Super Retail Group Consolidates Sports Division

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Equity Bottom-Up

We cut our fair value estimate of <a href="https://www.smartkarma.com/entities/6373" target="_blank" data-smartkarma-citation="entities:6373:1">Super Retail Group Ltd (SUL AU)</a> to AUD 7.70 from AUD 9.00, driven by a more muted outlook on sporting goods and leisure segments, partially offset by a more optimistic view on the auto parts business. Amazon is poised to shake up the Australian retail landscape in most categories when it commences its operations sometime during the next 12 months, and Super Retail is not immune. We expect competition to intensify across all the group’s segments, resulting in price cutting, lower margins, and greater investment needs in digital channels and in-store service. We anticipate the company can offset these factors by gradually consolidating the brick-and-mortar channel, as smaller, unprofitable competitors exit due to compressing EBIT margins, but now view shares as slightly overvalued. We rate management’s stewardship of shareholder capital as Standard.We estimate sales growth to average 5.3% over the next two years, and then slow to 3.4% long term, implying revenue continues growing only in line with the respective markets. We expect Super Retail to expand its store network by about 2% per year in fiscal 2018 and 2019, in line with the average growth rate over the past five years. Thereafter, we forecast no new net stores, with most of the incremental sales growth captured by the online channel in categories with already relatively high online penetration, like auto parts and fashion.Super Retail lacks an economic moat. Although the firm leads its respective markets in Australia, we believe formidable competition from existing and new players will lead to price cuts to maintain market share. The large store networks facilitate click-and-collect distribution and increasing private label sales are a competitive advantage, but not enough to sustainably generate returns above the group’s cost of capital. We expect price cutting to impact profitability and estimate the group’s EBIT margins will decline to 8.5% in the long run, from 9.4% in fiscal 2018.We expect the Rebel Sports chain to face more competition from international brick-and-mortar retailers, such as Britain’s JD Sports and Decathlon of France, as well as from vendors such as Nike expanding their direct-to-consumer channel. The sports segment contributed about 40% to group EBIT in fiscal 2017, but we forecast its importance to diminish over our 10-year forecast period, representing only 30% of group EBIT in fiscal 2027. We estimate EBIT margins in the sports segment to decline to our long-term estimate of 8.0% by fiscal 2021, from 10.6% in fiscal 2018, mainly driven by prices deflating by 2% per year from late 2018, as Rebel essentially gives up profitability to maintain market share at the current level of around 25%. Previously, we had estimated EBIT margins to hold up at 10% in the long run. We anticipate a higher portion of sales from private label brands and cost efficiencies to only in part offset the downward pressure on operating margins. For comparison, the number one retailer of sporting goods in the U.S., Dick’s Sporting Goods, saw EBIT margins decline to 5.7% in 2016 from 9.0% four years earlier, albeit coupled by strong topline growth averaging 8% over the period. We expect Rebel’s revenue growth to average 3.4% over the next five years, compared with 4.3% in fiscal 2017.Analyst: Johannes Faul, CFA

We cut our fair value estimate of Super Retail Group Ltd (SUL AU) to AUD 7.70 from AUD 9.00, driven by a more muted outlook on sporting goods and leisure segments, partially offset by a more optimistic view on the auto parts business. Amazon is poised to shake up the Australian retail landscape in most categories when it commences its operations sometime during the next 12 months, and Super Retail is not immune. We expect competition to intensify across all the group’s segments, resulting in price cutting, lower margins, and greater investment needs in digital channels and in-store service. We anticipate the company can offset these factors by gradually consolidating the brick-and-mortar channel, as smaller, unprofitable competitors exit due to compressing EBIT margins, but now view shares as slightly overvalued. We rate management’s stewardship of shareholder capital as Standard.We estimate sales growth to average 5.3% over the next two years, and then slow to 3.4% long term, implying revenue continues growing only in line with the respective markets. We expect Super Retail to expand its store network by about 2% per year in fiscal 2018 and 2019, in line with the average growth rate over the past five years. Thereafter, we forecast no new net stores, with most of the incremental sales growth captured by the online channel in categories with already relatively high online penetration, like auto parts and fashion.Super Retail lacks an economic moat. Although the firm leads its respective markets in Australia, we believe formidable competition from existing and new players will lead to price cuts to maintain market share. The large store networks facilitate click-and-collect distribution and increasing private label sales are a competitive advantage, but not enough to sustainably generate returns above the group’s cost of capital. We expect price cutting to impact profitability and estimate the group’s EBIT margins will decline to 8.5% in the long run, from 9.4% in fiscal 2018.We expect the Rebel Sports chain to face more competition from international brick-and-mortar retailers, such as Britain’s JD Sports and Decathlon of France, as well as from vendors such as Nike expanding their direct-to-consumer channel. The sports segment contributed about 40% to group EBIT in fiscal 2017, but we forecast its importance to diminish over our 10-year forecast period, representing only 30% of group EBIT in fiscal 2027. We estimate EBIT margins in the sports segment to decline to our long-term estimate of 8.0% by fiscal 2021, from 10.6% in fiscal 2018, mainly driven by prices deflating by 2% per year from late 2018, as Rebel essentially gives up profitability to maintain market share at the current level of around 25%. Previously, we had estimated EBIT margins to hold up at 10% in the long run. We anticipate a higher portion of sales from private label brands and cost efficiencies to only in part offset the downward pressure on operating margins. For comparison, the number one retailer of sporting goods in the U.S., Dick’s Sporting Goods, saw EBIT margins decline to 5.7% in 2016 from 9.0% four years earlier, albeit coupled by strong topline growth averaging 8% over the period. We expect Rebel’s revenue growth to average 3.4% over the next five years, compared with 4.3% in fiscal 2017.Analyst: Johannes Faul, CFA

Super Retail Group FVE Cut After Reassessing of Competitive Dynamics