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Retailing Difficulties Reach Into 2019

Australia | Jan 14 2019

Discretionary retailing encountered difficult Christmas trading in 2018 and brokers suspect a depressed consumer environment bodes poorly for the upcoming reporting season.

-December retail trading in Australia deteriorated relative to preceding months
-Margin issues loom large for specialty apparel & accessory retailers
-Food inflation continues to support supermarket growth

 

By Eva Brocklehurst

The Christmas shopping season of 2018 heralded more angst than usual for retailing, given the number of headwinds prevailing for consumers both domestically and globally. A reasonably solid November appears to have given way to a poor outcome in December, particularly for specialty retailers.

Ord Minnett points out investors are negatively disposed to discretionary retail, as good news appears to be ignored and bad news punished, and this theme may continue until countered by the delivery of strong results.

Morgan Stanley lowers its estimates for discretionary retail stocks under coverage to reflect the soft environment and weak Christmas trading. Headwinds include falling house prices, "Black Friday" discounting and weaker equity markets.

Meanwhile, Amazon continues to expand its offering and extend its advertising, although the impact appears limited to date. Morgan Stanley also notes consumers appear to be browsing online then transacting in-store yet, while this increases conversion rates, a soft market still prevails. New vehicle sales fell -14.9% in December, calculated to be the largest fall since the global financial crisis.

Most of Deutsche Bank's survey contacts signalled trading at the end of 2018 was much weaker than previously expected, and some said it was the worst Christmas for a number of years. Traffic and sales were soft and margin issues loomed large for specialty apparel & accessory retailers.

The broker notes consumers have been trained to buy on promotions and Black Friday in November pulled sales out of December. Department stores appear to have performed better than specialty retail, a departure from recent trends. 

Retail sales increased in November a little more than expected but less than the increase recorded in the prior November and, Morgan Stanley calculates, annual growth fell to 2.8% for the year from 3.6%. Strength occurred in apparel, while furniture and restaurant sales disappointed the broker. Electronics sales, while strong and helped by Black Friday sales, were less than the prior November.

In other categories, furniture/furnishings slowed versus trend while hardware was relatively resilient. Online takeaway food growth was 9.7% in November while total takeaway sales grew 1.7%.

The data are even weaker when taking into account inadequate seasonal adjustments, Credit Suisse asserts. The broker notes online transactions contributed 40% of the growth in retail sales in November. While discretionary retail is likely bearing the brunt of slower consumer expenditure, the broker suggests supermarkets may be "a place to hide".

Stock Outlook

Citi notes performances over Christmas were very stock specific, with the strongest feedback coming from Woolworths ((WOW)), Coles ((COL)) and Accent Group ((AX1)), which appear to have the most upside to market expectations along with Super Retail ((SUL)) and Premier Investments ((PMV)).

Following several years of discounting, ramping up to unsustainable levels in some categories, the broker notes this has stabilised and retailers in most categories have not resorted to increased discounting.

Credit Suisse envisages upside for Caltex ((CTX)) as it develops a convenience strategy, which is one of the few trend growth areas in retail. Meanwhile, weakness in the near term could be forthcoming for Wesfarmers ((WES)) in home improvement and Kmart. Still, there is the attraction of further development of the company's industrial businesses.

Ord Minnett comments about the company's Bunnings division, which has indicated slower like-for-like sales growth because of tough comparables and erratic weather, the issue will be the degree to which historical resilience can be maintained. The broker believes the Wesfarmers discount department stores and Myer ((MYR)) face the risk of consumers deferring purchases because of the external environment and this could moderate any trading-down benefits.

Deutsche Bank observes JB Hi-Fi ((JBH)) was among the best of the retailers but finds little scope for the business to outperform while Harvey Norman ((HVN)) is susceptible to weak housing conditions. Deutsche Bank still maintains a Buy rating for the latter, given the property segment and diversification.

Morgan Stanley lowers earnings forecasts for Super Retail, JB Hi-Fi and Harvey Norman to reflect the softer Christmas. An Overweight rating is maintained for JB Hi-Fi, given its earnings are relatively defensive and the competitive intensity in white goods is expected to ease in 2019. Meanwhile, Harvey Norman's earnings are the most tied to the Australian housing cycle and this is expected to create increasing pressure on the business.

Morgan Stanley maintains an Underweight rating for the stock and expects recent improvements in the international operations will fade as global macro conditions deteriorate. Credit Suisse is of a similar view, noting the company's Boxing Day sale commenced several days ahead of Christmas, which is consistent with weakness in December.

A slowing sector is unlikely to support JB Hi-Fi's brand performance, Credit Suisse believes, and the stock appears close to fair value. Ord Minnett points out both Harvey Norman and The Good Guys (JB Hi-Fi) are cycling weak comparables in the second half, which could provide some share price support.

Super Retail could be considered oversold, Credit Suisse acknowledges, although there are unknown issues as a new CEO is still to be announced. On the positive side, the automotive segment is fundamentally solid and underwrites half the value of the stock. Credit Suisse believes the near term risks for Myer are particularly elevated. Citi contends downside risk in FY19 is most apparent for Myer, JB Hi-Fi, Michael Hill ((MHJ)) and Lovisa ((LOV))

Supermarkets

Food inflation continues to support supermarket growth, which was 4.5% in November. Morgan Stanley suggests price rises for food are partly driven by higher input costs linked to the drought but also less promotional activity by supermarkets. Small food retailers grew 4.7% in the month while chain grocery stores grew 3.9% Competitive intensity remains low and has progressively reduced over the past two years, Morgan Stanley points out.

The broker highlights both major supermarkets ran collectables promotions over the Christmas trading period but neither appeared to have huge success, and the first quarter gains by the Coles' Little Shop promotion appears to be an aberration. 

Based on channel checks, Woolworths has out-traded Coles for the third straight Christmas period, Morgan Stanley calculates. Costa Group ((CGC)), a supplier of fresh food to supermarkets, has issued an earnings warning but Morgan Stanley finds limited implications for the big three supermarkets.

Valuation largely drives the broker's views on supermarket stocks, with an Overweight rating for Metcash ((MTS)), an Equal-weight rating for Coles and Underweight rating for Woolworths.

Credit Suisse prefers Woolworths to Coles, as the latter's underperformance in fuel is a risk for its first half result, while pressure on cash flow may come from increased capital expenditure in the medium term.

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