Feature Stories | Oct 13 2020
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It’s been more than seven months since the initial nation-wide lockdown dramatically changed consumer behaviour. As restrictions ease, will everything go back to “normal”, or has the future of retail been altered forever?
-Restrictions easing to date provide greater insight
-Online shift to persist
-Work-from-home to continue as a trend
-Home renovation and homeware consumption not over yet
By Greg Peel
There has been much discussion since the virus first hit as to what life will be like post-covid – an era that must presumably follow the discovery of a reliable vaccine. During the early lockdowns, there was one theme that stood out from any other – stay at home.
Stay at home led to three significant sub-themes: cook at home; work from home; and shop on line. Each sub-theme impacted on the retail sector in varying ways, to the point one question was much pondered – will this be the new normal even after the lockdowns are lifted?
Australia has since been provided with evidence, and comparative evidence at that. Each state has lifted restrictions by varying amounts, while Victoria was forced to return to lockdown.
Of the three sub-themes, the evidence appears to suggest that while cook-at-home may to some extent prove ongoing, on the basis of those taking up home cooking for time and enjoying both experience and the lower cost, restaurants can rest assured they’re not destined for the scrap heap of history. Australians have clearly indicated a desire to get back out of home to eat, drink and be merry once more.
The survival of restaurants, of course, depends on whether they can hold on through ongoing reduced capacity due to social distancing requirements, but if this writer’s experience last week of eating out at a pub bistro (booking required), and watching the constant queue outside the bar entrance as punters waited for someone to come out so they could go in, customer turnover should go a long way to countering said reduced capacity.
The conclusion is thus that the surge in supermarket shopping during lockdown should ease back to something more normal.
As for work-from-home, most agree that while some may choose to never return to an office again, the majority will embrace the opportunity of a flexible workplace – either working from an office but taking occasional WFH days, or working from home but occasionally attending the office.
There was considerable trepidation among companies large and small during lockdowns as to whether they could continue to operate as relatively normal with employees zooming and emailing in work while managing their own work hours at home, instead of nine to five, and behold, it worked a treat. No more trepidation.
Of the three sub-themes, online shopping is seen as experiencing the greatest structural shift as a result of the virus. Online shopping is hardly new, it’s just that lockdowns led to significant acceleration in online engagement, thus drawing in many new and previously reluctant users. Nor, for that matter, are Zoom and similar services supporting WFH at all new, but hands up who’d heard of Zoom before this year?
While the online surge has already set in train rolling physical store closures, one presumes for certain cohorts a day out shopping with friends in real shops will always remain an entertaining social experience, such as others enjoy a day out at the footy. But on the other hand, the convenience of online shopping for a wide range of products is something now staunchly embraced.
The lockdown WFH and online themes unsurprisingly led to a surge in sales of office equipment and internet/communication technology for the home, but what few saw coming was a surge in home renovation and updating of furniture and fittings, both from a view of “if I’m going to be stuck here, at least I can tart the place up a bit”, and out of sheer boredom.
But where did consumers find the money? For many, JobKeeper represented a big drop in income. Easy – tap into the holiday fund, the trip to Paris is off. Use the money otherwise spent on restaurants and bars. And for others, JobKeeper actually meant a pay-rise.
As we now enter the seventh month since the initial nation-wide lockdown, with a gradual easing of restrictions over that period, we have gained a much greater insight into what Life after Covid will look like than we had in April, despite not yet having reached the “after” part. It is clear there will be long-lasting implications for all segments of the retail industry – staples and discretionary, including hospitality, travel, electronic goods, homewares, hardware, apparel and more.
For the investor, the question is who will be the winners and who will be the losers among listed retail companies in the short, medium and longer terms?
Online – Retail’s Renaissance
Covid has structurally changed shopping behaviour, Citi declares. Online retail has recorded three years of growth in just six months and, the analysts believe, online penetration will continue to rise.
The only issue is one of building and maintaining an online service is more expensive than that of bricks & mortar, albeit retailers can help finance capital expenditure by closing stores.
Other than online-only businesses, the retailers best placed to deal with the structural shift, Citi notes, is those having already invested in online for several years and having the flexibility to to close stores cost-effectively as store economics deteriorate.
The broker forecasts total online sales growth across the retail industry to rise to 13% by FY22 from 8% in FY19. The surge in online sales experienced in the second half of FY20 and into FY21 will fade as restrictions continue to be lifted, with Victoria the obvious focus at present, but in the wake online will remain a much larger contributor, Citi believes, to sales growth in the future.
The majority of this growth will cannibalise in-store sales, thus accelerating store closures.
On the matter of online being more expensive, once supply chain and overhead costs are accounted for, Citi calculates every 1% of online penetration growth provides a -5-10 basis point earnings margin headwind for most retailers. However, those that should see a neutral or even positive margin impact, the broker suggests, are City Chic Collective ((CCX)), Premier Investments ((PMV)) and Super Retail ((SUL)).
Of course, the issue is always one of whether such forecasting is already priced into relevant stocks, which have enjoyed a solid run on FY21 to date sales numbers. Citi retains Buy ratings on Coles ((COL)) and Metcash ((MTS)), Harvey Norman ((HVN)) and Super Retail.
But Sales in General?
While increased online penetration may be here to stay, it’s only on a percentage basis of overall sales. The lockdowns clearly changed consumer behaviour for a period, but as things gradually get back to normal more definitive realties appear.
Aside from the earlier lockdowns driving consumer demand, consumer spending power was boosted by aforementioned diversion of household entertainment and/or travel budgets, as well as super withdrawals, mortgage payment deferrals, cash handouts and, for some, JobKeeper/Seeker. Government support is now winding down, super withdrawals are done with and the majority of mortgage payments have recommenced.
And in line with the winding down of government support, unemployment will rise.
UBS notes Australian discretionary retail sales grew by 14% year on year from April to July, and industry feedback suggests not only are August-September sales also strong (ex-Victoria), expectations for Christmas trade are optimistic.
The broker has compared 2021 consensus sales and earnings forecasts for retailers under its coverage to 2019 levels and concludes a “muddle-through” scenario is being priced in, with sales forecasts 5% and earnings 9% above pre-covid levels. The implication is these numbers look optimistic, and UBS singles out Super Retail forecasts as appearing the most optimistic, with Premier Investments and Wesfarmers ((WES)) the least.
UBS is nevertheless writing before last week’s federal budget, which provides a boost for consumers in several ways, from tax cuts to more cash handouts, and will go some way to offsetting aforementioned sales growth headwinds.
Late in September, UBS suggested 77% of discretionary retailers were trading at an average 16% premium versus pre-covid levels, the highest being JB Hi-Fi ((JBH)), Super Retail and Adairs ((ADH)), and the lowest Harvey Norman and Premier Investments.
Since last Tuesday’s budget, retail stocks have seen another step-up in valuation. For the record, the GFC experience saw relative price/earnings multiples retrace -35% from their stimulus peak, UBS notes.
If we make that comparison, we recall the then Rudd government handed out $900 in cash to low to middle income earners, which was used to help cover the cost of purchasing one of those new-fangled flat screen TVs. Aside from guaranteeing bank deposits, that was about it on the fiscal support front. At the time, unemployment jumped to nowhere near what it is today, and the whole GFC experience was over comparatively quickly.
Notwithstanding, UBS favours retailers with attractive valuations, offering structural covid benefits such as online presence and rent deals with landlords on a profit percentage basis, and offering medium to longer term growth opportunities.
The broker has Buy ratings on Woolworths ((WOW)), Harvey Norman, Adairs, Metcash and Premier Investments.
Looking Longer Term
Macquarie notes that FY20 earnings results for the retail sector were strongest for those benefiting from trends towards at-home categories and online. Looking ahead, should investors stick with the covid winners or now rotate into recovery stories?
Like UBS (and also writing before the budget), Macquarie questions the longevity of the post-April surge in consumer spending. The broker points out modern fiscal responses typically target consumer spending first given the immediate impact on the economy and employment, before public and capital spending take over the recovery on a lag.
[When then prime minster Rudd sought advice from Paul Keating in the GFC, Keating famously told him “go early, go hard, go households”, which were actually the words of former treasurer Ken Henry in reflecting on the nineties recession.]
The most common concern Macquarie is hearing from investors and corporates at this time is the risk of extrapolating current retail trends.
Investors have benefited up to now from being long covid beneficiaries, Macquarie notes, with specific categories seeing a shift away from impacted areas in services (hospitality, travel etc). This trend should at least partly normalise as restrictions are lifted, the broker suggests, however some areas could see enduring trends.
The AGM season, which is slowly beginning to build, is likely to produce strong updates and (for those on out of cycle financial years) first half results, Macquarie assumes, but investors may become increasingly wary of capitalising such numbers into share prices. The broker sees short term upside for any company significantly upgrading guidance, or for which trends indicate a shift in spending behaviour is structural for at least the next 18 months.
Such trends will become more apparent, Macquarie suggests, in later updates post the wind-down of stimulus measures (and net of the budget).
Ahead of AGM updates, the broker sees upside risk for at-home beneficiaries enjoying significant operating leverage from opening new stores, singling out Nick Scali ((NCK)) on that count, and from new customers, singling out Temple & Webster ((TPW)).
For those hit by the virus but now in a recovery phase, Macquarie prefers Premier Investments (there’s that name again) on additional support from online, followed by Lovisa Holdings ((LOV)) which has lagged this year. From a long term growth perspective, the broker likes Breville Group ((BRG)), Baby Bunting ((BBN)) and City Chic.
Home is where the heart is
The surge in spending on homewares, furniture and white goods due to the lockdowns was not something widely anticipated. Communications-related goods were obvious in a WFH scenario, but a new couch?
Clearly not everyone had an “office” at home, or just somewhere one could work away from the noisy kids, or the kids needed somewhere for remote learning. And if we are going to work from home more often and travel less, let’s make the place more liveable.
Which brings in renovation spending as another lockdown trend. The question now, however, is whether this was just a lockdown trend, such that such spending would ease back once restrictions are fully lifted, or does this trend have further to run, given the virus has reshaped our future?
In the wake of very strong second half earnings results for related companies, reported in August, the market response was to assume such results would prove one-off in nature. Indeed, renovation activity, building approvals and housing turnover had all begun to decline.
But not back to pre-covid levels. Macquarie notes Google searches for renovation-related information have picked up markedly again after an initial surge and ease-off. Third party spending data drawn by the broker from illion/AlphaBeta and Commonwealth Bank show that as at the week ending September 13, furniture & office spending remained 83% above “normal” levels and home improvement 66% above.
Evidence from North America, where lockdowns occurred in the summer, suggests renovation activity accelerated during the period and Macquarie expects a similar trend downunder. This should assist sales at Bunnings ((WES)) and JB Hi-Fi (including The Good Guys).
Evidence from a recent update from Harvey Norman suggested the shift to consumer behaviour to “indiscriminate buying”, as Macquarie puts it, has been prolonged. For JB Hi-Fi, the broker notes pre-order launches for new console products late in September were highly successful, suggesting new future product launches will support demand.
To that end, Macquarie has Outperform ratings on JB Hi-Fi and Harvey Norman but is more cautious on the outlook for the rest of the consumer discretionary sector. While Bunnings might be afforded a standalone Outperform, the broker has a Neutral rating on the full Wesfarmers conglomerate.
Credit Suisse is on the same page:
“Our new analysis makes a strong case that the behavioural change that has driven recent above-trend expenditure is likely to persist and support expenditure under a range of household income scenarios.”
Those household income scenarios remain unclear, as we are yet to see just how the labour market fares now the first steps have been taken to wind back stimulus, now super withdrawals are over and mortgage and rent holidays are mostly over. The offset is what has been promised in the budget. Credit Suisse does not foresee a return to the “overcompensation” of the June quarter, but nor is it likely household incomes would be allowed to collapse. We’ve seen that to some extent with the budget, but also the fact the government has not yet determined whether JobSeeker will return to the old NewStart rate after December or to a figure in between the two.
Credit Suisse acknowledges forecasting household spending out a few quarters is subject to wide uncertainty, but analysis of past episodes of changes in spending behaviour show average persistence of nine months from inception. Given the magnitude of the covid episode, the broker expects current behavioural change will run for a longer duration than past experience.
The longer international borders remain closed, and the more entrenched the WFH trend becomes, the longer that change will be supported.
A Crowded Christmas
Much has been made of the drop in Australia’s population covid will bring about given the closure of international borders, to the extent the Treasurer is now taking a sheet from his predecessor’s song book and suggesting we all get at it. But have you ever thought about how many people leave Australia to spend Christmas overseas?
In December 2019, half a million fewer Australians spent Christmas in Australia than in December 2018, Credit Suisse notes. Aside from residents either celebrating with family overseas or just choosing to holiday somewhere else, longer term visitors would typically head home for Christmas as well.
That’s not going to happen this year. This year Credit Suisse suggests there are likely to be one million more residents and longer term visitors in the country this December than in 2019.
That’s one million more people, or 4% of the population, buying prawns. And grog, and Christmas presents, and holidaying domestically.
To that end, Credit Suisse has recently upgraded its target prices for Coles, Woolworths and Metcash. An Outperform rating has been retained for Metcash, and Coles is upgraded to Outperform. A Neutral rating is retained for Woolworths, but only on a valuation basis.
The broker admits it did not foresee the run for Domino’s Pizza ((DMP)) the virus has brought about, and has upgraded its earnings forecasts and target price. However, Domino’s Pizza's share price remains well above the broker’s valuation, hence an Underperform rating is maintained.
Credit Suisse retains an Outperform rating on Super Retail, noting the company stands to benefit from a multi-year increase in domestic travel and recreational activity. Super Retail also boasts one of the better digital offerings amongst the conventional bricks & mortar retailers, the broker notes.
So we’re back where we started, with online.
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