Sell Down

It’s shaping up as the biggest battle in Australian retail history. Australia's two great department stores, David Jones and Myer, built their fortunes on a model of retailing that offered consumers "everything under one roof". Now their massive emporium roofs have these iconic retailers struggling for survival.

This week the struggle intensified as Coles Myer chief executive, John Fletcher, signalled a plan to sell off the Myer department store chain or to list it separately.

It’s a brave move, because Myer is like a beached whale – too much fat, no sense of direction and no momentum. And who in the international business community will be willing to pay a much-touted figure of $500 million for such an acquisition prospect?

Over the past three years, the battle of the department store brands has been won by David Jones (DJs) led by the exceptional talent of the youthful Mark McInnes. Over their long history, both Myer and David Jones have had their ups and downs. But observers will view as one of the most expensive of the many Myer blunders the 1997 decision by management to let McInnes and his colleague, Stephen Goddard, jump ship to join DJs.

McInnes and Goddard, instrumental in setting up Officeworks in Australia for Coles Myer, were headhunted for David Jones as joint heirs apparent. McInnes was appointed CEO in 2002 at the tender age of 37, and then appointed, with finance director Goddard, to the board in early 2003. Their arrival at the top table brought into stark relief the folly of allowing them to escape from the Coles Myer bunker.

About the same time, American-born Dawn Robertson was appointed managing director of Myer in an attempt to reverse the fortunes of the poorly performing department store group. This was not a good appointment. Let’s face it, Dawn Robertson got it wrong. It’s as simple as that. And Coles Myer MD John Fletcher has to carry the can for putting her there.

'Discount Dawn’ as she’s unkindly known in the retail game, confused consumers by talking about designer brands and quality, while at the same time staging sale events in every store virtually every day. The end was obvious to insiders. Over the past eight weeks the wheels have been falling off at the Myer bunker. Marketing people have abandoned ship as the panic set in. The critical seasonal fashion launch was comprehensively won by David Jones and the Myer ad campaigns looked unsettlingly like a 2005 version of a Monty Python sketch.

At the end of her three year term, Robertson’s scorecard makes for scary reading. While Myer has twice as many stores as David Jones, on a store-adjusted basis, each brand has about the same level of sales; and, worse for Myer, its sales are still below 2000 levels and profit is virtually non-existent.

David Jones is doing nearly four times better than Myer in lifting sales. On a total basis, including new stores and calendar adjustments, sales at David Jones in the last available set of accounts (six months to December 31 2004) rose 5.5 per cent while at Myer they increased by less than 2 per cent.

With her 'House of Brands’ strategy, Robertson brought a "best practice" approach, so favoured by John Fletcher, but best practice is "necessary but not sufficient" as a retail management tool. It relies solely on what has been done well by others and fails to allow for local factors or for the application of innovation and imagination so vital to getting the 61 Myer stores fit for the future.

And that's too many stores anyway.

Robertson should have insisted years ago that the CML board wear write-downs on the closure of underperforming stores and she should have stopped chasing David Jones for its valuable place in the market. DJs, being smarter and fleeter of foot, was always going to win that race.

Given the size of the Australian market, the optimum number of outlets for any department store brand is about 30. With 61 leases that run for 25 years, Myer faces great difficulty in achieving an optimum model. Alternatively, the David Jones portfolio, at 34, is much closer to the right fit.

This is one of the many reasons John Fletcher has decided to cut his losses this week.

This highlights the greatest challenge to both Robertson and, especially, McInnes '” and it's not a retail hurdle; it's a real estate barrier to success. With 15,000 to 20,000 square metres in each store, 25 year leases and a business model that measures success by sales per square metre and costs per square metre, losing real estate is not as easy as adopting the latest diet regime.

There are also plenty of redundant categories, among them sports equipment, furniture, television and sound equipment, refrigerators and other white goods, travel luggage, jewellery, nursery furniture, beds, mobile phones and office furniture. There is no longer a compelling reason for consumers to visit a department store to buy any of those products when they can get them at specialty retailers.

A critical measure of success will, therefore, be the speed and efficiency of the shedding of redundant categories, reduction of 'acreage’ and closure of underperforming stores. Though John Fletcher will undoubtedly sell the Myer chain - and David Jones chief executive, Mark McInnes, has indicated he would cherry-pick the better stores - the future of Myer's unwanted stores is still very unclear.

What does all this mean for investors? If Myer can be sold off or floated, CML will be a leaner, smarter investment proposition. Fletcher has made mistakes in the past with Myer, but this is the right thing to do. Myer, as a stand-alone vehicle is however a much less attractive investment proposition.

So, let’s examine the Myer report card for pointers of future value? Performance indicators place David Jones firmly in the lead and better placed for a bright future (see stock-price graph below). After all, less pain means more gain. While Myer continues with too many redundant categories, too many underperforming stores and a supermarket culture of constant discounts for commodity merchandise, it will be put under serious threat by the competitive emergence of discount department stores such as Target, Big W and Kmart.

David Jones & Myer Share Price Performance Comparison (Common Base comparison)

Source: Bourse Data

Myer did attempt to redress the category imbalance by splitting off bulky furniture and electrical into the Megamart brand. Megamart was launched in 1997 and soon expanded to include four stores in Victoria, three in NSW, and one each in Queensland and Western Australia. It has been another cot case for the Coles Myer board.

In a cheeky move in the first half of this financial year, Coles Myer split out the Megamart results from Myer's financial reporting. Megamart made $35 million loss for the year, which, if put back into Myer's result shows that Myer went deeply into the red for the full year. Over the seven years of its existence, Megamart has lost $100 million.

Retailer Gerry Harvey of Harvey Norman predicted Megamart would never work when it was launched and recently suggested "Megamart is terminally ill and should be put down". Harvey's has got his wish: Coles Myer is to sell the Megamart stores and has made provision for an $80m write-down in the process.

And while the department stores have been grappling with these financial and supply issues, the nature of demand has changed. The consumer landscape has evolved and is pushing the department store firmly back towards a quality and service culture. Twenty-four per cent of Australians account for more than half the discretionary spending in the economy. And remember, a department store lives or dies on discretionary spending rather than basic needs.

Known as neo-consumers (NEOs), these big spenders earn more, spend more, read more, are better educated, yearn for quality and personal service and are sceptical that a discount will automatically deliver what they want. 70 per cent of David Jones's customers have neo characteristics and, comparing the growth of NEOs at each brand between 2001 and 2004, Myer has suffered a 7 per cent decline in its share of high-margin NEOs while David Jones has increased its neo market share by 50 per cent over the same period.

It is unsurprising, therefore, that, as of December 31 2004, David Jones's retail margin at 6.1 per cent was nearly double Myer's (3.6%). Additionally, though David Jones's EBIT of $59.6 million was virtually the same as Myer ($60.7m), in the first half it grew 20 per cent compared with Myer's 2 per cent. The full year results for David Jones to be released shortly are expected to show an even stronger result.

The legacy of founder Sidney Myer is a rich one. It may have been pushed into the background at Coles Myer, but it cannot easily be snuffed out. Dawn Robertson has failed to deliver as the retail doctor and John Fletcher is smart enough to sell the Myer chain to someone who will hopefully do a better job. It's just a pity that Mark McInnes has a day job.

Ross Honeywill (ross@customerstrategy.com.au) is an internationally published author, a director of consumer think tank the Centre for Customer Strategy and managing director of the Neo Group.

NOTE:

1. Ross Honeywill spent four happy years as a senior executive at Myer immediately prior to the Coles takeover, and his Neogroup company has done work for both Coles Myer and David Jones.
   
2. Investment bank Carnegie Wylie, a shareholder in Eureka Report, is advising CML.
   
3. Source of all consumer data (unless otherwise noted) is from Roy Morgan Research Single Source

ACTION PLAN

For shareholders the retail shake up following Coles Myer’s decision of offload Myer has repercussions for share prices in CML, DJs and Westfield.

• At David Jones ($2.19), watch the forthcoming annual results – The stock has built-in expectations of very strong performance.

• At CML ($9.75) be very wary of buying more stock until it has sold or severed all contractual ties with Myer.

The CML share price will also be volatile until it has sold the Megamart group.

Any new listing of the Myer stores will still have to shed the excess stores.

• Watch the Westfield ($17.48) role in what is looming as the biggest retail real-estate shake-up in Australia’s history

As the main landlord for Myer department stores, Westfield would not allow the Coles Myer board to assign leases to just any purchaser of the Myer business. Should a buyer be smaller than Coles Myer, Westfield would insist that CML, with its huge balance sheet, retains the head leases and simply sub-let the properties to a purchaser. That means Coles Myer would have to retain liability for any liquidated damages in the event of leases being broken or altered by a new Myer owner.

Myer and Megamart combined represent less than 10 per cent of total revenue at Coles Myer. If Myer can generate only a first half profit of $60 million at the height of the cycle, and given its low attraction to economically resilient neo-consumers, it must be asked how well it will perform as the market slows – regardless of who owns it.

In conclusion, investors can take heart when (and only when) CML sells Myer. The sale price is less critical than the sheer relief of shedding the dying whale. As for investing in the new Myer? David Jones is well run and performing. It is fit for the future. Forget Myer.