Super Retail Group: 1H23 pre-announcement - Still super

About the author:

Author name:

By Alexander Mees

Job title:

Co-Head of Research and Senior Analyst

Date posted:

18 January 2023, 7:00 AM

Sectors Covered:

Gaming and Retail

• We have increased our FY23 EBIT forecast by 19% after Super Retail Group's (ASX:SUL) pre-announcement of its first half result indicated customer demand is holding up well and margins are more robust than anticipated. Our updated FY23 EBIT estimate of $390m implies flat earnings compared with FY22, which we see as impressive given the deterioration in consumer confidence in Australia.
• Group like-for-like (LFL) sales growth was +11% in 1H23, slightly better than our estimate of +10%. The comps get more difficult in the second half and we expect LFLs to soften, especially as the consumer starts to rein in discretionary spending. Although we forecast negative LFLs in the second half, we do expect SUL to deliver 3% positive LFLs in FY23 as a whole, allowing it to absorb significant inflation in its cost base and achieve broadly stable operating margins.
• Is this as good as it gets for SUL? We expect LFL sales to turn negative from this point (including in the month of January) and we continue to see next year (FY24) as a down year both in terms of sales and margins. We are keeping SUL on an ADD rating, however, as multiples remain attractive and to reflect the possibility of further positive earnings surprises and maybe even capital management by way of a special dividend. Our target price increases to (login to view).

Event

Pre-announcement of 1H23 earnings.

Analysis

LFL sales show few signs of the consumer pulling back. Each of SUL’s four brands, except BCF, achieved double-digit positive LFL sales growth in 1H23. Overall group LFLs of +11% are well above what was expected at the start of the year.

Sales have been supported by effective promotional activity and good discipline around discounting. It’s only in BCF, which is up against aggressive price competition from Anaconda, that promotional activity appears to be having an effect on performance.

The comps get more challenging in 2H23 as SUL cycles +4% in the second half of last year compared with (5)% in the first half. On top of this, we expect the consumer to ease back as the effects of inflation and higher mortgage and rent costs start to really make themselves felt.

Margin expansion demonstrates semi-fixed cost operating leverage. The group PBT margin in 1H23 is expected by SUL to be 10.8%-11.1%, up from 9.4% in 1H22. All brands except BCF are expected to report positive PBT margin expansion.

It is not that SUL is in some way immune from the persistent cost inflation affecting all retailers, but the semi-fixed cost nature of much of its business means that double-digit LFL sales growth facilitates operating margin expansion.

This will be challenging to sustain when LFLs turn negative and we expect margin contraction in 2H23 and into FY24.

Forecast and valuation update

We have increased our EBIT estimate for FY23 by 19% to $390m, implying broadly flat earnings on last year’s $397m. Our estimates imply a 62/38 1H/2H weighting, compared with 46/54 in FY22 and 57/43 in FY21. Our EBIT estimate for FY24 increases by 2% to $346m.

Our target price increases to (login to view) due to our higher earnings estimates.

Investment view

We retain an ADD rating. With over 700 stores, SUL is one of the largest discretionary retailers in Australia and New Zealand. Its brands are household names and ‘destination’ brands, both in-store and online.

SUL has delivered steady positive growth in earnings over the past ten years and pays out 65% of these earnings every year as fully-franked dividends. At the current share price, our FY23 DPS forecast implies a 6% yield and the P/E is barely in the teens.

We do expect trading to be tougher as the year goes on, but there is a possibility the deceleration could be milder than forecast. There is also a possibility of capital management, notably a special dividend given SUL has more than $250m in available franking credits.

Risks

The key risks are that sales fall away faster than forecast in 2H23, or that SUL is unable to protect its gross margin as it expects.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.