A stockpicker’s guide to David Jones Limited in 2014

Management changes may be needed in the short term.

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A tumultuous few months for David Jones Limited (ASX: DJS) appears to have reached a crescendo this week, as local media digest news that major rival Myer Holdings Ltd (ASX: MYR) made a merger approach to David Jones in October 2013.

Shareholder revolt

The previously secret development was revealed last week by numerous media outlets to the dismay of much of the investing community.

The Peter Mason-led David Jones board rejected the merger without disclosing the approach to investors or starting negotiations. It is believed that the failure to entertain the bid was part of the reason for CEO Paul Zahra announcing his departure in the same month as the offer.

The merger revelation came after investor groups successfully petitioned the corporate regulator to investigate a case of insider trading against two directors who purchased shares just days before an upbeat profit announcement. Incidentally, the purchases also came just one day after the board received the offer from Myer. This latest news has led shareholders to call for Mr Mason’s head, hardly the sort of environment conducive to strong shareholder returns.

Company performance

Perhaps surprisingly, the takeover debacle actually resulted in the share price rising by around 4% on the belief that a follow-up offer might be made. In 2013, David Jones shares handsomely beat the market, registering a 24% return to the S&P/ASX 200 Index’s (Index: ^AXJO) (ASX: XJO) 14%. The rise was in part due to a perception that retail stocks had been oversold in 2011 and 2012, and that consumer spending and confidence would improve with a stabilising world economy.

A note from Morningstar last week also pointed to David Jones’ sales volumes and profit having a strong correlation to asset prices, which generally performed well in 2013.

From a financial standpoint, David Jones’ revenue and profit has been moving steadily lower since 2010 and earnings per share are expected to fall another 15% in the 2014 financial year.

2014 outlook

While some commentators are positive on the sector as a whole, most acknowledge that Australia’s major bricks-and-mortar retailers are struggling to adapt their offering to the online marketplace. David Jones is certainly one such company and major risks remain from internet competitors, subdued consumer spending, and increased competition from premium international brands entering the Australian market.

Foolish takeaway

David Jones has had a terrible start to 2014 with no CEO, a board in disarray, dissenting and angry shareholders, and the prospect of another year of revenue and earnings reductions. In this Foolish investor’s view, changes will have to start at the top of the embattled retailer in order for the share price to appreciate and investors to regain trust in management. More focus will have to be put on internet sales and the company will have to find a way to differentiate its online offering from more agile internet-only rivals. 2014 may well turn into a transition year from which David Jones can springboard into the next five years.

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Motley Fool writer Andrew Mudie does not own shares in any of the companies mentioned.

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