Weekly Broker Wrap: Oz Retailers Under Attack

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-Luxury brands to expand here
-Foreign labels raise competitive stakes
-Construction and engineering activity declines
-Coal exports to rise in June quarter
 

By Eva Brocklehurst

Luxury goods spending in Australia is growing, which may come as a surprise given the subdued economy and the uncertainty ahead of the federal election. Citi asks why and finds there is scope for growth in luxury brands here, but it could be at the expense of the traditional luxury goods retailers – department stores. Citi estimates the luxury market can double in five years but David Jones ((DJS)), Oroton ((ORL)) and Myer ((MYR)) might lose share if they fail to invest in their stores.

Australian luxury goods spending per capita is less than half that of the US. The market is immature in Citi's view. Many global brands have only established a footprint here quite recently, although the demand is there. Tiffany's actually has higher sales per capita in Australia compared with the US. Citi expects the number of global brand luxury stores will rise to 300 in the next five years from the current 130. In terms of the statistics, luxury goods have grown at a multiple of three times GDP.

Sales are driven by the growth in high net worth individuals, and tourist spending. The definition of high net worth used by Citi is income over $150,000 per year. These individuals shop for premium goods (one step below luxury) and aspire to luxury. Those earning over $1m a year are clearly the target market for luxury brands. Luxury goods sales are expected to double to $4.4 billion in five years and the luxury goods retailers could take market share from the department stores, the traditional purveyors of luxury brands.

Assuming 10 brands develop 7-10 stores each there is $400-500m in potential additional luxury sales in Citi's view. There are at least 15 major luxury brands that do not have their own Australian stores, yet. They include De Beers, Dolce & Gabbana, Lanvin, Saint Laurent, Alexander McQueen, Celine and Marc Jacobs. Citi expects sales to be lost from David Jones as these brands provide a better store experience in their flagship locations. Moreover, luxury goods can take market share from other categories – trading up – and this will be a further negative for department stories unless they can capture more distribution points for these luxury brands.

Citi sees the need for Australian premium brands such as David Jones, Oroton and Sass & Bide (owned by Myer) to invest more. They have to be prepared to compete with the newcomers on the full spectrum of retailing such as price, range, service and in-store experience. Based on their existing strategies, Citi expects Australian retailers will lose market share and has Sell ratings on the above three retailers.

Morgan Stanley has taken a closer look at the Australian apparel brands and, in the same vein, finds global brands are appearing in increasing number and having an impact. While the store roll-outs have been slower than expected their competitive pricing is starting to re-set Australian benchmarks. The most exposed to this threat is Premier Investments' ((PMV)) Just Group. Morgan Stanley has downgraded PMV to a Sell rating. The broker finds 10 incoming global brands are in direct competition with 80% of Just Group's business. Continued pricing pressures will likely weigh on margins longer term. Moreover, the analysts note that four of Just Group's five apparel brands have lowered shelf prices on women's dresses compared with a year ago. These may not equate to final sale prices but the quantum of change has meaningful implications.

Of the brands that are already here, Morgan Stanley includes Zara, Gap, Topshop, Hollister, Miss Selfridge and Michael Kors. H&M, Uniqlo and River Island are coming. Morgan Stanley expects sales from these foreign brands to expand to $2.1 billion by 2018, representing 6.5% of the Australian apparel market. Incumbent retailers are responding, the analysts note, but they remain significantly more expensive than the incoming labels. The price premiums are expected to reduce.

The impact for those other than Just Group is greater for Myer than for David Jones, in Morgan Stanley's view. David Jones' private label doesn't overlap with this market whereas Myer's does. The analysts believe it will become more difficult for Myer to expand the private label offering as it competes at similar price points with the global brands. In contrast, David Jones has significant margin opportunity ahead. The retailer is already shifting the mix to 10% of sales from private label, from the current 3.5%. Pacific Brands ((PBG)) is seen as evenly balanced in terms of risks/rewards from the increased competition. The company is seeking to increase its direct-to-market approach and reduce the reliance on the powerful retailers but it may become more difficult in future for Pacific Brands to establish its own retail network, in Morgan Stanley's opinion.

On to construction activity. Citi finds there's been a notable deterioration in non-residential and engineering work. Together these sectors represent 75% of construction work in this country. Non-residential is expected to fall 17% over the next three years and the analysts have reduced forecasts for spending, to contraction of 11% in FY13, 5% in FY14 and 1% in FY15. The recovery in construction is expected to take longer because of a multitude of factors, such as weak tenant demand, compression of developer returns, difficulty in obtaining finance and limited foreign investment.

Engineering construction is expected to contract 10% over FY14-15, driven by a weaker outlook for resource-related rail and port capex, lower telco spending under the Coalition's NBN plan, and lower power asset growth. Government asset sales and super fund investment will play an increasing role in funding infrastructure, but given the long lead times and allocation issues Citi believe it won't be until FY16 that the next wave of transport projects ramps up. Associated with this decline in construction activities, the broker has downgraded earnings expectations for building materials stocks by up to 5% for FY13-15. Contractor earnings forecasts have also been cut. The best stock to emerge from all of this downgrading is Downer EDI ((DOW)) and Citi's least favoured is Boral ((BLD)).

Coal majors in Australia have increased production by 16.4% in the March quarter. Deutsche Bank observes that all four international big caps – BHP Billiton ((BHP)), Rio Tinto ((RIO)), Anglo American and Xstrata –  have recorded solid double digit growth for the quarter despite heavy rain. Volumes at the ports were up by 6.7% in the quarter. This result is made even more impressive by the fact that the Queensland rail network around Gladstone was closed in February because of floods. Of significance is the substantial increase in production relative to exports. Production is a useful leading indicator, in Deutsche Bank's view, and points towards strong export volumes in the June quarter. The broker rates the two key coal conveyors, Asciano ((AIO)) and Aurizon ((AZJ)), as a Buy.
 

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