 Sep 2014

UPDATED 4pmWarehouse Group [NZX: WHS] faces a year of reckoning as investors await evidence that New Zealand's largest listed retailer will get a return on the hundreds of millions of dollars spent overhauling stores and buying new businesses in the past couple of years.

Under chief executive Mark Powell, Warehouse has outlaid $115.8 million in capital expenditure on its iconic 'red shed' general merchandise stores over the past two years after what was considered almost a decade of under-investment, while spending more on products and staff in an attempt to lift shoppers' experience.

The Auckland-based company has also spent $158.9 million the past two years acquiring other businesses as part of a strategy to grow its 'non-red' profits to be as large as 'red'. In the latest year, the red sheds accounted for 81 percent of earnings.

The company last week posted an 18 percent drop in annual profit, while saying investments should start showing up in earnings growth in the current financial year. That would be welcomed by shareholders who have endured a 17 percent share-price decline in the past year, while the benchmark NZX 50 Index gained 11 percent. The stock is rated an average 'sell' according to analyst recommendations compiled by Reuters, and recently traded at $3.08.

"It will be quite disappointing if they don't show some earnings growth because there's a lot of capital that's been ploughed back into the company," said Douglas Lau, a senior portfolio manager at AMP Capital Investors (NZ). "At some point, investors want to see results from it. If they don't perform next year, I don't think there will be any other excuses."

The retailer may also have to battle unfavourable economic conditions beyond its control to achieve earnings growth, Lau said.

The Treasury, the government's economic forecaster, last month lowered its expectation for future economic growth, citing weaker commodity prices and tamer inflation. The Treasury cut its forecast for gross domestic product in the year through March 2015 to 3.8 percent from its 4 percent forecast in the May budget.

"We view FY15 as a pivotal year following two years of significant reinvestment," Chris Byrne, an analyst at Craigs Investment Partners said in a note titled 'FY15 is all about the bottom line'. "The challenge for the Warehouse will be to retain sales growth without further cost investment given moderating economic growth."

Warehouse chairman Ted van Arkel, speaking on a conference call after reporting the company's drop in 2014 earnings last week, said the board and management understood the focus now has to go on profit growth.

He declined to comment on whether Powell's job would be on the line should the company fail to boost earnings this year, telling BusinessDesk Powell's performance was reviewed on an annual basis, alongside other senior managers, and that all were under pressure. The performance reviews took all things into consideration, including the economic climate, van Arkel said.

"The board is keen to make sure we get some real traction going now that we have made a lot of investments," he said.

The company's adjusted net profit, which excludes one-time items and is the basis for dividend payments, should rise in the 2015 financial year, he said. Profit on that measure fell in 2014 to $60.7 million from $73.7 million the year earlier.

The bulk of the company's store refurbishment programme is now completed and the company has said it has no major acquisitions planned for the current year.

Warehouse is expected to focus on productivity in the coming year, with a better return on buying, labour and marketing, Citi Research analyst Craig Woolford said in a note titled 'Time for operating leverage'. He expects the 'red sheds' profit margin to rise 50 basis points this year, following a decline of 80 basis points in 2014.

While the company has turned around a decline in sales at the red sheds, with 14 quarters of positive same-store sales, that has yet to translate into profits.

"The recent substantial investment in its store base has reversed the long-term declining trend in sales, however earnings deterioration remains a concern," Chelsea Leadbetter, a retail sector analyst at Forsyth Barr said in a note, where she rates the stock 'underperform'. "Strategic changes remain a work in progress and we have yet to see evidence of a sustained turnaround in profits.

"Considerable execution risk remains around all its new ventures and its core red sheds business has yet to deliver profit improvement despite substantial capital investment," Leadbetter said.


Tina Morrison
Tue, 16 Sep 2014
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UPDATED: Warehouse, rated a 'sell', as investors await proof 2015 will show return on investments