In Brief: Retail Stocks, Supermarkets, Platform Providers, BNPL & The Australian Economy

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This story features COLES GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: COL
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

Weekly Broker Wrap: preferred retail stocks, the favoured supermarket, platform providers, new BNPL entrant & the Australian economy. 

-Retail stocks for a higher cost environment 
-Time to buy Woolworths?
-Term deposit rates lift cash margins for platform providers
-Apple’s move into BNPL
-Impact of rising interest rates on the Australian economy

 By Mark Woodruff

Retail stocks for a higher cost environment 

Following discussions with a leading freight forwarder, Jarden extends its timeline for ongoing supply chain pressures into 2024. 

Furthermore, the broker assesses upside risk to its peak Australian inflation rate forecast of 6% year-on-year. Having originally anticipated a decline back toward 3% over 2023, higher-for-longer inflation is now anticipated.

The next three to four months will be challenging, suggest the analysts, as impacts on global shipping from backlogs caused by China’s covid-zero policy and lockdowns are digested.

While supply chain challenges are unlikely to ease, at least global shipping freight costs have stabilised, notes the broker. However, surging energy costs have resulted in higher fuel surcharges for both ocean cargo and road freight.

As a result of higher transportation costs going forward, Jarden suggests importers will have to adjust margins where possible. Thus, retail companies with either defensive characteristics or pricing power are preferred including Coles Group ((COL)), Metcash ((MTS)), Woolworths Group ((WOW)), Endeavour Group ((EDV)), Costa Group ((CGC)) and Treasury Wine Estates ((TWE)).

The broker also likes Qube Holdings ((QUB)) within its Transport sector coverage, as the protracted demand environment is likely to be supportive for freight and container volumes. Additionally, the company’s near-term earnings margins are expected to be insulated by a variety of covid-19 and cost-related surcharges.

Time to buy Woolworths?

Industry-wide checks by Goldman Sachs reveal that recent price hikes have not caused any drop-off in supermarket volumes, and only a limited shift to value by consumers.

This solid undertone adds to the allure of Woolworths, after a recent share price fall, suggests the broker. This at a time when the group has its lowest valuation premium versus Coles since the latter was spun out from Wesfarmers ((WES)) in 2018.

Key suppliers and industry participants generally agree Woolworths is the superior operator by a sizeable margin, and Goldman Sachs notes the company is also a stand-out in the online channel in terms of market share. 

The broker feels several years will elapse before Coles even has the capabilities to compete online, especially where the volume of its consumer data and advancement in data analytics are concerned. Woolworths and Wesfarmers have jumped ahead in this regard by setting up Woolies X and OneDigital, respectively, as central digital divisions.

Nonetheless, consumers have a greater value perception of Coles, according to the analysts, which may insulate the company’s growth should consumers trade down. 

Goldman Sachs has a Buy rating for Woolworths, with material potential upside to its $41.70 target price, while Coles is Neutral-rated with a $17.20 target. 

Term deposit rates lift cash margins for platform providers

Citi expects increased earnings from higher cash rates for the platform deposits of Netwealth ((NWL)) and Hub24 ((HUB)) will trump any downside from ongoing flow weakness related to current market volatility. This comes as term deposit rates have increased by around 50 basis points in recent months.

However, both companies utilise ANZ Bank ((ANZ)) to manage their cash, and the major banks have only increased rates by 10bps in the term deposit market, due to excess balance sheet funding. This compares to 60-90bps for regional and branchless banks.  

Moreover, ANZ currently offers the lowest term deposit rates in the market. A higher rate for platform cash deposits could be achieved, note the analysts, should the companies entertain interest from other banks.

In the meantime, an increase in bank funding costs suggests upside to the broker’s cash margin assumptions, with a 10bps increase for Buy-rated Netwealth and Neutral-rated Hub24 estimated to lift profit by 4% and 7%, respectively.

Apple’s move into BNPL

Morgan Stanley believes the primary market for BNPL providers is consumers with more limited access to traditional credit options. The aim is to offer a full suite of banking services, once the consumers mature into more fully established customers.

Based on this view, the analysts believe the impact of Apple’s newly announced Apple Pay Later (BNPL service for US customers) is limited by Apple’s customer demographic. It’s felt customers have a higher income and are better banked than those that have gravitated to US-based Affirm and the Afterpay offering from Block ((SQ2)).

The new service will be available everywhere Apple Pay is accepted in the US (both online or in-app). In offering four equal instalments without incurring interest or late fees, the service most closely resembles Afterpay, suggests the broker.

The service will only bring incremental competition to the industry, according to the analysts, who maintain a preference for the wider offering from Affirm.

Separately, Apple stated its Tap to Pay feature for merchants will be available starting this month. 

Counterintuitively, Morgan Stanley predicts this will benefit Block's seller business called Square, as merchants using this tap to pay feature will still require a merchant account to accept payments.

Impact of rising interest rates on the Australian economy

In research released just prior to this week’s 50 basis point RBA rate hike, JP Morgan pointed to a reduced risk that rising interest rates in Australia will prove too restrictive, as labour costs remain benign and fiscal capacity is underpinned by surging terms of trade.

Nonetheless, an important caveat to the broker’s view is significantly higher wholesale electricity and gas prices, which are yet to be recognised in household bills. When this occurs, there’s considered potential for a more cautious consumer and/or a higher reset for inflationary expectations. 

Household utility costs are one of the largest contributors to inflation, and the transmission of these costs to the CPI readout has the furthest left to run, according to the broker.

More positively, the analysts note unit labour costs have fallen -6% since the start of the pandemic. It’s estimated wages growth of greater than 3% (currently 2.4%) would be required to create significant labour-cost frictions, as productivity is running at nearly triple its usual pace. 

By starting the rate hike cycle, the RBA inverted its own wage-based framework, explained JP Morgan, as it’s now assumed labour costs will reach certain targets and inflation is expected to drive higher wages, as opposed to the opposite. Thus, stronger productivity growth becomes a reason to expect more elevated wage growth in the future.

The same forces driving rising interest rates also insulate a commodity producing economy, according to the broker. Hence, the impact of rising interest rates has been reduced by the potential upside to government revenues from Australia’s terms of trade.

In short, the longer iron ore and coal prices hold around current levels, the greater the likelihood of further fiscal easing, concludes JP Morgan.

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