Retailers Facing Tough Times

This story features WESFARMERS LIMITED, and other companies. For more info SHARE ANALYSIS: WES

-Supermarkets weakest in 10 years
-Online food sales accelerate
-Chains winning in household goods

By Eva Brocklehurst

Retailers are facing a tough outlook, with brokers suggesting the sector is mired in post-election uncertainty amid continued weakness in the supermarkets as competition remains intense.

Moreover, Bell Potter points out discretionary sales were soft in May, month on month, particularly in the light of the reduction to the cash rate the Reserve Bank of Australia instigated on May 3. Australian Bureau of Statistics retail sales data showed growth slowed in May to 2.4% annual compared with the 4.9% pace in April.

Food sales weakened for the second month in a row and Morgan Stanley notes supermarket sales growth is at its weakest in over ten years, growing at just 0.7% versus 3% in January to April. The broker suggests ongoing investment in price, as a result of competitive pressures, and fresh food deflation are the drivers of the weakness. in light of the data the broker envisages a higher level of earnings risk for Coles ((WES)) and Woolworths ((WOW)).

Following Aldi's arrival in South and Western Australia, market growth has slowed further, Morgan Stanley observes, with the step-up in price investment the likely driver. NSW and Victoria report the strongest growth in the supermarket category.

Housing-linked retail growth has also slowed. ABS data shows sales were up 2.9% in May versus 9.5% in April (annual). The warm start to winter may have acted as a headwind in the electrical category but would have been supportive for the hardware category, Morgan Stanley attests. Brokers also suspect consumers became more nervous as the federal election loomed.

Countering this, online takeaway foods sales growth has accelerated in recent months, which, in Morgan Stanley's view, implies a strengthening in Domino's Pizza ((DMP)) sales, given this business is a considerable portion of the category at around 40%.

Ord Minnett expects earnings re-basing to continue for Woolworths, which will, in turn, weigh on the entire food industry. Across the discretionary sector the broker retains a preference for Super Retail ((SUL)), a specific turnaround story, or those with a skew to home categories, such as Harvey Norman ((HVN)).

The broker acknowledges the comparable prior period in the home sector was a tough measure to cycle. The medium-term outlook for the discretionary retailers is still robust, the broker contends. Recent employment growth is offsetting lower wage growth and housing wealth factors support consumption in selected categories.

UBS also observes the chains are winning in the household goods category and the smaller players are losing market share. In the sub categories, furniture was weak and electrical slowed, but hardware was solid.

The broker still expects mid single digit growth in household goods to continue, adding over $200m to industry sales in 2016, and Harvey Norman should have further upside. UBS continues to favour the latter along with JB Hi-Fi ((JBH)), Myer ((MYR)) and Adairs ((ADH)).

The risk in supermarkets is weighted to the downside, UBS maintains and its Sell ratings on Woolworths and Metcash ((MTS)) are unchanged. The broker notes suppliers now expect shelf-price deflation over the next 12 months.

Growth for the food & liquor segment overall, beyond just supermarkets, may have been better, driven by continued acceleration in liquor. UBS forecasts 3.4% growth in the F&L segment over 2016 but agrees the latest data suggests the downside risk prevails. The broker flags the fact that the independent supermarkets lost share in May at a slower rate versus the 12-month average, which is a a positive note for Metcash.

Soft growth in the cafe/restaurant segment does not bode well for Coca-Cola Amatil ((CCL)), UBS asserts, but the May data was positive for Super Retail.

Bell Potter expects muted growth overall in June/July, with the numbers signalling softness across the categories, with recreational goods the exception that recorded positive month-on-month growth. Department store sales were flat.

The positives include low interest rates, benefits from a lower Australian dollar and the housing wealth effect. These will be offset by the uncertainty over the election result, slower housing turnover and market volatility stemming from the British decision to exit the EU, Bell Potter believes.

The broker's stock picks are unchanged and include RCG Corp ((RCG)), with its acquisitions and store roll-out opportunities; Premier Investments ((PMV)), as the pull-back in the share price provides an attractive entry point to the Smiggle growth outlook; and Super Retail, where strong earnings growth is expected to be driven by an improvement in leisure categories.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms