Fat Prophets: Heading for the Hills

Monday 5th February 2018

International jeweller Michael Hill International recently provided trading updates that highlight significant changes for the group. The first being a shift into new markets that will lead to growing pains while the company is also exiting a sizable and important market in the US. Having originally pushed the shares around the $1.05 mark, and having taken some profits around $1.75, we believe this to be the opportune time for an exit.

Recap and Trading Update:

The past 18 months have been quite a ride for Michael Hill, with the company seeing changes at the top, starting with the departure of former Chief Executive Mike Parsell leading to CFO Phil Taylor taking the helm.

The shares have also backtracked following a transition of the main listing to the ASX, and with the market then in a consolidation phase. Since then, the company has reported facing headwinds in the fledgling US business and Emma & Roe chain while online threats have disrupted relatively mature operations in Australasia.

Given that, the company has provided updates of write-downs in their newer businesses. Unsurprisingly, the market was clearly disappointed by these revelations leading to the share price tumbling and bottoming at the $1.03 level in November 2017. Nevertheless, management has made a brave effort in remedying the situation and the appointment of Vanessa Brennan as the company’s Chief Customer Officer also helped bolster investor sentiment. This saw the shares recover some lost ground, to now trade around the $1.25 level.

That aside, the company also provided a trading update on 12 January 2018 which showed a modest operating improvement. The group reported total store sales growth of 4.7% on a year earlier for the six months to 31 December 2017, while same-store sales were somewhat flat, up 0.5% over the same period. The same store sales performance continued to face headwinds due to the Emma & Roe chain as well as the US business.

However the company recently announced that Emma & Roe was undergoing a "comprehensive brand review" and that management were in the final stages of assessing the 30-store portfolio in conjunction with landlord negotiations. The company also noted a “strategic shift” out into the relatively new “demi-fine” segment which has the appearance of fine jewellery but at lower prices.

Management reports that the reduced store footprint for Emma & Roe has not yet been determined and it is too early to provide lease liabilities associated with the affected stores. Management expects the non-cash write-downs of Emma & Roe store assets to be circa A$7 million.

In addition, management have also announced plans to shutter the company’s US operations after 10 years of losses, noting that the jewellery markets in the US are highly competitive with far fewer foot traffic in malls (thanks to the Amazon effect) and expensive advertising. The company currently has 9 stores spread out across 3 states.

Management also hasn’t provided details on the financial impact of the intended store closures, though they did note that US stores will continue to operate as the company negotiates and completes the exit.

Investors have welcomed the developments with the share price firming of late. The repositioning of Emma & Roe, and the US exit will arguably reduce near term earnings drains, while allowing management to refocus on operations in Australia, New Zealand and Canada which account for around 95% of total group revenues. We however note at the same time that the operations (especially Australasia) are relatively mature, and a key long-term growth angle has been removed. The repositioning into the ‘demi-fine’ segment will also come with its own risks.

The US has been tough to crack for Michael Hill, but abandoning the market removes a substantial growth avenue given its size (~$32bln). Recent moves by the company of late will, we believe, put unnecessary pressure on the share price in the medium term.

Greg Smith is the Head of Research at Fat Prophets share market research and funds management house. To receive a recent Fat Prophets Report, call 0800 438 328 or Click here.

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