Priced about right, page-2

SSG is a very problematic opportunity.

It looks cheap on current metrics, true. If the housing downturn turns out to be mild, it will provide superb returns from here.

Unfortunately, I believe that's an unlikely scenario. My examination of past discetionary retail downturns that have accompanied property downturns, around the world, at different times, leads me to conclude that there is a very substantial risk of revenue declines in this sector in the order of 4% to 5% per annum, over the next several years, for possibly up to 5 years or so.

Whatever management might say about LFL sales growth, which I take with several grains of salt, SSG sales per network store have been flat over the last several years. This despite the management claims of very substantial online sales gains. The picture is a little clouded by the suppossed "diagou" sales distortions. On this, I find it interesting (though not suprising) that the influence of such has being much trumpeted by management on the downside, but management were happy to remain silent on the upside.

My concern is that this may be indicative of supply led growth, rather than demand led growth.

What's more, if we subtract occupancy and staff costs from opex (as these costs must rise proportionately with new store openings), I see little evidence of productivity gains versus network store sales.

A downturn in sales, on the scale stated, presents major downside potential. The questions are many. Not least would be the impact of substantial declines in the AUD (which can be expected to accompany a severe property downturn) which would put serious downward pressure om gross margins. Cost margins here are such that EBIT margins will likely be smashed. Then there is the possibility of inventory write downs and store closures.

On top of that, when I adjust the balance sheet for seasonal working capital variations, I see a balance sheet that is substantially net debt. There is not a lot of balance sheet safety, that I can see.

What's more, the continuing program of buying out franchisees and bringing sales in house (a program that is now virtually complete) is tranferring risk (both margin and balance sheet) to shareholders of SSG, just when risks are on the rise. Related to this, if the need arises to reduce store numbers, it would be much easier to let a franchisee go, than to close an owned store. This is essentially now a lost option.

What I see is a management that is too focused on growth, when really the focus should be on making the business more robust. For my money the dividend should have been slashed, the store roll out program should have been halted, and the focus should be on strengthening the balance sheet and consolidating on the strongest stores. What's more, this should have commenced a year ago.