You can’t underestimate the importance of retail spending. When nations open their wallets, it stimulates the economy. Investors have been bracing for a cheerier Christmas, however should we be worried about recent data which has shown a marked slowdown in momentum?
Readers will recall we previously highlighted that one of the five small cap themes investors are increasingly looking to play is the potential recovery in domestic household consumption. The macroeconomic backdrop has arguably improved as strong headwinds from rapidly falling house prices, tighter credit conditions post the Royal Commission, and Federal election uncertainty have shown early signs of easing with some tailwinds emerging thanks to fiscal and monetary stimulus through tax cuts, RBA rate cuts and a general loosening of credit requirements.
Capital city house prices are rising (albeit on depressed volumes), unemployment remains historically low at 5.3 per cent and net migration continues to drive population growth (around 1.6 per cent annualised). However, wage inflation persists below target, household debt is high by global standards and consumer and business confidence levels are yet to rebound.
Retail sales data released over the first quarter of FY20 has been underwhelming, showing little evidence of any pick up in momentum since the start of the new financial year. September retail sales growth of 0.2 per cent (month on month) came in at just half the rate that economists were predicting with the annual growth rate slowing to 2.0 per cent (unadjusted data), representing just 0.4 per cent annual growth on a per capita basis. Monthly sales data can be highly volatile so we prefer to focus on 12-month rolling averages when analysing consumer trends. Stripping out food to concentrate on the more discretionary categories, 1Q FY20 evidenced a slowing trend in both Household Goods (0.3 per cent rolling annual growth, down from 0.6 per cent in 4Q FY19) and in Cafes, Restaurants and Takeaway Food (2.9 per cent growth in 1Q FY20 versus 3.2 per cent up in 4Q FY19), while Clothing, Footwear and Accessories slightly improved (3.8 per cent compared to 3.7 per cent in 4Q FY19).
Despite the recent pick-up in detached house prices, auto sales data continues to disappoint those looking for signs of a recovery (auto sales are highly correlated with house prices). New vehicle sales in October declined by 9.1 per cent compared to the same month a year ago, considerably worse than the 6.9 per cent annual drop reported in September. The industry body, The Federal Chamber of Automotive Industries, attributes the extended downturn to the drought and brittle consumer confidence, but mostly to financial sector regulation which has been overly restrictive on car loans.
Turning our attention to what the small cap retailers have been disclosing at their Annual General Meetings (AGM), the consumer outlook appears patchy and few have seen any pick up in momentum; rather, the majority have revealed a slowdown since last updating the market at the August results. Specifically:
- Baby Bunting’s (ASX:BBN) AGM (held on 8 October 2019) revealed a marked slowdown in comparable sales growth since August. Over the first 14 weeks of FY20, like-for-like sales reportedly slowed from 5.2 per cent over the first 6-week period to 1.6 per cent over the next 8 weeks. Management credited this slowing to cycling a very strong prior period and some technical issues with the website. Gross margins are benefiting from private label and exclusive product penetration, as well as less clearance activity, enabling the retention of FY20 earnings guidance;
- Beacon Lighting’s (ASX:BLX) AGM (held on 15 October 2019) called out improved momentum in comparable sales in August and September relative to a flat period in the prior year. Management continue to anticipate growth in FY20 from improved housing sales volumes and renovation expenditure. That said, AGM commentary did caution a mix of prevailing tailwinds (namely, record low interest rates, improving house prices, tax cuts and reduced mortgage lending requirements) and headwinds (low housing churn, weak AUD and global market instability) impacting the business outlook;
- Nick Scali’s (ASX:NCK) weak trading update (held on 15 October 2019) warned that 1H FY20 net profit after tax (NPAT) is expected to decline 28 per cent to $17-19 million. Difficult trading conditions have continued into the first quarter of FY20 with monthly store traffic down 10-15 per cent, driving comparable sales down 8 per cent year to date. Management believes this reflects lower general retail demand associated with the slowing in housing sales and renovations and a cautious consumer attitude. The company sees potential for a lift in sales in the second half of FY20 based on lower interest rates and signs of improvement in housing transactions;
- Super Retail Group’s (ASX:SUL) AGM ( held on 22 October 2019) highlighted that positive comparable sales momentum had been largely sustained since August, reporting 3.2 per cent growth over the first 16 weeks of FY20. However, Management flagged that retail consumer sentiment remains mixed and that top line growth delivered year to date was driven by a higher level of promotional activity across the business which has adversely impacted gross margins;
- Adairs’ (ASX:ADH) AGM (held on 25 October 2019) update showed a clear softening in the trajectory of like-for-like sales growth over the 9 trading weeks since the FY19 result. Comparable sales growth of 3.3 per cent for the first 16 weeks of FY20 (stores +0.8 per cent, online +16.6 per cent) represents a slowdown from the 4.8 per cent growth rate reported 9 weeks earlier (stores +0.6 per cent, online 29.9 per cent), particularly from the online business which has been a strong growth driver in recent years. Management noted the sales slowdown reflects a focus on gross margin dollars (less discounting) to offset foreign exchange headwinds. FY20 EBIT guidance was upheld; and
- Lovisa’s (ASX:LOV) AGM (held on 29 October 2019) update indicated year to date comparable sales growth of 2.3 per cent, a moderation relative to the FY19 update where the company cited a return to the 3 to 5 per cent growth range target. Management continues to expect to open more new international stores in FY20 than the prior year and the US roll-out appears to be tracking well compared to market expectations with 33 stores now trading across 5 US states.
To be fair, the first quarter of the financial year is not traditionally a seasonally strong trading period for most of these discretionary retailers. The critical sales period lies just ahead, with the importation of China’s Singles Day (11 November) and the US’ Thanksgiving cyber sales (Black Friday 29 November and Cyber Monday 2 December) essentially extending the Christmas trading window from November right through to the Boxing Day sales.
We see scope for a reasonable second quarter of FY20 for the small cap retailers in general. However at this juncture we think upside earnings surprise is relatively limited based on the patchy trading evidenced to date and market expectations for a cheerier Christmas.
Our retail exposure is skewed towards companies with global expansion strategies, like Premier Investments (ASX:PMV) and City Chic Collective (ASX:CCX), or e-commerce players like Kogan (ASX:KGN), rather than those more mature businesses simply reliant on a retail resurgence.
We will continue to monitor the domestic retail pulse closely because we are always looking for opportunities to buy good businesses at cheap prices.
I think one of the key headwinds facing retail in the future will be customers changing their habits from mass consumption to a larger focus on sustainability and resource management. The days of mass consumerism and waste must come to an end at some point and this will hurt the retail sector.
underestimate? probably could...