Australia | Sep 08 2021
This story features METCASH LIMITED, and other companies. For more info SHARE ANALYSIS: MTS
Retailing has emerged from an unexpectedly robust FY21 to face lockdowns at the start of the FY22 year. Can optimism prevail?
-Rising input costs, supply uncertainty, lockdowns diminish the outlook for retail
-Overstocking among retailers now requires double-digit growth in the first half
-The digital divide is reinforced by lockdowns
By Eva Brocklehurst
The new financial year has started off miserably for retailers, particularly tenants of shopping centres, after lockdowns were re-instated in Australia's largest population centres. Yet most retailers remain confident shoppers will return for the usual pre-Christmas splurge once the lockdowns are lifted by the end of October. What if that does not transpire?
Several brokers have expressed caution about presuming 2021 ends with the same buoyancy that occurred in 2020 for retailers. The latest lockdowns have weighed more on discretionary expenditure, and earnings are forecast to fall in the first half of FY22 because of operating de-leveraging and tough comparables, UBS points out.
Retailers appeared optimistic about the outlook for Christmas during the results season, amid a view that the economy will rebound sharply when lockdowns cease. Jarden is not so sure about this, asserting there will be less of a "hockey stick" recovery as the Delta variant has wreaked havoc on confidence.
While lockdowns may hurt, Morgans suspects demand could return quickly even though there is a significant impact on current trading. That said, there would be material risk to estimates if restrictions were extended through to the peak Christmas sales period.
In FY22 to date trading has been softer, with average July trading down more than -10% for discretionary items and up just 2% for food. Retailers are responding via increased discounting and investing in paid search as well as loyalty programs.
Credit Suisse notes sales growth in household goods retail has slowed as spending is reined in from the extreme peaks in sales that occurred in 2020. Still sales growth remains above trend.
In food retail, Metcash ((MTS)) has experienced the fastest acceleration in sales as consumers return to shopping locally. As food earnings growth remains low, the broker flags the higher dividend yield for Metcash, which at 4.3% is relatively attractive compared with Woolworths ((WOW)), Endeavour Group ((EDV)) and Coles ((COL)).
The reporting season was generally positive for retailers with like-for-like sales on average up 12%, Morgans points out. Those at the head of the line were Universal Store ((UNI)) and Super Retail ((SUL)) while The Reject Shop ((TRS)) reported a reduction in sales.
Emerging from the reporting season, Macquarie retains Outperform ratings for Coles and Harvey Norman ((HVN)) yet acknowledges supply chain disruptions, rising input costs and uncertainty around the resumption of trading in stores have dented the outlook for retail in the short term.
Morgans also notes stock positions have normalised and the risk is now around overstocking, which may become an issue for those with seasonal and fashion-led products.
Inventory is elevated, which indicates to Jarden that double-digit growth is required for the first half. If sales fail to rebound sharply post the lockdowns this could then lead to heightened discounting and, in turn, be a risk to margins.
Working capital remains high but manageable and inventory is likely to remain higher for longer so, at this stage, Credit Suisse assesses the impact is likely to be confined to profits.
The broker prefers integrated retailers such as JB Hi-Fi ((JBH)), Harvey Norman and Temple & Webster ((TPW)) as these have shorter supply lead-times and, therefore, are likely to have low inventory risk.
Credit Suisse expects demand for household goods will remain strong and inventory will be cleared when stores re-open. For clothing retailers seasonal stock issues are likely to emerge for spring/summer.
Morgans expects few retailers will hold onto gross margin gains in the year ahead, given cost inflation through the supply chain as well as increased promotional activity and a weaker Australian dollar. In terms of earnings margins, discretionary retail is at record levels, amid reduced promotions, and Jarden expects margins will narrow in FY22 compared with FY21, albeit stay above FY19.
Structural changes have been reinforced by the pandemic and lockdowns. The obvious one is the ever-growing ability to make purchases online, without visiting the store, enhanced by the options available in e-commerce.
Capital expenditure among retailers is likely to remain elevated because of investment in data and digital, and those with scale are the best positioned. Jarden highlights many companies during the FY21 results reported a need to invest more and Super Retail and Woolworths were guiding to higher expenditure compared with expectations.
Those retailers which had already moved to an omni channel presence were notable amongst the beneficiaries of the FY21 shopping experience and Credit Suisse describes the digital ecosystem as an emerging divide.
E-commerce sales were the most visible response to the lockdowns and social distancing but in the longer term changes in retailer strategies are also important. Those leading the pack have moved from simply analysing data to assessing how to better utilise stores and e-commerce to create loyalty ecosystems, with the broker noting Woolworths increased its investment in Quantium.
Wesfarmers has also announced a $100m digital ecosystem initiative and Credit Suisse flags the likely entry of Instacarte to Australia in 2022, which could develop the “immediacy” channel offering further. Furthermore, this could support Aldi launching online in 2022.
Morgans notes Lovisa Holdings ((LOV)) has led the way among omni-channel retailers in FY21 with growth of 178%, albeit off a low base. Even established operators in the digital arena experienced substantial growth in online traffic and conversions.
While bricks & mortar retailers clawed back some sales lost through lockdowns, the broker highlights that only 20-30% of lost physical sales have been reported as retrieved through digital channels.
On the other hand, the broker points to Baby Bunting ((BBN)), a retailer that was able to stay open because of the “essential” classification and has experienced a surge in online traffic.
Morgans suggests consumers have previously demonstrated a willingness to return to the shopping centre when lockdowns are lifted. Nevertheless, online sales appear to be settling at levels that are well above pre-lockdown days.
Consumers, having been forced into e-commerce out of necessity, are now more comfortable using the channel and retailers will have to adapt, upgrading platforms and distribution networks.
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