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The Markets
This week: ASX v Wall Street
FYTD: ASX v Wall Street
Consumer linked
In recent weeks, clients will have seen the addition of Premier Investments (PVM) to their Australian equity sub-portfolios. Famously partly owned and operated (whether formally or informally) by Solomon Lew, Premier Investments is amongst the most successful discretionary retailers in Australian history.
Mr. Lew was appointed as Non-Executive Director and Chairman of Premier on 31 March 2008. He is a director of Century Plaza Investments Pty Ltd, the largest shareholder in Premier and was previously Chairman of Premier from 1987 to 1994.
As a discretionary retailer, Premier’s fortune is inherently tied to the outlook of the Australian consumer. Over the past three years, we have written extensively regarding the ongoing pressures on the consumer from a series of factors, including weak wages growth, rising mortgage rates, and higher cost of living.
These issues have been reflected in the weak performance of this market sector (since June 2021, the industry has underperformed the broader market by more than 10%). We avoided significant exposure to this sector outside our successful positions in Lovisa Holdings and Aristocrat Leisure (considered a Consumer Discretionary stock).
Concern has passed
The first critical investment factor is that the time for maximum concern regarding this sector has passed. Historically, as interest rates have normalised and peaked, the market tends to assume that the outlook for this sector will begin to improve, driving share prices higher long before actual improved outcomes at the store level.
Premier Investments provides high-quality exposure to this possible outcome.
We have chosen to add exposure to this sector by adding companies with only the strongest brands and operations. We are continuing to avoid smaller, sub-scale or lower-margin retail offerings.
Population growth
The second critical factor likely to support consumer discretionary spending in the coming two years is the surge in population growth. Population growth already provides a solid ballast for current sales, despite high inflation levels forcing sales volume to fall over the past 12 months.
The additional flow-on benefits of high growth in temporary residents and long-term migrants will continue to bolster spending across several years, as the households they form settle into stable spending patterns.
More pyjamas and stationery than jeans and women’s fashion
Premier Investments: Portfolio of iconic brands
Premier is a collection of stakes in high-quality retail companies. Some run separately, some under a general corporate structure, and others are merely investments made at the equity level. These equity stakes are often considered to be “strategic” investments.
In this respect, we view Premier in a similar way to how we view Seven Group Holdings, i.e., having a high-quality portfolio view of investments. We appreciate in Seven Group and Premier that the company is implicitly always one that is willing to:
- Behave like an owner of assets that provides support and expertise and then demands performance from its investments;
- Sell assets and part stakes in business if it believes it is the right time to do so; and
- Always look for new opportunities to add assets or brands to the portfolio.
This strategic approach was put into the spotlight in August this year when the company announced “that it has commenced a formal review (“the Review”) to assess its corporate, operating and capital structure, with a particular focus on Peter Alexander, Smiggle and the Apparel Brands.”
Partially as a response to shareholder demands and partly due a reaction to transactions amongst global brands settled in the previous 12 months, the review will concentrate at a minimum on whether certain assets are best spun out (separate listing) or sold from the stable of assets.
We view this review, which will not be quick nor uncomplicated, as a key component of unlocking value over the next two years.
Old brands and fashion no longer the key drivers of value
On the face of it, seeing the names Just Jeans, Portman’s and Jacqui-E may hardly prompt visions of strong strategic growth options. The high prices, huge profits of mall-based retailing, and the domination of Australian supply chains by a couple of players in men’s and women’s fashion are long gone. Increased competition, the natural erosion of brand presence and the rise of online retailing all point to the limited value of these historic brands.
But historic retailing isn’t where the value is in Premier. Most of the value in the business lay in the new and emerging brands of Smiggle and Peter Alexander, along with a critical investment the company has in Breville Group.
A quick snapshot of the sum-of-parts valuation for Premier Investments is shown below.
Premier Investments: Sum of Parts
Although our overall Premier valuation is built from a bottom-up approach to cash flow modelling, it is possible to estimate the contribution of each business/investment to the total value.
In the case of the stake in Breville Group it simply reflects the existing Breville share price.
Peter Alexander, Smiggle and the equity stake in Breville Group account for more than 70% of Premier’s value, each a similar size. The total of all of the “Core Brands” – Jacqui E, Portmans, Dotti, Just Jeans, etc- is only 15% of the entire company’s value.
The explicit value of the dividends in the sum-of-the-parts valuation is important for two reasons:
- it highlights the strong dividend flow the company has historically supported and
- it notes the high levels of franking credits at the company’s disposal. This franking credit balance – worth an additional $1 per share may be more readily released after the strategic review.
What changed in July?
Three critical changes culminated in July and extended through November, provide confidence for our investment:
- Full-year financial results showed ongoing excellent execution of current strategies;
- The promise of peak or close to peak interest rates from the RBA creates a backdrop of improving financial conditions that have not been apparent in the past two years; and
- The departure of the existing CEO Richard Murray, and the announcement of a strategic review of existing assets due in FY24.
What hasn’t changed?
The business has five key features.
- Strong cash flow generation and fully franked dividend yield;
- Consistent growth in sales across the stable of brands over a long period;
- Active management of the number of retail stores allocated to each brand. Brands that have worked for decades are managed through their decline at the same time as others rapidly grow their footprint;
- Great cost control in general, and specifically demonstrably benefits at the head-office and supply chain level; and
- A highly profitable, growing, and expandable online sales channel.
Cash flow and sales tend to speak for themselves, so we have charts highlighting the remaining three features. The first shows a 20-year trend in the number of stores in Australia by brands. We would highlight.
- The rapid growth in Smiggle from less than 50 stores in 2008 to more than 340 pre-COVID
- The ongoing decline in Just Jeans since 2004, but the management of this decline has been exemplary with the brand still generating strong profits despite the lack of growth
- Associated with the decline of Just Jeans was the ability of the company to use the slightly newer brand, Jay Jays, through the period 2004 to 2012 to counter some of the declines
- The growth from scratch of Peter Alexander
- The commitment of capital and resources to new brands is evident in the speed of the growth of both Peter Alexander and Smiggle
Premier Investments: Active management of retail store numbers by brand.
The importance of the growth in Peter Alexander can be seen in the chart below, which highlights sales per store for each of the brands. Smiggle has sales of around $1m per store on a smaller sqm footprint, whilst Peter Alexander, with more than $3m of sales per store, generate more sales in total from its 140+ stores than the combination of Just Jeans and Jay Jays’ 400+ stores.
Premier Investments: Sales $m per store by brand
With high sales per sqm and high gross margins, the profitability of Peter Alexander must also be high. The strategic review may find that separating these businesses and clarifying the brand-specific profitability unlock far more value than is currently assumed in the Premier Investments share price.
Cost Control
The chart below shows the evolution of costs, by type since 2019.
The pale blue line shows that the company has been able to hold on to some of the excess profit (higher margins) it was able to capture during COVID.
Premier Retail: Cost of goods sold (COGS) and Cost of doing business (CODB) as percentage of sales
The critical elements of the chart include:
- Reducing rent to sales, falling from 17.1% and 19.0% in 1H and 2H19 to 12.9% and 12.2% in 2023. This result is partly a function of online sales, partly a result of Covid but also partly due to Premier exerting significant influence and pressure on mall owners. Only now has Premier reached a mutual agreement with landlords as to the future outlook for rent, and this appears to include significant assistance (cash contributions by the landlord) with capital expenditure at the store level. This will continue to assist cash flow generation in the coming years.
- Higher staff costs over the past 12 months are likely to be partially offset by higher prices, along with less pressure on wages as the impact of migration increases the supply of semi-skilled workers.
- Included in the benefits seen in rent/sales ratios, gross margin, and other costs is the benefit of a higher share of sales through the period. We assume online is now a positive contribution to overall margins (online is more profitable than in-store).
Online
The growth of a great online offer is core to our investment thesis. The chart below shows the company’s reported online sales.
Source: Company reports
The mixture of pure online, in-store pickup of online purchases and the use of online research prior to travelling to the store directly to purchase is now driving a huge share of total purchase behaviour. The influence of the Premier brand’s online advertising and social media only adds to the benefits that continue to accrue to the business.
As shown, online sales, which amounted to $112m in FY18 (9.5% of sales), are now, post Covid, more than $320m and almost 20% of sales. As this online percentage grows, the barriers to new, purely-online entrants carving out a stake similar to Premiers is reducing.
Investment thesis
Referring to our standard set “Themes and Structural Drivers” that we look to identify good opportunities, Premier provides the following access to these themes:
1. Companies that benefit from inflation
Premier Investments is a company that clearly benefits from a range of inflationary forces, especially if it can use its market power. This market power is evident not only in the pricing of the goods it sells but also insofar as it can force rents paid to landlords to grow slower than overall inflation.
2. Technology
An increasing percentage of Premier Investments sales (~20%) are migrating to digital means. This entrenches their brands as a means of being able to stave off new, online-only competitors. Also, as online channels increase in scale, logistic capability, and supply chain solutions improve, margins in the online space will continue to expand. Having portfolio exposure to a mature business with online growth driven by brand power is appealing.
3. Cheap
Concerns about the financial health of the Australian consumer have seen the stock underperform the broader share market over the past year. The stock, therefore, presents favourably against longer-term valuation measures for one of the best-managed retailers in the country. On a prospective earnings basis, the stock is trading around 25% lower on a PE basis.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.