Myer Holdings Ltd (ASX: MYR) is Australia's largest full line department store group and one of Australia's most iconic companies. It has a very strong brand and over 5 million MYER ONE cards are still in circulation.
Nevertheless, the company is in major trouble. Sales have stagnated for five years and the company's net profit has decreased by 50% in the last five years. Myer has been slow to adapt to the changing consumer environment and a flood of competition has meant that their business model no longer works as they lack operating leverage.
Operating leverage is crucial to a retail business, as a high fixed cost structure means that high returns on capital are only generated if a large volume of goods are sold. For the revenue Myer generates, the cost structure is too high and margins tightening at too rapid a rate, with consistent declines in sales volumes there is no reason to believe that operations are turning around anytime soon.
A broken business model
Myer suffers from a fundamentally flawed business model as a result of its high cost structure. Myer has gross margins of just 38% and razor thin operating margins of just 3%. With sales dipping, this has led to its operating margins worsening and should current trends continue, Myer is headed toward losses.
A turnaround does not look like it is in sight anytime soon despite a restructuring plan. In a release to shareholders in mid-December, the company reported that declining foot-traffic continues to negatively impact the business and that the recent trading environment continues to cause Myer significant challenges as the company has not been able to stem the decline of its retail operations despite a push into e-commerce.
Additionally, competition is only increasing and retailers are being pushed into price wars.
While Myer has tried to leverage the "shopping experience" for its clients, it is clear that more people are shopping online. Consumers, who see the same item selling over the internet for significantly less than it costs in store, are now no longer purchasing from traditional brick & mortar retail outlets.
Competition also means that consumers are increasingly more inclined to wait for sales or store discounts rather than purchasing items at full cost, again hurting margins. Concessions cost Myer $700 million dollars last year alone.
While the MYER ONE loyalty cards do help to create some customer loyalty, they also cost Myer a significant amount of money. Around 2% is rebated to clients for every thousand dollars spent. This ultimately eats away at the bottom line.
Another major problem that Myer has is the need to spend more money on marketing and promotion to preserve its existing customer base. A decrease in total sales would be fatal to the company which could spiral into a downward cycle if it decreased its advertising spend, as fickle consumers who are price conscious explore their options.
The likelihood of this occurring appears to be increasing as inventory levels are down and store closures are increasing. The lack of transparency in the business is apparent as no full year guidance has been provided and the company lacks visibility on the kind of profit or loss that it may achieve this year.
Finally, the involvement of businessmen Solomon Lew is probably a net negative for the company. Restructuring is painful and the viability of Myer as an enterprise is currently in doubt – having the added pressure of an impatient big money investor will not make things easy for management and will be a distraction.
Foolish takeaway
I would steer clear of Myer, although the shares have declined 80% from their peak – there may be more heavy material declines ahead.
