Amazon, Housing Challenge Oz Retail Outlook

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The launch of Amazon Prime, ahead of expectations, suggests to brokers the company is serious and confident regarding delivery of its business model to Australians.

-Amazon's Australian delivery times slower on average but still compare well with sizeable geographies
-Amazon most disruptive in first party supply of well-known brands as well as toys, video games and small appliances
-Slowing housing market adds to the earnings risk for homewares retailers
-Further drop in the savings rate required to maintain current level of retail sales growth
 

By Eva Brocklehurst

Amazon Australia is improving, fast. The company's Prime launch, ahead of expectations, is expected to change the game for retailing across the country. Morgan Stanley suggests the low $59 annual Prime fee supports a long-term investment horizon and shows the company is confident in its delivery.

Amazon is offering two business days delivery to nearly 90% of the population and is available to consumers outside of major metropolitan areas. Morgan Stanley also considers the price for Prime is cheap versus the US, UK, Germany and Canada.

While Australian delivery times are slower on average, they still compare well with others. The US offer includes two-day delivery to nearly all addresses and Morgan Stanley estimates around 37% of Canadian addresses are eligible for two-day delivery.

The Prime offer at this stage includes video and excludes music and cloud. Penetration will expand as more products are brought online for free delivery and incremental services are added.

As Australian retailers tend to charge between $5-10 for delivery this implies the number of purchases required to pay back the Prime fee is low at 6-12 annually.

Prime subscription fees are below Citi's expectations and appear to be targeting higher subscription uptake, which potentially reflects a limited offering. Amazon is offering subscribers free 2-day delivery in Australia and free delivery on Amazon US orders over $49.

While users will have access to Amazon Original content such as videos and e-books Citi does not envisage this as a catalyst to drive membership, given the competitors in the Australian market such as Netflix and Stan.

Rather, Citi suggests, like any retail business, attractive prices, ranges and good service will determine Prime's success. At this stage Amazon is considered to be most disruptive in the first-party supply of well-known brands and most advanced in toys, video games and small kitchen appliances. First party supplies are limited in shoes and apparel.

In the broker's view the largest risk exists for electronics retailers. Combined with a slowing housing market and elevated price competition Citi flags significant earnings risks for JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)).

In terms of retail exposure, Morgan Stanley believes the category killers such as JB Hi-Fi are relatively well insulated, while department stores are most exposed. The broker suspects the market underestimates the impact most in the case of Wesfarmers ((WES)).

Housing

The outlook for housing is not expected to support retail and UBS has become more cautious. House prices are expected to fall more than -5% over the next year because of credit tightening. Consumption growth estimates are circa 2.2% in FY19, benefiting from accelerating disposable income growth and housing starts.

The main risk to the broker's forecast is contained in the savings rate. If this rises around 100 basis points, i.e. to 2.7%, consumption growth could fall around -1.2% in FY19.

This would create significant risk to listed retail forecasts. Furthermore, a further -50 basis points drop in the savings rate is required to maintain the current level of retail sales growth, which UBS suggests could be optimistic.

As the risk is firmly weighted to the downside and the headwinds are building, the broker trims estimates for Harvey Norman and JB Hi-Fi, as these retailers having high historical correlations to a slowdown in housing.

UBS downgrades Super Retail ((SUL)) to Neutral from Buy. The broker's estimates for Bunnings and Metcash ((MTS)) hardware are unchanged, given the upside via market share gains.

The broker favours companies with lower exposure to the macro environment and the housing slowdown, such as Woolworths ((WOW), and upside from international expansion such as Costa Group ((CGC)) and Domino's Pizza ((DMP)).

A second derived negative impact from the housing slowdown is via the wealth affect and this includes Myer ((MYR)) and Super Retail. Still, despite a muted outlook for consumption, UBS believes discretionary retailer valuations are not demanding and are pricing in the softer outlook.

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