New Trends and Challenges For Oz Retailers

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By Chris Shaw

After rebounding in 2009, and even in the face of growing uncertainty with respect to the global economic growth outlook, the Australian economy remains on course for a broadening recovery in 2010, in the view of Westpac Bank.

The bank's senior economist Matthew Hassan expects an upswing in housing building to act as a key growth engine for the Australian economy in 2010, though recent interest rate increases mean this upswing is unlikely to continue through 2011.

This means business investment will be important in sustaining momentum this year and in 2011, so Hassan suggests the downside risks next year are becoming more pressing. This is especially the case as policy is swinging from a major support for growth to a drag.

In 2009 consumers represented a large part of Australia's strong economic performance, helped by aggressive policy moves that boosted consumer confidence as an expected rapid rise in unemployment failed to materialise.

As Hassan points out, perceived job security is a big part of the consumer cycle through any downturn. As growth weakens consumers cut back on discretionary spending and delay the purchase of big ticket items.

As unemployment rises the risk of individual job losses declines, as those still with jobs start to feel more secure in their positions. This traditionally prompts an initial recovery in consumer demand as previously delayed purchases are again put on the agenda.

The policy stimulus measures offered by the Australian government in 2008/09 represented about 4% of annual disposable income and while much of this was saved, there was enough being spent to help reverse a contraction in demand.

Into 2010, Hassan notes spending is now picking up in key cyclical items. This trend is expected to continue as employment is rising again, so boosting consumer sentiment. But the key for the retail sector in Hassan's view is the current consumer cycle is an abnormal one, as the soft consumer spending numbers of recent months suggest a fundamental change in consumer behaviour.

The focus since the Global Financial Crisis hit has been on paying down household debt, while household savings rates have also increased. Assuming consumers are becoming more conservative, Hassan suggests any recovery in the Australian economy is likely to be weaker than is usually the case at least until household incomes begin to rise solidly.

The problem here is the Reserve Bank of Australia (RBA) has moved more quickly than normal to restrain growth in the current recovery, which will act to constrain growth in disposable income. Hassan forecasts disposable income will rise by 2.9% in 2010 and by 2.5% in 2011.

Any sea change in consumer behaviour has implications for Australian retailers in Hassan's view, as retail spending typically accounts for about 40% of total consumer spending. This segment of the market is also the most volatile, as historically retail sales cycles are about 1.5 times those in total consumer spending.

A likely outcome of a more cautious approach from consumers suggests spending in retail ex food will be weaker in the current upswing, especially early in the cycle when disposable incomes are still growing slowly.

In Hassan's view this suggests some challenges for retailers, so the key will be providing the right sort of products at the right price points. In such an environment, Hassan is forecasting overall growth in real retail sales volumes will slow from the 3.4% achieved in 2009 to 3.3% this year and 3.2% in 2011. This would be a disappointing outcome given real retail sales volume growth has averaged 4.3% since 1990.

Looking at the major retail categories, Hassan notes the weakest segment has been household goods, especially electrical and electronic appliances. This is significant as this segment of the market accounts for about 15% of total retail sales.

A recent JP Morgan survey of consumer electronics retailers showed there was strong demand for some products such Apple's iPad and 3D televisions, though in both cases retailers suffered from a lack of stock.

This reflects the fact new product development is a positive for retailers in the consumer electronics space, as it boosts sales of premium priced products as well as associated accessories. There is also a resultant increase in store traffic.

In terms of how this plays out for the Australian retailers, JP Morgan suggests Apple's iPad is a driver of sales and store traffic for retailers, with JB Hi-Fi ((JBH)) the largest beneficiary. The lack of available stock is likely to limit the financial impact for the company of this increase in FY10 in the broker's view.

As JB Hi-Fi is better known for stocking Apple gear, JP Morgan also sees scope for further benefits down the track as that company develops new products. The latest example is the iPhone 4. In contrast, Harvey Norman ((HVN)) is being hurt to some extent by limited exposure to Apple products, something that is a contributor to its weak overall computer sales at present.

While JP Morgan makes no change to its Underweight position on consumer discretionary companies in the retail sector, it points out new product development remains an attractive feature of retailers that sell consumer electronics.

According to Westpac other retail categories have been more mixed, with department stores and clothing retailers recording solid sales volume increases, but at the expense of aggressive discounting in prices. The recreational goods category has also been relatively weak, while those offering a mix of discretionary and staple components such as books and pharmaceuticals have been mixed.

The retail sector did fare well in terms of profits in 2009 as fiscal stimulus measures boosted sales and retailers were able to boost margins. This was helped by strong cost control and falling imported goods prices thanks to a stronger Australian dollar.

But this profitability boost will be harder to sustain in Hassan's view, as the lack of growth in sales volumes and a lack of any further boost from the currency won't help with respect to either margins or earnings.

Looking forward, Macquarie suggests two key factors in the retail sector will be the impact of the internet and that of consumer loyalty. For the former it notes in 2005 Australian consumers spent just under $13 billion online, with better than 80% of that money staying in Australia. By 2008 however, internet spending had risen to around $23 billion but just 57% of that money stayed onshore.

The internet is also impacting on consumer behaviour by allowing shoppers to focus on price, as Macquarie notes there is a growing trend in markets such as the US, UK and Japan to scan product barcodes and immediately compare the cheapest prices in the area.

This means retailers will need be the lowest cost retailers in their landscape to sustain sales, or make greater use of loyalty programs to entice customers to increase their impulse purchases. This is being made increasingly possible by the technology available on smartphones.

The key for Macquarie is while such technology offers scope for incremental revenue growth there are as yet no leaders in the real time marketing and advertising space among the large cap listed retailers. This means digital capability could become a differentiating factor for retailers in the near future.

Those likely to be best placed to compete in the digital age will be the low cost operators in Macquarie's view, as price will be the major focus of the merchandise offer and the low cost players will have the most flexibility on prices.

In the Australian context Macquarie suggests those listed players with the greatest advantages in their respective sectors are Wesfarmers ((WES)) in hardware via their Bunnings division, JB Hi-Fi in the homes entertainment sector, Woolworths ((WOW)) via Big W in the lower cost department store category and David Jones ((DJS)) among the more traditional department stores.

With respect to loyalty cards, Macquarie notes the key is to collate customer data with transactional data to maximise a customer's share of “market basket”. The problem is the large number of such programs means sufficient differentiation is needed to make any proposition compelling for customers.

One example is Woolworths' loyalty program, as there are now 5.2 million Everyday Rewards cardholders. Around 2.1 million of these have linked their cards to the Qantas ((QAN)) Frequent Flyer program.

Macquarie notes customers appear to be spending more after they link their cards, with a further boost to spending being achieved once targeted offers are sent to customers. This suggests the successful execution of this program will deliver growth to Woolworths as the company will be able to sell more to existing customers.

One issue in all this is the cost to the company, as Macquarie points out in the case of Woolworths customers are already receiving a benefit of 4c per litre off their fuel costs. Add in the cost of payments to Qantas for the frequent flyer points and such programs are becoming more expensive. This means achieving higher sales from such customers will continue to be necessary.

In terms of Australian retailers, the FNArena database shows Sentiment Indicator readings of 0.4 for JB Hi-Fi, 0.6 for Harvey Norman, 0.2 for Woolworths and 0.3 for Wesfarmers. David Jones has a Sentiment Indicator reading of 0.2, while Myer ((MYR)) scores a reading of 0.9. The maximum reading possible is 1.0.

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