The positive January trading update for Super Retail Group has provided a false sense of comfort in the sustainability of sales growth this year. Inflation will begin to fade, and consumer spending may echo this as confidence wanes with household budgets under pressure. SUL has a strong balance sheet with capacity for capital management, but the Board is taking a cautious approach.
January trading. Included in SUL’s recent interim result was a trading update for January (first 6 weeks of 2H23) which showed strong like-for-like sales growth across most of its brands. Supercheap Auto LFL sales were up 8%, Rebel 13%, BCF 3% and Macpac 30%. While these numbers are impressive, they are being compared against a prior period that was affected by the Omicron variant of COVID-19, plus a surge in domestic tourism and outdoor activity in 1H23. January 2023 also had better weather and the advantage of back-to-school vouchers in NSW.
Inflation has been kind to SUL over the last three years, pushing up prices in auto, footwear and recreational goods particularly. This price effect has contributed to SUL’s sales growth performance over that period, but as inflation begins to fade in 2023, this will soften sales growth. SUL has a natural sales bias to the first half of its financial year with only the smaller Macpac division more skewed towards winter sales.
We expect to see sales growth normalising across all of SUL’s brands, with the first signs of decline likely to appear mid-year as the larger brands enter a seasonal dip. The group financial impact will be seen mostly in FY24f.
Gross margins are improving as freight and logistics costs normalise. This is important for SUL which sources around 30% of its goods from China and Asia. But we are particularly focused on the gross margin performance at BCF which has been SUL’s most volatile brand. BCF is carrying more inventory as a percentage of sales than the other brands and faces stiff competition from Anaconda.
Capital management. SUL had a net cash position of $212m at 31 December 2022 and company management is considering some form of capital return. This will probably be announced at the annual result in August and will obviously be influenced by the trends emerging through 2H23f. The company’s net debt to EBITDA target range of 0.0x to 0.5x are the boundaries but we expect the Board to take a conservative approach. It will need to balance the slowing sales environment against the higher capex spend of ~18 new stores and a new DC in FY24f in Victoria.
Investment View
SUL has been a strong performer so far this year, up almost 20%. But a PE ratio of almost 14x FY24f EPS is too rich, particularly as consensus forecasts appear generous if a sales slow down eventuates in 2023. The SUL PE is also too optimistic when compared to JB Hi-Fi (JBH) which has slipped below 10x.
We view the recent price appreciation in SUL as optimistic and does not adequately consider the fading inflation and weaker consumer landscape ahead.
The potential for capital management may provide some share price support. But until the SUL Board decides, likely in August when the situation may be different, then this is less of a positive factor, in our view.
Risks to Investment View
Sales volatility and online competition could cause SUL’s earnings to fluctuate if demand altered or consumer discretionary spend fell.
Recommendation
We have reduced our recommendation from Hold to Sell.
Figure 1: PE RATIO SUL VS JBH
Figure 2: SUL’S INVENTORY IS HIGH BUT MANAGEABLE
Figure 2: GROSS MARGIN IS SETTLING AT ~46%
