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If one believes the bears, Amazon will decimate our retailing sector, foreign retailers will stomp on their Australian peers and a property crash will crush consumer spirits.
Some of that thinking is behind sharp falls in many retail stocks this year and the opportunity is for investors who can see beyond the gloom. Value is emerging in the retail sector but landmines still lurk, even after large share-price falls.
Fears about Amazon’s effect on retailing, when it ramps up operations in Australia, look overdone. That is not to downplay the threat: Amazon has been a huge disrupter in overseas retail markets. It’s near impossible to compete with Amazon on price, such is its scale and logistics genius.
But some Australian retailing nuances could slow Amazon’s growth. The logistics challenge is harder because our major capital cities are less densely populated than comparable cities in the United States and Europe. New York, for example, has more than twice as many people per kilometre than Melbourne and Sydney.
Moreover, Amazon is yet to create a “network effect” in Australia – that is, lots of products on the one platform attracting more consumers, which in turn attracts more product suppliers and consumers. The “network effect” has been a key part of Amazon’s growth.
Australia’s better working conditions and wages compared to the United States are (thankfully) another headwind for Amazon. As is the dominance of Woolworths and Coles in so many retail categories and their capacity to respond to Amazon.
Moreover, it will take time to convince consumers to buy more goods online, particularly food. Australia is broadly in line with international trends when it comes to online sales – good, but not enough to suggest an e-commerce revolution is imminent.
Kudos to Amazon for getting millions of dollars in free publicity from media outlets, but the fear campaign, evident in slumping share prices of retailers has gone too far.
So has the hysteria about Australia’s property market. Is there a bubble in parts of Sydney, Melbourne and Brisbane (in inner-city apartments)? Absolutely. Is the bubble about to burst, bringing down Australia’s banking system and sparking a Down Under GFC? No.
Census 2016, released this week, was telling. Nationally, 7.2% of households with mortgages said they spent more than 30% of their income on house payments – the point that is considered “mortgage stress”. That’s down from 9.9% in 2011 because of historic-low interest rates.
In Sydney, households grappling with mortgage stress have fallen from 12% in the previous census to 8.4%. It’s a similar story in Melbourne. Of course, that will change quickly if interest rates race higher, but a gradual rise seems likely.
On income, Census 2016 showed the number of families earning more than $3,000 a week rose by more than 50% in the past five years. With stagnant wages growth, this suggests more family members are going back to work or putting in extra hours. Either way, more families reported to Census that they earned higher income than five years ago.
Even the threat of foreign retailing in Australia looks overstated. Uniqlo, Zara, H&M and other offshore retailers have attracted plenty of attention as a huge threat to local retailers. Macquarie Equities research in late May noted Zara’s soft sales growth. Other international apparel retailers, like their local peers, appear to be struggling.
None of this analysis is to downplay the immense challenges facing retailers. One need only witness the duration and depth of price discounting these days to understand the compression in margins. Or the lengthening list of retailers in receivership.
But it does suggest that talk about “retail Armageddon”, the “coming property crash” and Australia’s “great income recession” is overblown. As are share-price falls of up to 30-40% in several retail stocks over the past 12 months.
Nevertheless, my strategy is to buy Australian retailers that have a growing proportion of offshore earnings. I am concerned about elevated household debt and its handbrake effect on consumer sentiment and retail sales growth. Restoring personal balance sheets is a long process and more spending must be diverted from consumer goods to service debt.
Australian retailers exposed to faster-growing Asian or European markets look a better bet than those relying on this market for revenue. Even after price falls, several Australia-focused retailers look more like value traps than good value, such is the risk of further earnings downgrades as cautious consumers rein back spending.
There are exceptions. Beacon Lighting Group (BLG) is an example. The stock has fallen from a 52-week of $1.98 to $1.31 after lower-than-expected earnings growth (partly because of excessive discounting of light fixtures by the failed Masters home-improvement chain).
Beacon is well run, has a good market position and high return on equity. The company looks less exposed to online competition to the nature of its product and may be a touch undervalued.
Even so, look for retailers/consumer-goods suppliers with offshore exposure. Here are three to consider:
Small electrical appliances are an obvious target for Amazon. JB Hi-Fi (JBH) and Harvey Norman (HVN) Holdings, for example, could struggle if Amazon takes market share in electronic devices.
I doubt Breville is as exposed to consumers opting for cheaper kitchen appliances bought online. The company’s consumers value the brand and its innovation.
Unlike many consumer-goods companies, Breville has rallied this year. After a solid interim result, it scooted from $8.10 in February to $10.50. A 10-year annualised total return of 18.5% confirms Breville’s status as a great small-cap company.
I like Breville’s strategy to speed up its innovation and transform into a global kitchen-appliances maker, from an Australian company that exports. Essentially, Breville is boosting its R&D cycle and selling the same products to more countries.
I doubt the market fully appreciates what Breville, already strong in innovation, is achieving. Although not a retailer, the company will sell more products in more offshore consumer markets that have better growth prospects than Australia.
A consensus of seven broking firms has a share-price target of $9.38 for Breville, suggesting the stock is overvalued. It is due for a pullback after gains this year, but any price weakness would be an opportunity to buy a company that earns three-quarters of its revenue overseas.
The developer, maker, distributor and marketer of skin and haircare products has brands such as Sukin, Derma, USpa, Edward Beale and Renew Skincare.
BWX shares soared after it raised $39 million in an Initial Public Offering (IPO) on ASX in 2015 at a $1.50 issue price. The shares spiked and now trade at $5.87, making the company one of the best small-cap floats in years.
BWX’s offshore growth strategy is the key to its next re-rating. The company reported a doubling of export sales in its latest interim profit (off a low base) and is implementing long-term strategies to target cosmetics markets in Britain, Canada and China.
BWX last year announced Boots, a leading UK pharmacy retailer, was stocking the flagship Sukin range at 80 of its highest-turnover stores. Boots UK is part of the Walgreens Boots Alliance, the largest pharmacy retailer in Europe and North America.
I like the growth prospects of the mid-priced cosmetics market. The coming boom in middle-class consumption in emerging markets will be a tailwind for “affordable luxury” cosmetics that BWX supplies. Such products tend to have loyal customers who are less likely to buy cosmetics online, and BWX benefits from higher margins.
An average price target of $5.65, from a consensus of six broking firms, suggests BWX is fully valued. Watch the company do better than the market expects over the next two years as it sells more products in offshore markets that grow faster than Australia.
The owner of stationery chain Smiggle, bedroom-wear brand Peter Alexander and several well-established fashion chains has been a retail favourite of this column for several years.
My interest was based on the offshore growth prospects of Smiggle, among the most successful retail concepts to emerge from Australia in years. Young kids cannot get enough of its brightly coloured, higher-margin stationery.
Premier has fallen from a 52-week high of $17 to $12.76, in line with the broader sell-off in retail stocks. The company’s interim result, released in March, broadly met market expectation and was a decent performance in a competitive retail market.
Smiggle is Premier’s key growth engine – its sales are up 81% over two years – and nearly 60% of its revenue is now earned offshore. Premier opened another 26 Smiggle stores in the United Kingdom and seven in Asia in the first half of FY17. One Smiggle store is being opened overseas each week on average.
Analysts expect the Smiggle rollout to expand to Ireland, France and Germany and some believe Smiggle could have a global network of 500 stores, but even that is starting to look conservative.
Premier’s Peter Alexander brand, also offering higher margins, is performing solidly, but the company’s older fashion brands in teenage and women’s apparel have slower growth prospects and need refreshing.
A price target of $15.42 for Premier, based on the consensus of 11 broking firms, suggests the company is undervalued after recent share-price falls. Morningstar values Premier at $14. I agree with the brokers on this one: Premier has fallen too far.
As strong growth in offshore revenue compensates for slower growth in its Australian operations, Premier typifies the benefits of buying retailers with an expanding global footprint and scope for high organic growth through store rollouts.