The news yesterday was dominated by the announcement that Dick Smith was being placed into receivership. We believe the electronic goods section of the retail sector is set to continue to struggle in 2016. Higher costs of imported goods from a lower AUD and lower margins from increased competition and industry discounting are key reasons for our negative view.
What Happened?
Dick Smith was placed into a trading halt on Monday and yesterday announced that they had entered voluntary administration and were subsequently placed into receivership by its banks. Dick Smith has been experiencing problems for some time, with the company reporting disappointing sales and issuing profit warnings over the course of the past 6 months. Lack of cash flow generation and a poor Christmas trading period were the final straw which resulted in Dick’s major lenders finally pulling the plug on the electronics retailer.
Dick Smith generates annual sales of around A$1.1bn across 393 stores in Australia and NZ. It accounts for approximatley.5.4% of the wider A$21bn Australian Electrical and Electronics market. Based on FY15 reported sales, Dick Smith is the 4th largest electrical and electronics retailer in Australia behind JB Hi-Fi, Harvey Norman and The Good Guys.
What now?
The company will continue to operate its retail stores for the time being. It is possible that a private investor or a competitor see value in the remaining assets of the company and decide to buy the remains of the company.
Who Else is at Risk
If further write-down sales are undertaken by the company to sell its existing inventory, believes it is likely to put pressure on Harvey Norman and JB HiFi, Dick Smith’s direct competitors. This increased price competition will lead to lower sales margins and lower profits for the industry and consequently remains cautious on electronic retailers as a sector. Further, our view is for the Aussie Dollar to move lower, and a lower Aussie Dollar directly translates to higher costs for retailers that import their goods from overseas. Furthermore, competition amongst retailers in the small appliances category has been intensifying as the incumbent players look for growth in a slowing cycle.
Retail Sector – We Remain Selective
A ‘Spending Spree’ is a key theme of our portfolios and we believe that the low cash rates with drive economic growth within the sector. As a result we hold a number of Australian consumer facing stocks in our portfolio. While we are positive on the retail sector, we remain selective as picking retailers we believe will outperform such as Myers, which has had a strong share price run of late.
Chart of the Moment
Dick Smith’s share price plunged 82% over 2015 which was largely due to profit downgrades in October and November. In an attempt to spur sales growth, the retailer slashed the value of its inventories by $60 million, or some 20 per cent in November. Unfortunately this was not enough to alter the course of Dick’s demise. Dick Smith’s management said in a statement that sales and cash generation in December were below management expectations, and it did not expect to be able to secure new funding quickly enough to restock its stores over the next 4-6 weeks.
Dick Smith shares opened on the market at $2.20 when it was floated by private equity firm Anchorage Capital Partners in December 2013, valuing the company at $520 million. Anchorage bought the business from Woolworths for about $20 million in cash upfront just a year earlier – in total the private equity firm ended up paying around $115 million. At close of business on the 31st December 2015 the company value had sunken to $84 million.