Bargain Basement?

The 18% improvement in net profits on the back of a modest 5% improvement in sales reported today by David Jones confirms chief executive Mark McInnes as the leader in a new generation of retailers.
The result is a particularly impressive performance against the wilting performance of Myer, the struggling department store division of Coles Myer, which has been put up for sale in recent weeks.

Though retail analysts had questioned the dependence of David Jones on credit card incomes, the numbers for 'department store EBIT (excluding credit cards)' tell a different story. David Jones enjoys EBIT margins of 4.1% against a palty 1.3% at Myer.

In a wide ranging interview McInnes put his case for investing in the retail sector to Ross Honeywill.

RH: How do you see the retail landscape in Australia?

MM: I've said for some time, and I think you and I agree on this, that if you’re caught in the middle, you’re dead. You can either be a low cost operator or you can be a distinctive benefits retailer. And if you’re caught in the middle, (not necessarily in the short term) but in the long run, you’ve got no proposition which is sustainable.

We’re a distinctive benefits retailer. People come to us for a lot of different reasons and we give people a lot of reasons to come. If you’re a low cost retailer, then that’s the benefit: you offer low cost and low prices. But anywhere in the middle, and in the long run you’re dead.

RH: How you view retail as an investment?

MM: It’s interesting Ross because I would say that our total company EBIT margin this year will be in excess of 6% and that is pretty much global best practice for retailers. When you think about our business though, what’s really important is that we’re a strong cash generator. And if we use our cap-ex expeditiously we generate a fair amount of cash that in my view is better in the hands of our shareholders’ than our own hands. So the strategy we set in 2003 of paying a dividend increasing with our profits and of returning excess cash to our shareholders, in my view makes us an excellent investment. So we see ourselves as a yield stock. Obviously we pay fully franked dividends so from an investment point of view we’re talking about paying a 5 or 6% yield and then, if we franked it up we’re talking about a 9 or 10% return. And that’s a pretty good return from my perspective.

The question is – how sustainable are your cash flows? And when you look at our business model, I would argue that we offer ourselves to investors as a cash generator, returning that cash to shareholders in the best manner over time, so I think our business model is sustainable. And I think over the last 2 years we’ve been able to get profit growth in good times, but also in tough times.

RH: How do you see the short term, medium term outlook in Australia?

MM: I think we’re in the middle of the trough and we’re going to bounce along the bottom for the next 6 months and business will be relatively flat.

RH: Are we at the bottom?

MM: We’re bumping along the bottom and therefore it may give the impression it’s not quite the bottom. I suspect that we’ll be bumping along the bottom until Christmas. In fact I don’t see any great retail growth returning until the Christmas of next year. So those retailers that are being optimistic about sales revenue forecasts to get their profit forecasts, in my view have got the cycle completely wrong. I think that trading conditions will continue to be tough. I think that the wealth effect all adds up to sentiment and discretionary spending. There are no government handouts as there were this time last year; the tax cuts have largely been eaten up; petrol price increases particularly impact the demographic areas that find it a bit tougher. In general I think it’s a subdued consumer-spending environment and that will remain in place until all of those effects are through the system – we’ve probably got another 6 to 9 months of that.

RH: How important do think it is that a retail business is run by a retailer?

MM: I think that retail is an instinctive business and you must have a knowledge of how to get maximum use from your supplier base, your space and your staff. And you must have had experience at doing that or you will simply not know how to maximise it. However, traditionally, retailers have not necessarily been good financial managers and people have often talked about having good retail skills but not being good financial managers. But in my view, they can be both. There’s no need for you to one or the other.

Financial skills are managing your capital base, managing your cost base, making sure that you’ve got the right infrastructures in place for procurement and managing all sides of your business that touch the financial component. And at the same time being able to connect between being a good retail manager and a good financial manager.

I think that over the last 12 months the difference between our company and our competitors is that we’ve realised that our fortunes will rise and fall with economic times but it’s in our hands to manage the financial inputs into our business to make sure we get a better return for shareholders. And the fact that we’re one of the few listed retailers in the discretionary sector that have increased profit after tax in a difficult trading period is testament to the fact that we can be good retailers. But we can also be good financial managers

RH: Is it easier for a retailer to get financial management skills around him/her than it is for a financial manager to get retail resources?

MM: I think retailers are eternally optimistic. One of the downsides of being a retailer is thinking that this time next year, growth is going to continue. But it’s actually not true. In general, the economy works in cycles and retailers have got to manage those cycles. So I think, to be very frank with you, the companies that have done best over time are those who’ve had a retailer with financial skills attached to them rather than the other way round. And I think the best example of that is Roger Corbett who, when he took over, took over the business as a retailer and obviously has fantastic financial skills. In saying that I think good retailers at senior levels are hard to get.

RH; What has Myer done wrong?

MM: Firstly at a brand level they’ve moved in the right direction as quickly as they possibly could. You and I might disagree about whether some of those brands were good or bad but in principle they’ve tried to 'brand up’. And I think that’s a good strategy for them. In principle they’ve attempted to return service to their business and you know the Myer heritage as much as I do and there was always a service philosophy, so I think that’s a good thing.

But I don’t think, to be frank with you, that they acknowledged that there was an economic cycle and I don’t think they were managing their financial disciplines at the same time as they were managing their retail disciplines. And if you ask me as a competitor – they’re a fierce competitor; they’re the price-setter. And so we’ve got to watch that very closely. Mind you, they’re under the skirts or the umbrella of a corporation that gives them far more benefits than we have as stand-alone company, but at the same time I think they have not managed those things well and therefore they’ll be looking backwards to fix the problems while we’re looking forward.

RH: What will be the impact of the sale of Myer on David Jones?

MM: Well we’ve put our hand up to be part of the process and expressed an interest in a number of stores. It’s pretty clear to us that there is more than one business going on in Myer in terms of their store locations. So we still expect to be trading in our core locations against a department store competitor. I think the bigger issue is what happens to all those stores and outlets that are actually not in department store catchment areas and locations and where does that business go. I remain unclear about that because the landlords ultimately will have the say as to what happens. I still expect on the basis of capital city stores – and the major store locations like Bondi and Chatswood and Chadstone – that there’ll still be two major department stores. I don’t see any reason why that won’t be the case. Now whether they operate at the same market level or not, I think will be a function of who owns them.

RH: What do you put your own success down to?

MM: I put it down to many things. One is an absolute focus on who we are as company- that we’re a department store operating in a cyclical economic environment and we’ve been focusing on the core operational fundamentals of the department store.

We’ve been focusing both on getting our retail offer better – investment in brands, refurbishment new stores, improved customer service, better marketing – and at the same time we’ve had as many rigorous processes in our business on cap-ex productivity, cost efficiency and credit card performance. So we’re building our strategy around a sustainable retail model that can rise and fall with the cycle AND we’re getting the financial indicators in our business in line so that they also rise and fall with the cycle. The result is that we deliver after-tax profit growth throughout the economic cycle. And I think that we’re the only company doing that.

I think that ultimately it’s not that we’ve been significantly more successful, it’s just that others around us have failed to manage their business and as a consequence have reported huge profit drops. So we’ve stood out as a result of just being steady, not as a result of doing anything spectacular, but as a result of being steady; of concentrating on our business; of getting our financial disciplines in place. Our competitors and others in our sector are not doing that. And I think we predicted that some time ago but the real benefit in that for us in that we’re not looking back to fix problems of the past, we’re looking forward. So we see ourselves as well placed for the future – unlike our competition, we don’t have excess inventory, we don’t have profit drops to deal with, we don’t have stock we don’t want to sell, we don’t have bad stores and bad leases. All that stuff rests with other companies and we’re just concentrating on how we can get even greater productivity out of our business.
RH: Where do you invest your own money?

MM; That’s a very good question. I’ll tell you a funny story. I’m quite a fan of David Paradice (Paradice Cooper Investors) who’s a shareholder in our company. I said to him 'I’ve looked at the returns that your funds and portfolio have got over the last couple of years and I’d like to invest my money with you’. And he said to me, 'Mark if you invest that money with me, I’m just going to go and put it all in David Jones shares’. So he was telling me as a shareholder that if I was going to invest with him, he was going to put all my money in David Jones shares because that’s where he wanted me to focus.

Look, I believe in owning your own home and I have a small share portfolio but my greatest investment is David Jones shares.

RH: You’re a young man – probably the youngest successful CEO in corporate Australia – so what would you love to do in the future?

MM: I think I’m a bit like you in this regard. I never dreamed I’d be doing this when I was coming up through the retail ranks – I started as a cadet at Grace Brothers and then was a trainee buyer and a sales manager. If you had asked me when I was 24 or 25 or 30 or 33 whether I would be running David Jones I would have thought it was a ludicrous proposition. So in one way I never thought I’d have this opportunity and I do see it like that by the way. I’m deeply, deeply honoured to have this opportunity to steward a fantastic old heritage brand back to a market position it should have. I haven’t given the future any thought because I never imagined I’d be here. If you grow up poor and you do all that and you work your butt off and you end up in this position, you think 'how did I get here?’. What was that? So I can’t even imagine what the future looks like.

I’m one of the luckiest people because I love what I do. I’m sure it will come to an end some day. I wake up every morning vitalised by the challenge of the new day. And I take very seriously this role of stewarding this brand. But I love what I do so I’m fortunate. I think I’m one of the lucky ones.