No-moat Myer (ASX: MYR) has made a nonbinding, indicative, and conditional proposal to acquire no-moat Premier’s (ASX: PMV) Apparel Brands business, comprising Just Jeans, Jay Jays, Portmans, Jacqui E, and Dotti. Apparel Brands’ fiscal 2023 sales of $845 million accounted for roughly half of Premier’s group revenue, and the acquisition would materially lift Myer’s sales, which stood at $3.4 billion in fiscal 2023.

Following the bid Myer shares surged over 20% and are now trading slightly above our fair value estimate of $0.75.

Premier’s board is considering the proposal. With no firm deal and the price tag unknown, we maintain our fair value estimates for Myer and Premier at $0.75 and $20.50, respectively. At current share prices, Myer looks fairly valued and Premier trades at a significant premium to our value estimate.

The acquisition could create synergies for Myer, including a stronger bargaining position with landlords and the fractionalization of overhead costs. But Premier simultaneously loses these benefits, and we expect Myer would need to compensate for this in the acquisition price.

Myer’s footprint of around 60 department stores would expand significantly if it absorbed Apparel Brands’ over 700 stores across Australia and New Zealand. This means a meaningful uptick in lease liabilities, which we see as a risk against a backdrop of increasing channel shift to online shopping. Online accounts for about 20% of sales at both Myer and Premier. For the apparel industry more broadly, we expect online penetration will rise by an average 0.5% per year over the next decade.

The proposed deal would combine two mature, low-growth retailing businesses. We forecast similar sales growth for Myer and Apparel Brands over the next 10 years, with a compound annual growth rate (“CAGR”) of about 1%. Under the proposal, Myer acquires Apparel Brands in exchange for new shares issued to Premier, on a multiple of "maintainable" earnings before interest and taxes (“EBIT”). Premier does not report EBIT by segment, so no indicative acquisition price can be drawn based on current disclosures.

Myer business strategy and outlook

Myer targets the middle to upper market, selling exclusive brands in competition with department store David Jones. The five largest Australian department stores share virtu

ally the whole of the department store sector between them. While Myer, with a market share of around 15%, and key competitor David Jones (around 10%) operate at the upper end of the market, they also compete to an extent with the discount department stores operated by Wesfarmers (around 50%) and Woolworths (around 25%).

With entry into the Australian market of brands like Zara and H&M, and online competition from players such as Amazon, we expect domestic department stores will increasingly find it difficult to compete with the international disrupters because of limited comparable sales volume growth.

We expect online sales to become an even more meaningful percentage of sales during the next decade as consumers increasingly perceive online retailers as offering value and convenience. Myer’s strategy is to strengthen its online presence and is rapidly growing its e-commerce business, while rationalizing its physical footprint to maintain productivity levels, owing to relatively weak sales growth in the brick-and-mortar channel. But we forecast competition from e-commerce to intensify.

While we expect the online channel to grow faster than the brick-and-mortar channel to fiscal 2030, and Myer to partially capture its share of this e-commerce growth, Amazon Australia will pursue its piece of the pie, leading to a decline in the size of the sector's addressable market.

The outlook for Myer remains highly uncertain as it grapples with cyclical and structural industry headwinds. In tough economic times, it is the discount department stores that benefit from more frugal customer behavior.

Moat rating

Myer lacks an economic moat. We do not believe the company has established a durable intangible asset or cost-based advantage over competitors. Adjusted returns on invested capital, or ROIC, in the midsingle digits are well below estimated weighted average cost of capital (“WACC”) of 11%.

Founded in 1900, Myer is an iconic Australian department store chain. However, its brand hasn’t supported outstanding sales growth or lucrative returns on capital. Since listing in 2009, more than half the book value of Myer’s brand name has been impaired.

The appeal of the traditional department store business model is in multidecade structural decline. The department store sector’s share of Australian retail spending shrunk to 5% from 13% three decades earlier. We expect the sector’s relevance to fade further in the decade ahead. Within the structurally challenged department store sector, Myer is losing market share to discount department stores. In the 10 years to fiscal 2023, we estimate Myer’s share of the sector declined to 16% from 19%.

Consumer shopping habits gradually changed over the past decades, favoring big-box chains, or category killers, specialty retailers, and more recently e-commerce.

Myer is building a solid digital platform, with over 20% of its sales generated online. Its online penetration is broadly in line with the overall fashion category. However, competition is intense online, with many other retailers and online marketplaces offering broad ranges of comparable products. Myer predominantly sells apparel and accessories, making up close to 60% of sales. Homewares and beauty products each account for about 20% of sales. We estimate Myer’s online sales are cannibalizing in-store sales, rather than generating incremental revenue.

The Myer One loyalty program counts over 4 million active customers, offering rewards and exclusive deals. However, we don’t believe the loyalty program constitutes a competitive advantage.

Myer one membership is free and hence there is no opportunity cost for customers to shop at competing stores. Also, many competitors offer discounts and special offers to loyal customers. While most transactions are generated from members and these spend almost twice as much as nonmember, the causality is uncertain—whether customers sign up as members because they intend to spend more or they spend more because they’ve signed up. In a sector that is distinguished by multiple annual sales events with deep discounting, we suspect the rewards offered are too insignificant to drive meaningful customer loyalty. Myer one rewards include a $10 reward for every $500 spent, equating to a 2% discount, and a birthday voucher of up to $30.

Myer’s nationwide store footprint doesn’t present a cost advantage, neither over online pure plays nor specialty retailers with large store networks. Highlighting the diminishing importance of its store-network, floor space is over 14% lower than in fiscal 2018 despite a high-single-digit increase in sales since.

In-store and online sales generate similar operating margins, suggesting online pure-plays can successfully compete. While about one third of sales are from brands exclusive, we do not believe Myer has significant power to negotiate lower prices from producers. Its mid-single-digit operating margins are broadly on par with other no-moat retailing chains in Australia and department stores globally.

We don’t expect Myer’s economic moat potential to be undermined by material shareholder value destruction from environmental, social and governance, or ESG risks. Myer’s policies and initiatives to mitigate ESG risks are appropriate, including a code of conduct, a whistleblower policy, an ethical sourcing policy, and environmental and sustainability initiatives. All of Myer’s suppliers must adhere to its sourcing policy, prohibiting all forms of modern slavery. Also, Myer is steadily reducing its energy usage and associated greenhouse gas emissions.

Terms used in this article

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.