Property could be the difference between David Jones and Myer: Bartholomeusz

There was something eerily familiar about the David Jones numbers today. In almost every respect, except one key number, the metrics of the David Jones result were remarkably similar to those reported by arch rival Myer last week.

David Jones just pipped Myer in terms of after-tax profit, with a $170.8 million profit versus Myer’s $169 million. David Jones does, of course, have a financial services business that contributed $44.4 million of earnings before interest and tax (EBIT) to the result.

A more direct comparison of its department stores’ performance with Myer, however, shows how closely the groups’ are mirroring each other’s performance – and how dramatically Myer has improved its.

DJs’ gross profit-to-sales ratio within its department store business was 39.7. Myer’s was 39.63. DJs cost of doing business as a proportion of sales was 29.8%. Myer’s was 29.43 per cent. DJs EBIT-to-sales ratio was 10%. Myer’s was a somewhat lower 8.25 per cent.

It is that last number that hints at the biggest difference between the two groups. At $3.3 billion, Myer’s sales base is about 60 per cent bigger than DJs’. Its EBIT of $271 million, however, was only 32% bigger than the earnings generated by DJs’ stores.

Given the near-identical gross margins and costs of doing business relative to sales, that would appear to create something of a conundrum. The larger part of the explanation, however, appears straightforward.

When Myer’s private equity owners acquired the group in 2006 one of the first big decisions they made was to sell the group’s flagship Melbourne store in Bourke Street to Colonial First State, the Myer family and the Government Investment Office of Singapore for a staggering $605 million.

Not only did that immediately de-risk what was ultimately a remarkably profitable play for the consortium but it meant Myer itself had only a modest exposure to the $300 million redevelopment of the stores and the $1 billion-plus broader redevelopment around it. Myer’s contribution is $50 million. Without the sale and leaseback deal it is doubtful whether Myer could have contemplated funding the redevelopment itself.

Not long before Myer sold its key Melbourne site, DJs was buying its Bourke Street presence back. It paid Deutsche Bank $414 million to unwind a complicated sale and leaseback arrangement over its CBD stores in Melbourne and Sydney and then on-sold its Little Bourke Street store to the CFS consortium for $50 million.

Thus Myer pays rent on its key CBD sites while DJs is its own landlord. That provides most of the explanation for the relativities in sales and department store earnings.

Both groups will benefit this year from their respective redevelopments in Bourke St. DJs has completed its major renovation of stores while Myer is nearing the end of its transformation of a store that generates about 10 per cent of its total sales.

Both are also counting on new store openings and refurbishments to generate sales and earnings growth over the next few years, along with the repositioning of their in-store offerings.

And both are cautious about the outlook, with DJs’ chief executive, Paul Zahra, and Myer’s Bernie Brookes, offering identical guidance for 2010-2011 – after-tax profit growth of between 5 and 10%.

DJs has produced seven consecutive years of growth during what would have been regarded, until recently, as the McInnes era. It has been a model of consistency regardless of the external environment. Brookes has been able to build a steadily improving trend into Myer’s once-dreadful numbers, engineering a complete rebuild of the group and most recently producing a result that bettered Myer’s prospectus forecasts.

The similarity between their numbers would suggest that their competition isn’t a zero sum game; that both can be simultaneously successful and, indeed, that the near-simultaneous upgrades of their key stores in Melbourne could be very good for both their businesses.

This article first appeared on Business Spectator.