1. Sector Landscape and Outlook

Retail sector includes a sub-line of businesses that market wide range of products from bread to car. Moreover, the merchandising of goods ranges from essential items to luxury items. As a broad sector, the retail industry provides investors with pockets of spaces to create wealth across economic cycles, but investors need to be cognizant of changing economic conditions, as some of these pockets such as consumer cyclicals are economically sensitive.



As evident by Fig 2, during the last one year, S&P/ASX 200 Consumer Staples Index (XSJ) and Consumer Discretionary Index (XDJ) outperformed the benchmark ASX 200 Index. If we break out the performance, the retail indices remain in sync with the benchmark index till July 2019 and outperformed significantly in the last 6 months.

Let’s have a look at the sector’s current standing. 

How is the sector performing lately?
The face of the retail industry is transforming rapidly with online retail becoming convenient to millennials at a rapid pace. In 2018, the online retail spending constituted ~10.5% of the total retail spending, translating to ~$29.4 billion, ex cafes and restaurants, according to Australia Post 2019 eCommerce Report. The report suggested that over 73% citizens are making their purchases online. This transition to online-based merchandising channels could be attributed to the second order ramification of smartphones.

As per Australian Bureau of Statistics (ABS), in 2019, the seasonally adjusted total retail turnover was ~$329.6 billion. When cafes, restaurant and takeaway food services are excluded, the number was ~$282.8 billion. During the year, essentials like food retailing constituted the most, followed by household goods retailing. 



Overall, household goods retailing was resilient in 2019, and includes further sub-industries such as electronics, hardware, building supplies, homeware, textile goods, etc.

As evident from fig 4, some sub-industries within the retail sector are volatile due to their cyclical nature, and fluctuating spending changes across the sub-industries is reminiscent of the sector.

Fig 5: Seasonally adjusted retail turnover in 2019 (in millions)


Source: ABS, Kalkine
 
With the understanding of the sectors performance in the past year, now let’s look at some of the key measures taken by policy makers that might act as a catalyst for the Australian retail sectors’ future growth. 

Income tax cut: The Morrison Government’s win had all eyes on the Coalition’s $158 billion income tax plan implementation. In July 2019, the plan was finally passed in the Parliament, indicating that over 10 million people will receive tax cuts in tranches spread across 2019-2025, and thus reduce the tax burden on the wage earners.

In a bid to promote fast-economic recovery, economists have been demanding a preponing of the three-stage tax package, of which the first stage was already launched in July 2019, with tax benefits ranging from $255 to $1080.

Expected impact of interest rate cuts: In 2019, the RBA created history by lowering the cash rates thrice in June, July and October, and the rate currently stands at historic low of 0.75%.

The major consumers (households) and major investors (businesses) take time to adjust their behavior after a monetary policy actionlike rate cuts, which boosts purchasing power and lifts the overall consumer spending in the economy.

Unemployment is stabilising:  Australia's seasonally adjusted unemployment rate decreased to ~5.1% in December 2019, the lowest level since April 2019, with participation rate also improving in the last quarter of CY2019. Although the unemployment rate increased to 5.3% in January 2020, it is expected to remain more or less stable in 2020. Unemployment rate has relatively stabilised against the numbers recorded in 2018. This may provide additional support to the consumer spending as more people return to work.



Wage Growth: On a seasonally adjusted basis, the wage growth has fared better in 2019 as against last few years. Since, Q3 2018, the year-on-year growth in wage was 2.3% across all industries for each quarter, which moderated to 2.2% in Q3 2019.

Having gone through the key factors that might add impetus to the sector, we will now gauge the consumer mood. 

Consumer Sentiment
The Westpac-MI Consumer Sentiment has fared below the long-term average (i.e. 101.4 points) in monthly terms. In its November issue, Westpac Economics had mentioned that consumers had been somewhat unnerved by the prospect of interest-rate cuts.

With no interest-rate cut prospects in the upcoming months, it is likely that the consumer sentiment gauge would return to average levels. In the last quarter of 2019, the consumers had faced detrimental consequences due to bushfires and drought, which carried through to January 2020 with widespread rains.

Most recently, the sentiment index improved 2.3% to 95.5 in February issue, reflecting easing concerns related to bushfires, despite the coronavirus outbreak.

Figure 6: Consumer Sentiment Index and its major constituting indices (in points)

Source: Westpac-Melbourne Institute Consumer Sentiment Index, Kalkine 
 
With the interest rate cuts not nudging the consumer much is there any ray of hope for the retail sector in the near term? 

Outlook
The future of the Australian retail sector depends on disruptive forces- changing consumer spending patterns and the influx of foreign companies that focus on formulating new approaches in retailing.

After a busy and positive December festive season, Cyber Monday and Black Friday, the retail industry has set foot in 2020 holding more promises. An industry research by Deloitte states that the retail outlook for 2020 remains optimistic with retail spending expected to grow 2.6% over the year.

Robust wage growth, a revived housing market and increase in disposable income thanks to planned personal tax cuts, are catalysts that are likely to support a much stronger growth outlook in 2020. Besides this, opportunities in retail will continue to flourish.

Online marketplaces are growing increasingly popular as another sales channel for retailers to reach a wider consumer base.

Tech-savvy Australia’s technological assistance to browse and analyse business data of retail trends will aid better interactions between consumers and retailers. Moreover, innovative technology and efficient logistics will improve the path for cross-border e-commerce in Australia.

Omni-channel strategies (wherein physical store retailers are growing their online presence and vice versa) are expected to pave the opportunity to increase overall sales while providing advantages to both online and physical retails.

Having browsed through the opportunities knocking at the doors of the retail businesses let’s look at the headwinds posing this sector. 
 
Some Key Headwinds 

Wage Reviews and Remediation Measures to Hit margins: Current workplace arrangements in Australia are relatively complex and traditional. Industry bodies like the National Retail Association and Australian Retailers Association have been working with the Government constructively in an effort to streamline the system and develop better ways to facilitate contemporary retail.

In May 2019, the Fair Work Commission handed down its decision on the Annual Wage Review, awarding an increase to minimum wages of 3% (w.e.f. July 2019). This has elicited pressure on Australian retail companies and the Gig economy which are bound to increase remuneration at a time when margins are under stress, catalysed by rising input costs and muted price pressure on end products. 

Another risk triggering Australian retailers pertains to the remuneration that should ideally comply with the law. “Wage theft” has been a hot topic politically and Parliaments have been undertaking inquiries into the matter at a State level since 2018. These inquiries made many recommendations, but without the constitutional power to put them into effect.

Consequently, incumbent companies launched their wage reviews to identify the magnitude of damage caused to employees. The Australian conglomerate, Wesfarmers (ASX: WES) faced several cost headwinds due to higher personnel costs from new enterprise agreements which is likely to have an impact on earnings growth in the near term. Besides this, WES acknowledges the increasing unease about executive remuneration and the structure of remuneration packages, which has been scrutinised by stakeholders across the industries.

On similar lines, 5.7k salaried store team members working in supermarket chain Woolworths were not paid in full compliance with the Group’s obligations under the General Retail Industry Award. The Company had vouched to fully rectify all payment shortfalls to current and former salaried team members across the Group, including interest and superannuation contributions.

However, it was alleged by a Canberra law firm in December which intended to file an employee class action proceeding against the Company and accused it of payment shortfalls to salaried store team members.

It is likely that the more retail companies would be undertaking salary reviews, resulting in additional costs, including remediation costs. However, balancing this well with growth is a key aspect to watch for.

Household Debt: With interest rates currently and projected to be at record lows, Australians are on a verge to demonstrate mortgage debt binging, which will be a huge economic vulnerability, with a lot of debt on Australian business’ balance sheets relative to income. Mortgage holders appear to be diverting their spending away from the retail sector to cover their repayments.

Although these headwinds pose certain questions to the retail sector, an accommodative monetary policy along with lower income tax would more than offset these challenges to some extent.

2. Investment Theme and Stocks under Discussion

With decent monetary policy support augmented with fiscal policies, it is likely that some pockets in the retail sector would boom in the near-term, as the economic growth reverts to an upward trend.

After understanding the sector, let’s take a detailed look at five retailers in terms of their outlook and performance. To gauge the potential of the mining stocks, we have followed the market multiple approach and used ‘Price/Sales’ and‘Price/Cash Flow’ multiples.  The peer group for each stock has been shortlisted based on their respective market capitalisation.