By Greg Peel
Alphinity is a boutique fund manager established 18 months ago after the four founders left a well known institution together to do their own thing. Prior to leaving, the team had racked up eight years of equity fund management returning an average 2% above the ASX 300 index. Today Alphinity has $1.5bn under management for both retail and high quality institutional clients.
Alphinity's sole focus is on investing in quality undervalued companies undergoing an earnings upgrade cycle. The managers' valuations are deeply rooted in assessments derived from talking at length to those “on the ground” in the various industries which make up the sectors of the Australian stock market. Aphinity's portfolio currently consists of 14 stocks (only one change has been made in 18 months) representing, at present, the sectors related to resources (and resource servicers), the consumer, the US housing market and insurance.
FNArena previously detailed Alphinity's view on the resource sector in LNG: Where The Upside Lies. Today's article deals with the fund manager's views on the Australian retail and listed retail trust sectors.
Online shopping – it's the talk of the town. At least it has been, ever since Gerry Harvey alerted oblivious Australians to the bargains to be had online, particularly from offshore sources in a strong currency environment. It wasn't a good move as far as established local chains are concerned.
Alphinity's retail sector specialist recently travelled to the UK to gauge what Australian retailers should expect from here on as online shopping continues to explode. According to retailers, online shopping in Australia accounts for only 5% of all sales, but that figure is growing at a rate of over 25% per annum (Note: National Australia Bank monitors the online sector in Australia and estimates growth is progressing at around 19% annualised). Australia has been slower to adopt mainstream online shopping than the UK, likely due to the strong Aussie dollar being a relatively new phenomenon. No doubt smart phones, allowing for instant in-store price comparisons, have also helped. Online accounts for some 20% of current UK sales, across both the discretionary and staple sectors. Predictions are that 40% of all “high street” shops will close by 2017.
Alphinity suggests that given the Aussie is likely to retain relative strength while the pound will remain weak, Australia should catch up to UK sales levels very quickly.
It is an issue that Australia's listed retailers must concede and respond to, or perish. Companies such as Seek ((SEK)) and Carsales.com ((CRZ)) have risen to positions of power in the online classifieds market in recent years, to the point where analysts now suggest Fairfax's ((FXJ)) real estate and print classifieds, for example, have only around three years to live. On that basis, Australian chain store (or any store) retailers cannot simply blame weak sales numbers on the post-GFC consumer malaise. Change in the retail industry is structural as well as cyclical – a fact David Jones ((DJS)) has now belatedly realised.
Alphinity notes Australian retailers are struggling with increased costs for rent, utilities and wages, and falling sales on price deflation and online leakage. This is “bad dynamic” and will promote “lots of losers and not many winners”.
When considering the Australian retail sector we can also consider the “landlords” – listed retail property REITs. Alphinity suggests landlords will be increasingly vulnerable to either negative rent resets or rising vacancies, which will flow through to share price valuations. Westfield Group ((WDC)) is now an operator rather than a landlord, having spun off its property responsibilities to the Westfield Retail Trust ((WRT)), but it is one company in the retail space proactively adjusting its model to accommodate the new world order, notes Alphinity. This means cutting back on store mall plans while assessing warehousing requirements and paying close attention to shopping mall “mix”.
In the following chart, Alphinity has created a simple comparison by averaging the share price performances of major listed retail REITs Westfield Retail Trust, CFS Retail ((CFX)) and Charter Hall Retail ((CQR)), being the blue line, and listed retailers David Jones, Myer ((MYR)), Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)), being the red line.
The question is this: In the current Australian retail environment, and considering the rapid growth of online preference, which line do you believe might rise/fall more to meet the other?
Retail REITs were severely hammered very early in the GFC – a good nine months before Lehman – based on their overextended gearing levels. While valuations have much improved today as leverage has been reduced, share price values remain universally below net tangible asset values and yields remain attractive in a falling yield environment. This no doubt goes a long way to explaining why landlord prices have not fallen in line with the prices of their tenants.
As to whether such a trend can be maintained is nevertheless unclear. REIT analysts place a good deal of faith in “quality” retail tenants, but such quality usually includes the big chains such as those in the graph.
Alphinity's observations from the UK, where online now accounts for 20% of sales, are as follows:
It is changing the way retailers do business
It is changing the type of physical store retailers want
It is changing the type of shopping centre retailers want to be in
It is changing the type of logistics space required
It is accentuating the difference between prime and non-prime valuations of retail and logistics property
There will be some significant winners and losers.
On the matter of logistics, online global retailer Amazon has seen remarkable sales growth in Europe. Alphinity visited a brand new Amazon distribution centre in Germany, located on the outskirts of a city. On the outside it is an enormous warehouse. On the inside it hums with the latest in logistical hardware and software. Australia's innumerable suburban warehouses are under threat from such a model, Alphinity suggests – a point not lost in Westfield Group's transitional strategy.
The growth in online shopping suggests less need for chain store rollouts and locally dispersed warehouses. In the recent round of Australian chain store quarterly earnings results, the chains hardest hit in the current environment were those undertaking rapid store rollout programs, such as JB Hi-Fi and Kathmandu ((KMD)). The big department stores have also been forced to reassess their rollout plans as they redirect funds towards the tardy embrace of online options for customers. Online was the major reason cited by one analyst as the reason why Woolworths ((WOW)) should cut back the number of its Big W stores.
In drawing upon the current retail experience in the US, JP Morgan analysts note a clear transition from an old model to a new model, driven by the “customer value proposition”.
With a plethora of brands and models often available in most products, the market share winner under the old model was the store offering the widest range at the best price in the most convenient store location. The internet has now determined the new model, in which assortment and location is no longer relevant. JP Morgan suggests the Australian chain suffering most from such a transition is David Jones.
Gerry Harvey recently complained that online shopping was growing due to Australia's sub-$1000 GST exemption. Yet the GST difference is only a minimal consideration compared to the threat of the simple “price transparency” the online world offers. JP Morgan notes that in Australia, David Jones recently cited research suggesting Australian shoppers are willing to pay a 20% price premium relative to overseas retailers. Blind defiance? The suggestion of major US retailer Best Buy is that as the online experience improves, consumers will become more demanding. This is a particular problem for David Jones and Myer, JP Morgan believes.
A friend of this writer, lets call him a “source very close to Harvey Norman”, puts it in more simple terms. “We used to buy a sofa for $1000 and sell in the store for $2000,” he told me. “Now we buy a sofa for $1000 and hope to sell it for $1100 after a shopper has compared prices, asked for a “cash” discount and pointed out that even with freight, the same sofa is cheaper from offshore”.
JP Morgan also cites the threat to Australian retailers from the “vertical integration” model exemplified by the high-flying Apple. JB Hi-Fi is particularly exposed to Apple's success, the analysts believe, because the company relies on the popular products to encourage shoppers into its stores where a whole range of products and brands are on display. But Apple is rapidly growing its own chain of shop-fronts in this country which are very much tied into the online model of low in-store inventory carry.
In selecting its portfolio allocations, Alphinity has recognised one listed retailer and one listed retail trust (of sufficient free-float size) which have been quick to see the writing on the wall and adapt their businesses to the changing world. As first movers among the listed choices, they should continue to enjoy success in the analysts' view. They are Super Retail ((SUL)) and Goodman Group ((GMG)).
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