The recent struggles of the Australian retail sector are well known — falling share prices, ratings downgrades and the threat of Amazon looming ahead.
But according to UBS analysts Ben Gilbert and Aryan Norozi, those same market conditions mean now is a good time for listed retailers to reassess their capital management strategies.
The pair found a number of big Australian retailers are well-placed to return capital to shareholders by way of increased dividends or share buybacks.
Specifically, they said Harvey Norman, Woolworths and Flight Centre were the three companies most likely to return capital in the near-term.
The analysts formed their view by assessing how each retailer was placed against five key metrics.
They looked at gearing levels, earnings growth, cash flow, pending acquisitions and stored franking credits as a result of paying franked dividends.
For one thing, lower valuations make share buybacks more appealing. Gilbert and Norozi said many large retailers are trading at 20-30% discounts from their long-term historical valuations.
There’s also the fact that tough operating conditions have forced retailers to tighten up the ship. In other words, there’s been a renewed focus on margins and short-term cash flow.
This chart shows the expected free-cash flow yield for listed Australian retailers, compared to the ASX100 index:
With no major acquisitions or capital expenditure plans in the industry, that leaves surplus funds to return to shareholders.
For Harvey Norman and Woolworths, returns will be most likely be in the form of an off-market share buyback, while Flight Centre is better placed to lift its dividend.
Gilbet and Norozi found that Harvey Norman has one of the largest franking balances on the ASX relative to its size (around 12% of market capitlisation). The company also has low gearing levels.
HVN shares have been hammered lately — it was one of the most shorted stocks on the market earlier this year and the stock price dropped again in the wake of the company’s recent earnings result.
Given the price drop, the analysts said that a $300 million off-market buyback would be a good use of Harvey Norman’s franking surplus, and would add 4-5% to earnings per share.
Woolworth has similar metrics — a big franking balance (around $2.6 billion) and a lower stock price. There’s also the potential the sale of its $1.8 billion fuel division, which the analysts said would support a buyback in the 2019 financial year.
Flight Centre’s franking surplus is also accompanied by a strong balance sheet — it has a net cash position of $370 million — which will provide a platform to increase its dividend payout given that the company’s share price already trades at a 20% premium to its five-year average.
This table shows the screening process the two analysts used to determine how each listed retailer matched up against their five key metrics:
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