I. Sector landscape and outlook

Retail industry is a service industry which introduces consumers to new products and assists them to assess and compare prices and also provide a range of supplementary services such as arranging financial services or providing after-sales services. The retail sector is going through an exhilarating phase, characterised by a curious interplay between e-commerce, technology, and customer experience with brick-and-mortar stores at the centre of it all. Rapid digitisation is further driving new customer trends and behaviour. Hyper-customization and mass personalisation are expected to be primary offerings from retail brands, going forward.

Fighting Against the Global Pandemic and Changes in the Consumer Spending Pattern

Australia is one of the most urbanized societies and has witnessed significant growth in the retail sector despite a significantly low increase in wages and rising household debt. This is supported by lower interest rates and higher household credit and the impacts of changes in the consumer spending pattern. The retailers of Australia have faced a slump in their business because of the COVID-19 crisis along with soaring job losses, tipping spending behavior of consumers.

Since COVID-19 has grappled Australia, the Retail Industry has seen massive disruptions as non-essential retailers closed stores forcibly. When one door closes, other opens; this came true for a lot of retailers as they took to the online route to make up for the lost sales. Further, ease in restrictions and large fiscal stimulus package has provided some support and has paved the path for the retail industry for rapid recovery. The recent cycle of the retail sector can be classified in the following five phases:

1. Normal Phase (Pre-COVID): The pre-COVID was the phase with minimal disruption and monthly growth patterns.
2. Hoarding Phase: With the sudden outbreak of the COVID-19 pandemic, the market witnessed a state of panic and entered the phase of stocking up essentials. This resulted in record sales growth on a monthly basis for the retail sector.
3. Sales Plunge: With the shrink in the stock-up phase, the retail markets came back to normal rather saw a slump in the discretionary spending, particularly in the restaurants and apparel. As a result, the Australian market saw the worst fall.
4. Bounce Back Phase: With the ease in restrictions and green signals in the shopping centres, the retail sector bounced back to growth and helped in cushioning up the wounds by COVID-19.
5. JobKeeper Program and Growth in Sales: The Government has offered significant support with the JobKeeper program under which the JobKeeper Payments have now been extended by further six months until 28th March 2021.

Retail Sales increased in July 2020

According to the Australian Bureau of Statistics (ABS), July Retail sales have increased by 3.3% on M-o-M basis accelerating from a 2.7% gain in the previous month. On an annual basis, turnover recorded an increase of 12.9%. There were large increases in household goods retailing, the recovery in cafes, restaurants and takeaway food services, and clothing, footwear and personal accessory retailing. Turnover in household goods was 30% higher compared to July 2019, with sales of furniture, white goods and electrical items remaining high. Meanwhile, other retailing and department stores saw similar monthly rises to household goods in percentage terms. Food retailing also saw a rise of 1.2%, with supermarkets and grocery store turnover elevated in Victoria especially.

Fig 1: Retail Sales (% Change M-o-M)

Source: Kalkine, Australia Bureau of Statistics 

Key trends in the retail industry

• The rising footprint of Omni channels: E-commerce transactions across the board are growing significantly faster, making this a huge untapped market for the next growth phase. Further, the cost of servicing to smaller cities is likely to reduce as supply chain, and logistics companies are innovating digitally. Omni-channel initiatives such as 'click and collect' would allow companies the luxury of not needing to maintain a separate inventory at the warehouse, thereby reducing costs. This would help companies to reduce duplication of inventory, increase the throughput of the store, and offer customers seamless online and offline experiences. Younger consumers' preference for novelty, coupled with technology and social media, has helped new brands to enter the market and disrupt the business models of legacy brands, dramatically levelling the playing field. Instagram advertising and influencer marketing have helped their cause, coupled with e-commerce focused distribution. 

• Use of technology in supply-chain management: Supply-chain challenges have increased multi-fold during the current environment and include a) inventory management, b) demand forecast accuracy, c) order fulfilment and d) returns management. Technology has helped to manage and enhance the exchange of information between various supply-chain partners to attain outcomes such as increased control over demand planning, better inventory management, and effective and near real-time tracking and delivery. A single view of product for efficient execution of online orders is a key for higher sales through the omnichannel. By using technology to establish a two-way flow of information, retailers have started to adopt the 'replenish and pull' supply-chain model against the 'forecast and push' model, leading to better inventory management. 

• Retailers are focusing on Future Store: Customers are becoming channel-agnostic, leading to the rapid adoption of multichannel commerce. Well-integrated technology is no longer a value creation, but now a necessity to deliver a unique customer experience which increases customer stickiness. Customer experience is likely to play an important role in the next 3 to 5 years and would overtake price and product as a key brand differentiator. To drive footfalls to stores, retailers are focusing on endless aisles, self-checkouts, VR zones, free Wi-Fi, lounge area, WhatsApp shopping, wheelchair service, virtual trial rooms, and customised 3D printing of accessories. We believe that AI services, smart assistance, and cameras and sensors are likely to be used in stores in delivering personalised services to customers in the medium term. 

• Payment Flexibility: Flexibility is the name of the game when it comes to payments in 2020. While cash and credit cards are not going away anytime soon, millennials and Gen Z will lead a revolution in more convenient, flexible ways to pay for what they purchase. Mobile payments will increasingly appeal, as will "buy now pay later" solutions, which allows merchants to receive payments for purchased items upfront while letting customers pay in regular instalments. As a system, it gives customers the option to pay for their purchase over time, which means they can buy more of what they want while being able to budget. 

Retail Stocks Remained Firm Amid COVID-19 Pandemic

Since the outbreak of COVID-19, majority of sectors witnessed unprecedented headwinds and sector players beaten down badly on the stock market. However, despite mayhem in the broader financial market Retailers stood firm and leapt up significantly on the ASX on a YTD, 3-Month and 1-Month basis. Also, the retailers have outperformed the broader index during the same time period. Among a range of retailers, Internet & Direct Marketing Retailers have done exceptionally well amid pandemic days, followed by multiline retailers, distributors and specialty retailers. 

Fig 2: Performance of Retailers on ASX Amid COVID-19 Pandemic

Source: Kalkine, Refinitiv (Thomson Reuters)

Further, over the past month, 41 retailer companies listed and traded on the ASX reported an average price return of 21.4% and significantly outperformed the benchmark S&P/ASX 200 index by ~ 19%. In the last three months, retail sector stocks were up by 46.4% on an average and of 55% on a YTD basis.

Fig 3: Retail Stocks vs S&P/ASX 200 Performance

Source: Kalkine, Refinitiv (Thomson Reuters)

Key Risks

The future of the Australian retail sector depends on the disruptive factors, including the changing consumer behaviour and spending patterns, rising influx of foreign countries. Further, a slump in the consumer purchasing power due to massive lay-offs could weigh on the demand side of the economics. Though the government has announced a series of stimulus, the next wave of the outbreak could be a catastrophe, especially for the non-essential and discretionary product retailers.

Outlook

As a result of globalization and various trade agreements with markets and industries, many companies in the retail sector is capable of doing business on a large scale. With the lucrative market, Australian companies are competing at lower prices and a wide selection of products. The forward-thinking retailers are setting higher marks, positioning themselves to navigate the challenges in the year ahead. Given the rapid change in technological advances and social transformations, there comes a trade-off in quality and profitability. The focus has been shifted from purchasing power to the act of using products. Despite the fall in GDP and dimming outlook for most of the sectors, the retail industry seems prepared for the changing conditions in the economy. In order to create value for consumers and stakeholders and capturing value for investors, retailers are adopting new business models which are focused on consumer choice and demand.

II. Investment theme and stocks under discussion (LOV, APE, WES and HVN)

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘EV/EBITDA’ method.

1. ASX: LOV (LOVISA HOLDINGS LIMITED)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 786.6 Million)

Lovisa Holdings Limited is engaged in the retail sale of fashion jewellery and other accessories, through a network of retail and franchise stores.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~17% over the current price of 7.79 at 3:30 PM on 3 September 2020. We have considered Kathmandu Holdings Ltd (ASX: KMD), City Chic Collective Ltd (ASX: CCX), and Blackmores Ltd (ASX: BKL) etc., as a peer group for the comparison purpose.

2. ASX: APE (EAGERS AUTOMOTIVE LIMITED)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 2.26 Billion)

Eagers Automotive Limited, formerly known as AP Eagers Limited, is engaged in the sale of motor vehicles, the distribution of parts, and the repair and servicing of motor vehicles.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~21% over the current price of 8.87 at 3:30 PM on 3 September 2020. We have considered Autosports Group Ltd (ASX: ASG), Inghams Group Ltd (ASX: ING), and City Chic Collective Ltd (ASX: CCX) etc., as a peer group for the comparison purpose.

3. ASX: WES (WESFARMERS LIMITED)

(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: A$ 52.29 Billion)

Wesfarmers Limited is a diversified industrial company which is involved in the retailing of home improvement and office supplies, general merchandise and speciality departments stores, gas processing and distribution, chemicals and fertilisers.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~7% over the current price of 48.66 at 3:30 PM on 3 September 2020. We have considered Woolworths Group Ltd (ASX: WOW), Eagers Automotive Ltd (ASX: APE), and Baby Bunting Group Ltd (ASX: BBN) etc., as a peer group for the comparison purpose.

4. ASX: HVN (HARVEY NORMAN HOLDINGS LIMITED)

(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: A$ 5.46 Billion)

Harvey Norman Holdings Limited is primarily involved in the operation of integrated retail, franchise, property, and digital enterprise business.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~8% over the current price of 4.47 at 3:30 PM on 3 September 2020. We have considered JB Hi-Fi Ltd (ASX: JBH), Metcash Ltd (ASX: MTS), and Coles Group Ltd (ASX: COL) etc., as a peer group for the comparison purpose.

Note: All the recommendations and the calculations are based on the current price at 3:30 PM on 3 September 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

Disclaimer

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