In Brief: Retail, Radiology & Wilsons’ Best Ideas

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Weekly Broker Wrap: Brokers lower earnings forecasts for retail stocks; falling housing turnover also impacts home furniture companies; improving radiology volumes & Wilsons' favourites locally and overseas.

-Brokers lower earnings forecasts for retail stocks
-Lower housing turnover also impacts home furniture companies 
-Radiology sector upside from improving volumes
-Wilsons' best ideas among domestic and global equities

By Mark Woodruff

Brokers lower retail spending forecasts for goods

While the Reserve Bank argues monetary policy works via multiple channels in Australia, Jarden believes the mortgage channel is the strongest, given the leverage and variable interest rate-exposure of the household sector.

While many households are being squeezed by higher rates, some households are experiencing strong income growth as wages accelerate, note the analysts, and may keep spending, thereby maintaining upward pressure on demand/inflation.

The broker still sees upside risks for costs and inflation and forecasts the cash rate will reach 4.6% after two more interest rate hikes, while interest payments should peak at around 10% of disposable income.

Disposable income growth remains soft, with consumption largely fuelled by excess savings built up over the last three years, explains Jarden, and goods consumption is set to turn negative, which is reflected in the broker’s preference for consumer staples over consumer discretionary, and services (i.e. travel) over goods (i.e. furniture and electronics). 

In a backdown from its former view, Jarden now acknowledges a surge in rents and recent company results show retailers with exposure to the low-debt youth market are not immune from macro headwinds.

Cash flow growth for ‘Younger Renters’ and ‘Older Owners’ is forecast to slow but remain positive, yet once essential spending is taken into account, discretionary cashflow is expected to be nearly flat.

Industry feedback and recent updates from the likes of Baby Bunting ((BBN)), Adairs ((ADH)) and Universal Store ((UNI)) suggest to Jarden consumer spending has slowed materially through May and early June.

Wilsons holds a similar outlook to Jarden for the Retail sector, and anticipates a near-term goods-spending recession, with mounting evidence of a shift to spending on travel and entertainment away from apparel and household goods.

Several macroeconomic indicators, including retail sales and consumer confidence, are already indicating slower sales, which could further pressure retail earnings, suggest the analysts.

There is currently no exposure to retail in Wilsons Focus Portfolio, which aims to hold 25-30 Australian stocks and achieve the best risk adjusted returns over the long-term, along with the optimal level of diversification.

While retail stocks may appear cheap, considering the recent sell-off, the broker believes earnings forecasts are still overstated. Both sales and costs are expected to be impacted by an economic slowdown, while higher wages are also set to weigh.

Beacons in the gloom

Despite the generally murky outlook, Wilsons singles out two high PE stocks for special mention.

The brands owned by Wesfarmers ((WES)), such as Bunnings, Officeworks and Kmart, have a strong customer base and tend to perform well regardless of the economic backdrop, explain the analysts.

Also, the low average selling price of jewellery sold by Lovisa Holdings ((LOV)) suggests to the broker demand may hold up relatively well in a slowdown, particularly compared to big ticket items.

Moreover, the company’s store rollout strategy momentum is building and should provide insulation against a softening in like-for-like sales growth over the medium-term.

In research out today, Bell Potter also remains constructive on the investment thesis for Buy-rated Lovisa Holdings and its other favourite in the sector, Accent Group ((AX1)).

However, store traffic trends in Australia and the US across all retail have seen a sharper decline more recently, and Bell Potter expects ongoing weaker trends for the rest of year.

Moreover, the recently announced wage review decision on the industry award rates in Australia will also weigh on the outlook for both companies.

This broker’s 12-month target for Lovisa falls to $30.50 from $32.50, while Accent Group’s target also slips to $2.50 from $2.80.

Further downgrades

On the flipside, when considering normalised PE ratios, Wilsons suggests downgrades have not yet been fully priced into the share prices of JB Hi-Fi ((JBH)), Premier Investments ((PMV)) and Super Retail Group ((SUL)).

Goldman Sachs agrees and points out that relative to small cap Australian retailers, the contraction in price earnings multiples for large caps has been more muted.

As revenues stagnate in the Australian discretionary retail space, as evidenced by soft April ABS data, the broker anticipates a normalisation of gross profit margins back to pre-covid levels. 

A higher number of discounts is expected to offset cost of goods sold (COGS) deflation, while higher lease and wage expenses as a percentage of sales will also result in a normalisation of earnings margins.

After updating forecasts for household final consumption expenditure (HFCE), the broker now expects Discretionary Goods will have negative growth in contrast to all other categories. 

In another headwind for many large retailers, the analysts point out that as foot traffic returns to store, e-commerce sales, which were margin accretive, are now declining.

For Goldmans' research coverage, the result is lower target prices for Premier Investments, Super Retail, JB Hi-Fi and Harvey Norman ((HVN)) as detailed in the Broker Call *Extra* Report on the FNArena website.

The broker also downgrades its ratings for Premier Investments to Sell from Neutral, and for Harvey Norman to Neutral from Buy, on future market share losses.

For Premier, the analysts anticipate increasing competition for its Apparel Brands segment from similarly priced international players and expect a reversion to higher lease expenses will erode earnings margins more than the market is forecasting.

Goldmans believes Harvey Norman will continue to lose market share to JB Hi-Fi and international expansion will increase capex as a percentage of sales.

The broker reiterates is Buy rating on Super Retail on market share gains, while JB Hi-Fi, with an unchanged Neutral rating, will continue to exercise its scale advantage with suppliers to stabilise gross profit margins.

As a result of the retail slowdown, Jarden prefers defensive plays in the Retail sector and companies with less housing-related exposure such as: Woolworths Group ((WOW)), Metcash ((MTS)), Treasury Wine Estates ((TWE)), Webjet ((WEB)), Corporate Travel Management ((CTD)) and Flight Centre Travel ((FLT)). 

Home furniture impacted by macro backdrop and slowing housing turnover

The biggest risk for Nick Scali ((NCK)) and Temple & Webster ((TPW)), according to Macquarie, is allocation of spending away from the home furniture category as housing turnover slows and macroeconomic headwinds persist.

In the first three weeks of May, average home furniture spending was 2.4% of total spending, after the 2.6% average for April.

Despite price inflation, Macquarie points out the average spend for 2023 is only marginally below the pre-covid average of 2.7%.

A key upside risk for Temple & Webster is a better-than-expected return on investment (ROI) for marketing spend, resulting in stronger top-line sales.

For Nick Scali, a greater-than-expected gross margin would provide a boost, suggests the broker. It’s foot traffic for the company declined substantially in February and into March, though a recovery has been evident in recent months.

Upside risk for Baby Bunting ((BBN)) is now not worth contemplating, as Macquarie’s key downside risk for a FY23 guidance downgrade unfolded (-37%) just after the broker’s research was issued on June 6. 

The following day, Macquarie lowered its FY23 and FY24 EPS estimates by -37% and -26%, respectively, and reduced its target to $1.55 from $2.45, while keeping a Neutral rating.

The broker also has a Neutral rating for both Nick Scali and Temple & Webster, on ongoing macroeconomic headwinds for retailers in general.

Radiology sector upside from improving volumes

Following disruption to volumes for the Radiology sector caused by covid, Goldman Sachs anticipates near-term upside from a recovery to pre-pandemic levels.

The broker believes the sixth-largest player in Australia, Capitol Health ((CAJ)), is well positioned to benefit from this volume recovery and initiates coverage with a Buy rating and 33c target.

Buy-rated Integral Diagnostics ((IDX)) also appeals, as it is currently the cheapest stock across the broker’s Radiology coverage on a growth-adjusted basis. The company’s 12-month target price rises by 23% to $3.70 after the analysts mark-to-market multiples and upgrade the earnings forecast.

Goldmans expect margins will bottom for both companies at upcoming FY23 results, as such measures as increased Medicare funding and recent accommodative immigration policies take effect.

The broker points out one of the key bottlenecks within the Australian healthcare system has been a shortage of healthcare workers. This issue has been particularly pronounced for GPs and Radiologists, and hopefully will be mitigated by the recently announced government Migration Program allowing an additional 190,000 skilled migrants to enter Australia.

Capitol Health is set to benefit as its volumes have historically been closely related to GP attendance, given most of its revenue is tied to bulk billing.

Favourable price/mix dynamics are also contributing to stronger radiology revenues, note the analysts. In particular, the proportion of MRI and CT scans as a percentage of total volumes has increased to 45% from 37% in 2010.

M&A opportunities could also arise for both companies as either an acquirer or target, in what Goldmans describes as fragmented radiology industry. The top six players account for around 57% of revenues compared to more than 90% for the top three players in the pathology industry.

Wilsons domestic and global share suggestions

As inflation risks ease and China re-opens, portfolio managers at Wilsons continue to hold a very slight overweight position for both domestic and global equity allocation.

While there is potential for further volatility, it’s felt shares can push moderately higher over the balance of the year. The broker expects slower but not recessionary growth, high but falling inflation and an imminent end to the central bank hiking cycle.

Supplementary to Wilsons Australian Equities Focus Portfolio, the broker provides a list of its most-preferred direct equities and other ideas for stocks that are either speculative in nature, oversold or represent a long-term growth opportunity.

Highlighted in bold include stocks in common with the broker’s 29-stock Australian Equities Focus Portfolio.

Most preferred direct holdings include: Mineral Resources ((MIN)), CSL ((CSL)), IDP Education ((IEL)), APA Group ((APA)) and Worley ((WOR)).

Select Harvests ((SHV)) is the only oversold idea, while speculative ideas include: Immutep ((IMM)), Neuren Pharmaceuticals ((NEU)) and Leo Lithium ((LLL)). 

Long-term growth opportunities are represented by: Ridley Corp ((RIC)), TechnologyOne ((TNE)), Aroa Biosurgery ((ARX)), Lovisa Holdings, SiteMinder ((SDR)) and Tourism Holdings Rentals ((THL)).

For Wilsons global equity exposures, an around 40% Australian dollar currency hedge is applied, given the broker sees medium-term upside against the US dollar.

The broker also lists its most preferred direct global equity investments, which is separate to its 20-stock Global Opportunities List.

The only stock in common to both lists is Microsoft for exposure to the burgeoning ‘AI revolution’.

The other preferred direct global equity investments are: luxury goods company LVMH for leverage to the China reopening; British-based alcoholic beverage company Diageo; French personal care company Loreal and customer relationship management company Salesforce, to gain exposure to long-term digitalisation tailwinds.

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