Fourteen months ago I wrote an equity strategy note [1] titled “the real wealth effect is property”, that was followed by another one in July 2013 “the real wealth effect is property part 2”.
The main point is that these notes prove Australian behavioural economics hasn’t changed. A year ago I was making a forecast based on how I thought Australians would behaviourally react to macro settings and it proved accurate.
The interesting aspect is today median resident house price gains are even higher than I forecast, auction clearance rates are even higher than I forecast, and new home construction is even higher than I forecast.
The East Coast property effect
I was pretty much the lone East Coast strategy bull back then but even I was too bearish (relatively).
The wealth effect of property is 100% real in Australia and I did pose the question back in January last year at the end of this note: “The question we also need to ask ourselves is: Is it time to buy discretionary retailers? Austerity is so yesterday.”
This is the biggest question still a year later and I think the answer is “absolutely, yes”.
I absolutely believe the real wealth effect of property, combined with population growth (immigration) and increased foreign tourism, as Australia becomes better global value (falling Australian dollar), will drive retail spending.
But the bigger driver, which is again an inverse correlation to rising property prices, will be the Australian household savings rate falling.
Let’s look at four charts from the RBA.
House prices and household assets have recovered strongly, yet the savings rate remains elevated and quarterly retail sales growth is about half its peak.
To me, it is now obvious that this savings rate will drop and discretionary spending will increase. It all comes down to confidence increasing.
And on the topic of “confidence”, let’s look at Australian retail sales. Did you know that seasonally adjusted Australian monthly retail sales are now tracking 5% ABOVE the pre Federal election levels? We have now seen six straight months of growth in Australian retail sales since the change of Federal government, with January’s data (+1.2% month on month) showing ALL categories of retail GROWING. December retail sales data was also revised up (>.7%).
Confidence builder
I wrote for many years that Australia’s “confidence” problem was the woeful minority Federal government and the more I sit here, the more the domestic data confirms that was the correct call. The combination of rising house prices, rising equity prices and ultra-cheap money will drive the savings rate down.
Australians are not natural savers via cash hoarding. They save via residential property and shares. As the savings rate drops to a more normalised 5% (currently 10%), that cash will find its way into property, equities and a high proportion of it will be consumed as Australians reward themselves with a splurge or two.
So while the negatively sensationalist Australian press focus on the negatives (car manufacturing ending, Qantas, unemployment ticking up), the data I look at on Australia is beating all expectations. So are industrial equity earnings and dividends. Australia is going BETTER than anyone predicted, with the RBA’s attempts to rebalance the economy back towards the East Coast clearly working. Unemployment is a lagging indicator (94% of Australians who want a job, have a job), just as it was in the USA. Job ads are actually rising.
But when I look at the Australian discretionary retail sector, I see prognosis of gloom and large open short positions. This is right as all the macro drivers of discretionary spending are turning up.
Watch the shorters
One thing I have learnt over the years is that companies that are being shorted take it very, very personally. They do everything within their powers to prove the shorters wrong and make them hurt when they have to buy their short shares back. This is the key reason I take a keen interest in stocks with large short positions, because it can actually be the catalyst for much stronger corporate performance.
The large open short positions in Australian discretionary retailers are based on the premise that these “bricks and mortar” retailers are structurally terminal business models. Yes, there is clearly structural pressure from forms of internet-based retailing, but the Aussie dollar and potential changes in Australian cross border taxation rules, could dampen that structural pressure at the same time traditional cyclical discretionary demand is turning up.
I can see a very clear situation where there is a short squeeze in listed “bricks and mortar” Australian discretionary retailers over the next 12 months, with the biggest open short positions being Harvey Norman (HVN 12.3%), Myers (MYR 14%), David Jones (DJS 6.7%), Flight Centre (FLT 14.8%) and JB Hi-Fi (JBH 12.4%).
Remember Fairfax (FXJ) was also seen as “structurally terminal”, but its shares also just rallied 100% from June 2013 as big shorts covered.
JB Hi-Fi
My number one fundamental pick remains JB Hi-FI (JBH), which has clear leverage to increased personal spending and home improvement via JB Home.
Interestingly, JBH consensus earnings continue to be revised up, yet the short position remains large and analyst recommendations bearish. The table below shows the JBH share price lagging consensus earnings estimates for FY14 (red line).
On our estimates, JBH is trading on 14.7x FY14 and 13.7x FY15. EPS growth is forecast at +10% for both years. The dividend yield is 4.2% fully franked and ROE 51%. The balance sheet is very strong (enterprise value/ebitda 8x), with our forecasts seeing the balance sheet holding net cash by FY16, driven by a rise in EBITDA to free cash conversion. FY14 interest cover is 28x, FY15 forecast interest cover is 74x.
JBH are excellent retailers and well positioned to capture a disproportionate share of the pending boom in Australian discretionary retail spending.
Yes I wrote “boom”. ”Boom” and big shorts is a combination I like.
JBH price target is $24.00
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Penny Pryor – Art for money’s sake [2]
- James Dunn – The value to be found in mining services [3]
- Staff Reporter – Buy, Sell, Hold – what the brokers say [4]
- Ron Bewley – Know your objectives when building a portfolio [5]
- Tony Negline – How to fix a problem in your SMSF [6]
- Question of the week – SMSF versus industry funds [7]