Thinking back to its humble origins of a lonely store in South Yarra in 1981 selling abandoned tableware, it’s easy to conclude that the past 40 years have been kind to The Reject Shop ((TRS)). Fast forward to 2021 and the company is a household name with over 337 locations across the country.
While the discount variety store chain has had its fair share of challenges over the past four decades, the company’s biggest challenge has arrived with covid. Before the pandemic hit, the company had already embarked on repositioning the business to better compete with traditional rivals such as Big W and Target, and relative newcomers such as Aldi.
Management recognized that their business was a numbers game that required them to be much smarter than in the past. As a result, the company embarked on a turnaround strategy that saw it put a knife to the volume of in-stock items lining its shelves, resulting in downsizing of storage units, or reference numbers.
Management knew that in light of a more intensely competitive environment, The Reject Shop’s survival hinged on recalibrating its offering around the dynamics of high volume, low margin on a limited range of rotating stock items. fast.
During the initial phase of recovery, the company worked to stabilize the business by strengthening its balance sheet and reducing costs. Approximately – $ 12 million of underlying costs were taken out of the business in the first half of fiscal 21.
In addition to reengineering The Reject Shop’s store network and redefining its product line, the company has also started renegotiating leases, although this will take time to bear fruit.
When the pandemic hit, The Reject Shop’s turnaround was still in its infancy and the company’s sales activity fell sharply. But that was the tail of two distinctly different narratives: The modest increases in sales across its portfolio were curtailed by downtown stores and large malls.
CBD blockages and supply headwinds
In short, Australia-wide CBD blockages have started to wreak havoc on the trade. Other trade barriers manifested in the form of delays / freight costs on high margin inventory until early March, and a channel shift from metropolitan areas to regional areas.
Impacted by the 7.1% same-store sales growth cycle over the prior period, as well as lower pedestrian traffic at its 47 CBD malls and stores, The Reject Shop’s revenue is expected decrease by around -11% in the second half of FY21. Then there are persistent inventory availability issues due to delays in international shipments, while transportation costs are expected to remain high for 6-12 months.
Impacted by the closures, the 47 stores in the CBD metropolitan locations and major shopping centers recorded a -12% drop in sales compared to the same period of fiscal 19, and continue to trade well below levels. before Covid. In comparison, the rest of the company’s stores saw a 0.9% increase in sales.
Management expects a profit (EBIT) for fiscal 21 between $ 8 million and $ 10 million, compared to $ 4.5 million the previous year, which implies a loss of profit in the second half of the year 21 between -13.3 and -15.3 million dollars.
With sales trends expected to remain volatile and given the pressure on gross profit largely due to rising international shipping and supply chain costs, Ord Minnett cannot see a solution. miracle for the company.
With recent developments undermining the company’s initial progress in lowering labor and in-store administrative costs, the broker has downgraded The Reject store to Hold from Buy and reduced its target price to 5.70. $ for $ 10.34.
Ord Minnett notes that the decline in gross profit margins was exacerbated in the second half of the year after previous management locked its USD exposure at disadvantageous levels.
While Ord Minnett acknowledges that the story of the turnaround is in its infancy, the broker expects sales to remain volatile as the company continues to focus on reducing inventory levels, reducing the number of suppliers and reducing the number of SKUs.
Tail winds ahead
Having concluded that headwinds are near term and the long term outlook continues to improve, Jarden maintains a buy rating on The Reject Shop. While Jarden lowered the target price to $ 10.00 from $ 11.00 in light of short-term headwinds, the broker believes the proposed proposal is a story of long-term margin increases.
While the headwinds are now expected to last longer than initially expected, Jarden is encouraged by the company’s underlying cost reduction efforts.
The broker also expects the company to benefit from a significant cost of goods sold during the key trading period of the first half of FY22. Equally encouraging, Jarden adds, are further rent cuts – with 35 of the 47 CBD leases expiring in 18 months – as well as a growing store network. It is understood that approximately 9 stores are planned for the first quarter of fiscal year 22 (2.5% network growth).
The broker believes that management’s proven ability to consistently deploy stores and reduce the cost base reaffirms the underlying strength of internal factors execution.
Since Jarden does not view headwinds as structural, the broker’s long-term outlook remains relatively unchanged. However, the broker lowered its profit guidance for FY21 by -26% and FY22 by a similar amount to reflect the continued rise in supply chain costs next year.
A slower normalization of consumer spending habits is also expected, and Jarden believes it may take some time for customers to return to stores in pre-covid numbers. Despite current exposures to the US dollar, Jarden expects the company to start benefiting from a tailwind of more than 20% on forex during the first half of FY22.
In the meantime, Morgans has lingering concerns about The Reject Shop’s ability to generate positive sales momentum for extended periods of time. However, the broker also believes the company can resolve / compensate for the current headwinds fairly quickly. Morgans is also encouraged that the underlying cost reduction strategy remains on track.
The broker sees the opportunity for most problem stores to return to profitability fairly quickly and maintains an Add rating but lowered its price target to $ 6.80 from $ 8.91.
Morgans notes that 10 of the 47 stores affected contributed 50% of the drop, with 7 of those 10 stores now having to renew their leases. The broker expects owners to come to the table with reasonable discounts. However, if not, the broker understands that the company has a reasonable pipeline to replace ailing city stores in more suitable and cheaper locations.
Morgans lowered its earnings per share forecast by -25%, -17% and -11% in fiscal years 21-23. However, Morgan’s original investment vision centers on the requirement of patience on the sales front as inventory is reduced and product is optimized with cost reduction being the key area of the upswing.
Having concluded that the sustainability of the business model and structural deployment far outweigh the short-term transient headwinds, Morgan Stanley maintains an overweight rating on the company with a price target of $ 10.00.
The consensus target, which combines the targets set by Morgans, Morgan Stanley and Ord Minnett, is $ 7.50, which suggests a 32.5% rise from the current share price. Jarden is not one of the seven brokerage firms monitored daily by FNArena.