Has Brookes put the cart before the horse?

Bernie Brookes is a very able retailer, and he has modernised the Myer chain. The question Myer's profit numbers raise again, however, is whether doing up department stores is the equivalent of changing the upholstery in a horse-drawn cart a century ago to meet the challenge posed by automobiles: there are new ways to shop, and Myer cannot easily respond.

It was retaining only 2.3¢ in the sales dollar as earnings before interest and tax in 2006 when a private-equity consortium led by TPG bought it for $1.4 billion and appointed Brookes chief executive.

He had lifted the margin to 7.2¢ in the dollar by the time Myer refloated in November 2009, and stretched it to 8.25¢ the following year.

But it has been downhill ever since. Earnings before interest and tax fell from $230 million to $215 million in the latest year, and are 20.7 per cent below their peak of $271 million in 2009-2010. The EBIT margin is back down to 6.83 per cent, and post-tax earnings in the traditionally slow second half were only $39.3 million, 24.5 per cent down on the same half last year.

Sales have been flat for three years. They fell by 1.6 per cent on a same-store basis in the final three months, and the weakness has spilled over into the new financial year. Brookes says earnings in the first half that includes Christmas are not expected to match earnings of $87.3 million in the same half last year, as store refurbishments crimp revenue and Myer absorbs some once-off spending on its online expansion.

The group's shares fell by 11¢ or 3.8 per cent to $2.77 on the profit news. At that price, Myer's 1¢ lower annual dividend of 18¢ is yielding a tidy 6.5 per cent before tax credits and 9.2 per cent after them, and Brookes is predicting the group will deliver earnings that anchor it.

It extracts fatter profit margins on its Myer Exclusive "house" brands, for example, and their share of total sales rose from 18.9 per cent to 20 per cent in the latest year. Brookes says Myer's EBIT margin would be 8 per cent if Myer Exclusive brands accounted for 25 per cent of sales, and says that is where it is headed.

The big plan that was in place when Myer refloated is history. Investors paid $4.10 a share in the belief Myer would boost revenue to leverage higher profit margins by aggressively expanding store numbers from 65 to between 80 and 90. In the event, store openings have been offset by the closure of underperforming outlets: there are 68 stores now, and Brookes says that with consumers subdued and internet retailing on the rise, the chain will top out in the mid-70s.

He says the money he is spending to beef up Myer's online presence will begin to pay off from this year on. Online sales doubled in 2012-2013 and will hit $50 million this year, the level at which he says they become profitable. Store renovations, including three this year, will make Myer more profitable in the medium term, he says.

Capital expenditure was $77 million in the latest year and will rise to about $90 million this year, including $11 million of spending on online software and store refurbishment. That is well below capex of $150 million, $154 million and $142 million in the three years to July 2010, when Brookes' makeover peaked.

Cash costs have risen from 29.4 per cent of sales in 2010 to 32 per cent, however, and while higher electricity and employment costs are unavoidable, the increase also reflects higher spending to remain competitive in a market where online competition is relentless, and bricks and mortar competition intensifying as specialty retailers proliferate and overseas groups, including Zara, Topshop and H&M, join the fray in Australia.

The business has become more cost-intensive as Brookes attempts to hold the line. With no over-arching plan to boost the revenue base in sight, the $4.10 price investors paid in the refloat of the group in 2009 is far away.

mmaiden@fairfaxmedia.com.au