Rising Retail Costs Will Strain Margins Yet Reveal Hidden Value

Key Takeaways

• Omnichannel investments and product innovation drive personalization and sustainability, but face margin pressures from inflation, higher costs, and growing price competition.
  
• Stable sales from productivity gains and fulfillment upgrades are offset by risks tied to declining discretionary spend, regulatory costs, and reliance on physical stores over digital channels.
  
• Persistent retail headwinds, margin pressures, and underperforming acquisitions challenge revenue and profit growth, with increased risk to shareholder returns and long-term profitability.

Catalysts

Owns and operates jewelry stores and provides related services in Australia, New Zealand, and Canada.

• While Michael Hill's investment in omnichannel retail, AI-powered operations, and a consignment stock model positions it to benefit from technology-driven personalization and supply chain efficiency, ongoing inflationary pressures and increased store labor and occupancy expenses continue to weigh heavily on operating margins and net earnings.
  
• Although the company's sustained focus on product innovation, as seen with its certified sustainable lab diamonds and proprietary collections, taps into growing consumer demand for ethically sourced products, the proliferation of lab-grown diamonds and heightened price competition threaten to compress average selling prices and gross margins in coming years.
  
• While rising discretionary spending among the global middle class should provide longer-term growth opportunities, particularly in Canada where record sales are being achieved, Michael Hill's exposure to cost-of-living pressures and declining discretionary spend in New Zealand and Australia risks suppressing revenue growth and same-store sales in its core markets.
  
• Despite disciplined store closures and productivity improvements that have kept sales stable even with a reduced physical footprint, the company's high reliance on brick-and-mortar stores and paused Bevilles expansion leave it vulnerable if consumer preferences accelerate further towards digital channels, potentially limiting revenue growth and eroding market share.
  
• While establishing state-of-the-art fulfillment infrastructure and warehousing in all operating countries reduces supply chain risk, increasing regulatory demands for ethical sourcing and compliance may elevate operational expenses and create additional headwinds for sustainable net margin improvement.

Michael Hill International Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Michael Hill International compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Michael Hill International's revenue will grow by 2.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 0.3% today to 3.5% in 3 years time.
• The bearish analysts expect earnings to reach A$24.5 million (and earnings per share of A$0.06) by about September 2028, up from A$2.1 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.7x on those 2028 earnings, down from 66.9x today. This future PE is lower than the current PE for the AU Specialty Retail industry at 26.7x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.73%, as per the Simply Wall St company report.

Michael Hill International Future Earnings Per Share Growth

Risks

• Ongoing store closures across Australia, New Zealand, and Canada highlight persistent challenges in physical retail, signaling pressure on store productivity and potentially leading to stagnating or declining group revenue if these closures are not offset by sufficient growth in other channels.
  
• The absence of a final FY '25 dividend, due to compressed earnings and the need for prudent investment in the face of flat revenues and margins, suggests ongoing pressures on net earnings growth and overall shareholder returns.
  
• Aggressive promotional activity and record-high gold prices are being offset only partly by higher-margin products, indicating the risk that persistent pricing pressure and rising input costs may erode gross margins and limit long-term profitability.
  
• The Bevilles acquisition has underperformed, with sales and margins suppressed in challenging retail environments and a $7.4 million non-cash impairment of brand value, raising concerns about the company's ability to successfully scale new brands and improve top-line sales growth.
  
• Inflationary pressures on operating expenses, particularly in store labor and occupancy costs, combined with flat revenues and a high reliance on the physical store network, could sustain margin pressure and constrain future net profit growth.

Valuation

• The assumed bearish price target for Michael Hill International is A$0.5, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Michael Hill International's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$0.75, and the most bearish reporting a price target of just A$0.5.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be A$700.6 million, earnings will come to A$24.5 million, and it would be trading on a PE ratio of 10.7x, assuming you use a discount rate of 10.7%.
• Given the current share price of A$0.36, the bearish analyst price target of A$0.5 is 27.0% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.