Warehouse Group increased sales more than Morningstar expected in the third quarter, prompting the investment research company to lift its estimate for the retailer's full-year sales and earnings.
New Zealand's dominant discount retailer announced on Friday that group sales increased 2.6 percent to $701.2 million in the quarter ended April 29, in line with its own expectations and keeping intact its forecast for full-year earnings of $50 million-to-$53 million, a decline of about 25 percent from the year earlier.
Morningstar said in a research note that the sales were slightly ahead of its expectations, leading it to increase its forecast for full-year revenue growth to 0.3 percent, versus its previous forecast for a 0.7 percent decline, and raising its estimate for adjusted net profit after tax to $56 million from $55 million, which it noted was 9 percent above the midpoint of the company's earnings range.
Warehouse said its sales growth in the quarter was "encouraging" and shows a positive turnaround from the first half year, as it moves its largest red shed discount department store business The Warehouse to an 'everyday low prices' model, cutting down on sales, marketing and stock clearance activity. The transition is weighing on margins, as average prices fall while volumes increase.
"The board is under no illusions about the business' performance and the company's overall underperformance in the nonfood retail sector as a result of poor execution," Morningstar said. "Management is determined to turn around the franchise by positioning The Warehouse as the 'House of Bargains' and the 'Home of Essentials' for shoppers. We think management's strategy is gaining traction, which is substantiated by the recent advancements."
Still, Morningstar said it remains to be seen whether the momentum is sustainable, noting online shopping is threatening all retailers.
While The Warehouse Group dominates New Zealand's discount department store market, the research house said it was concerned about the intense competition in retail, which it expects to increase following Amazon's entry into the Australian market.
"We believe it is essential for retailers to embrace the online trend," Morningstar said.
"We forecast most of the incremental sales growth across many categories to be captured by e-commerce, particularly in those categories to which The Warehouse Group is exposed, such as consumer electronics and apparel. However, management has formulated a sound strategy, and we expect its successful implementation to protect operating margins and to generate sustainable long-term earnings growth."
Warehouse stands apart in New Zealand because of its sheer size and unprecedented scale, with a retail trading area four times the size of rival Briscoe Group, Morningstar said.
However, its brands were easily replicable with low barriers to entry and had failed to resonate with consumers in the past three years, the research company said. It added that discount department store and electronic retailing were "highly competitive", with price competition a major factor in determining sales and The Warehouse Group's offering was not differentiated enough to justify selling products at a premium retail price.
Price competition had led to margin pressure, with operating margins having fallen by more than half, from 7.4 percent in 2010 to 3.6 percent in 2017, it said.
Morningstar expects Warehouse Group to achieve compound annual revenue growth of 2 percent per year during the next five years, with operating margins averaging 3.3 percent. It said the company's investments in e-commerce would result in strong online sales growth.
The research company values the shares at $2.40, noting they were undervalued at current prices. Shares in Warehouse advanced 1 percent to $2.06 in morning trading on the NZX, having shed 1.9 percent so far this year.