Rough Ride Ahead For Oz Retailers

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-What if housing cools?
-Structural concerns remain
-AUD key to labour competitiveness
 

By Eva Brocklehurst

Retail sales growth in Australia has steadily improved over the past 18 months, with a buoyant housing market underpinning consumer confidence as house prices rise. Several analysts consider this may be about to change.

The strongest categories in retail have been linked to housing, such as in furniture and hardware. Morgan Stanley notes trading has softened significantly since the federal budget in May. Conditions in the first quarter of FY15 have signalled to the broker that outlook for Australian retailing is not improving. Unemployment is rising and income growth is slowing and the broker calculates this weaker macro environment will lead to a 250 basis point headwind for discretionary retailers. Unemployment is expected to rise to 6.8% from 6.1% and household consumption growth to slow to 3.9% from 5.1%. Any cooling of the housing market or a flat savings rate prevailing for longer would make the broker even more bearish.

Staying with the bearish signals, the broker observes the Westpac consumer sentiment survey's Christmas spending indicator is the worst since 2008. Consumers are shifting their spending towards staples and services at the expense of discretionary retail and this trend is expected to continue. Structural issues facing discretionary retailers have been well known for some time, such as greater competition emanating from online and international operators. The broker observes the proportion of Australian consumption spent on retail continues to decline. Consumers are spending more on categories like education, communication, health, recreation, cafes and restaurants. This is also a structural issue which the broker believes is unlikely to change in the foreseeable future.

Morgan Stanley notes valuations for these retailers relative to the ASX appear fair rather than stretched and retains an In-Line industry view. Wesfarmers ((WES)) and Super Retail ((SUL)) are Morgan Stanley's only Overweight stocks in the Australian consumer sector. Super Retail is chosen because it is cheap and offers growth categories. Wesfarmers is justified as Bunnings continues to take share in the robust home improvement category and staple retailer Coles provides defensive qualities. At the other end of the spectrum Woolworths ((WOW)) and Harvey Norman ((HVN)) are the broker's highest conviction Underweight ratings under coverage in the retail sector.

The latest quarterly wages statistics revealed growth remained at a 16-year low, where it has been for more than a year. UBS observes public and public wages were subdued in the third quarter, although there was a seasonal jump in bonuses which lifted private wages. The broker considers this subdued growth is a positive for company profits and should help keep inflation in check over the coming year. The broker acknowledges that the figures signal that a forecast pick up in consumer spending growth, to 3% in 2015 from 2.5%, relies on further gains in confidence as well as low inflation. In terms of the Westpac consumer sentiment survey, UBS remarks that the headline sentiment number may have bounced in November to its highest level since August but remains down by 12.5% year on year and below its long-term average.

Wages growth may be slowing but there are benefits for business, in terms of reduced costs. ANZ economists note, as a result of the slower wages growth, Australia's international competitiveness has not deteriorated in the last couple of years. Nevertheless, over the past decade the loss of international competitiveness has been stark. Australian unit labour costs increased 34% between 2004 and 2013 in Australian dollar terms, with currency movements amplifying the increase. A depreciation of the Australian currency will, therefore, provide welcome assistance in reducing these costs.

The economists find it difficult to envisage Australian wages growth will run at a significantly lower rate than global counterparts for a sustained period, although wages in some countries such as the US will outstrip Australian wages over the next few year, given the cyclical upswing that is envisaged. Hence, once the currency benefit fades any substantial improvements in labour competitiveness will need to come from productivity. In turn, productivity enhancements will depend on infrastructure spending, competition & innovation policy and taxation reform.
 

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