Australia’s largest shopping centre, Chadstone, provides a glimpse of the immense challenges facing discretionary retailers. The Melbourne centre is a magnet for international fashion retailers that are forcing sector margins and earnings lower.
Uniqlo, H&M and Zara dominate Chadstone’s $660 million extension, unveiled late last year. Their dual-level stores resemble mini-football fields and sit side-by-side, creating an arc of international retailing in the centre’s newest popular area.
Uniqlo and Zara moved their Chadstone stores and took on significantly more floor space in the extension – a trend that will quicken as international retailers expand their footprint through more stores and larger ones.
Like or loathe their products, it is hard to deny the value. During my recent visit to the centre, customers lined up at Uniqlo to buy lower-priced basic clothing, and trading at H&M appeared brisk. Activity at Myer and David Jones, in Chadstone’s older part, seemed quiet by comparison.
These international retailers, recent arrivals on the Australian scene, account for just over 1% of total clothing, accessories and department store sales. That’s still enough to worry local retailers who are watching their foreign rivals quickly grow market share.
Other trends at Chadstone Shopping Centre reinforce the retail sector’s problems. I counted dozens of stores in February with “sale” signs still in their windows, some offering 25% or more off everything on the floor.
Aggressive discounting is nothing new, but retail sales seem to start earlier and finish later each year. Some stores, in perpetual discounting mode, have conditioned customers to avoid paying full price. The discounted price is now the full price and margins are suffering. Promotional fatigue among consumers is rife.
Another reminder of changing consumer tastes was the centre’s jam-packed food courts. Chadstone’s fancy new food court was full and its gourmet section had long lines of people waiting for seats at half a dozen or so restaurants. Consumers will pay $30 for a meal but baulk at full price for a similar-priced top.
Retail anecdotes, of course, are hardly scientific. Extrapolating the experience of one shopping centre to all retailers is dangerous. But the signs are unmistakable: more international retailers, lower prices and margins and greater spending on services.
Latest retail-trade sales figures add weight to these trends. December quarter retail sales, released this week, fell 0.1% month on month, below market expectation. Weak price increases compounded the low nominal sales growth.
Statistical anomalies (such as a Masters-related fall in hardware sales) explain some of the slowdown. But the inescapable conclusion is Australians are paying less for several categories of retail goods, amid a sluggish overall retailing background.
Retail conditions will get uglier. M Webster Holdings, owner of the prominent Marcs and David Lawrence brands, appointed voluntary administrators this month. Herringbone and Rhodes & Beckett, owned and supplied by global German luxury apparel maker van Laack GmbH, have also gone into voluntary administration. That followed last year’s collapse of Payless Shoes and Pumpkin Patch.
Competition for centre floor space from international retailers, profit pressures, the online retail threat and rising wage and leasing costs… it’s a long list of threats for retailers.
Investors need extra care with discretionary retailers this year, even after heavy price falls.
Consumer demand looks okay at face value because of a broadly supportive macro environment in 2017: low interest rates and unemployment, and rising property prices. But fragile consumer confidence and high debt levels could weigh on spending at a time when retailers can least afford it.
My concern is the supply side. As international retailers compete aggressively for market share, margin pressures will intensify. And that’s before Amazon cranks up its Australian operations and convinces us to buy more goods online and pay less.
Of course, there are always retailers who defy the trend. They have great management, a top product or are in a hot sector. Others grow by opening stores in a relatively immature market for their concept. Every company should be judged on its merits and valuation.
But selling discretionary retailers into a market rally makes sense. Those that disappoint with lower-than-expected earnings in the February reporting season will be smashed. Expect more profit downgrades from small retailers in the next few weeks.
Two retailers that still offer value
The flipside is declining retail sentiment provides an opportunity to buy high-quality Australian retailers when they trade below their intrinsic value.
JB Hi-Fi is one of them. The electronics and homegoods retailer remains one the sector’s best-run, best-value companies. JBH’s $870 million acquisition of The Good Guys last year is off to a good start, judging by market chatter. The Good Guys, a consumer-appliances retailer, is thought to have had a reasonable Christmas trading period.
I suspect the market might be overestimating the integration risks of The Good Guys acquisition and underestimating JBH’s ability to make the deal work. Running the Good Guys and JB Hi-Fi as separate businesses, while leveraging synergies, is a good move.
JBH has clear market leadership positions in electronics and consumer appliances – two market segments that are less affected by bricks-and-mortar international retailers. Online competition is a risk, but JBH has done a good job building its online presence.
JBH’s forecast price earnings (PE) multiple of 14 times is not excessive for a retailer that leads its retail segments, has an excellent record and visible medium-term growth prospects. JBH has fallen from a 52-week high of $31.21 to $27.58.
Chart 1: JBH
Source: Yahoo Finance
Seven of 13 broking firms rate JBH a buy and six rate it a hold. There are no sell recommendations. A median price of $30.12, based on the consensus, looks about right. It suggests JBH is marginally undervalued at the current price and I suspect the valuation risks are on the upside as The Good Guys integration tops market expectations.
Premier Investments is another preferred retailer, principally because of the offshore growth prospects for its fast-growing Smiggle stationery chain, and on valuation grounds. Premier has been on the columnists’ favoured retailers over the past three years.
I like small- and mid-cap retailers with a growing international presence (JBH is an exception). Stocks such as Premier, Lovisa Holdings (which has rallied after earlier losses and was featured positively in this report) and Michael Hill International.
Premier is not immune to competition from international retailers. The company’s older brands, such as Just Jeans, Portmans and Jacqui E, have huge challenges as international retailers take a share from tired Australian retailing formats.
Premier has two genuine growth engines in Smiggle and, to a lesser extent, bedroom-wear chain Peter Alexander. Premier needs to increase its exposure to offshore markets as Smiggle rapidly rolls out stores in Asia and the United Kingdom.
Premier defied the trend with a positive market update this week that droves its shares 11% (it was $12.50 when then this column was written. Damn those deadlines!). Its earnings guidance is for $92-$93 million of underlying earnings (unaudited) in the first half of FY17. That’s was below consensus, but enough to suggest Premier is avoiding the worst of the retail rout thanks to is excellent Smiggle chain.
Smiggle is probably offsetting weakness in Premier’s other business (excluding Peter Alexander). The company is refurbishing and refreshing its older store networks, but one wonders if an exit from some of these businesses makes more sense. It is hard to see Premier’s smaller discretionary fashion brands prospering amid an onslaught of foreign competition.
Premier’s 26% stake in electrical appliances maker Breville Group is another positive. I rate Breville’s outlook under its refreshed management team and its potential to speed up its innovation cycle, launching more products in more markets. Breville is a great company and more innovative, and globally focussed, than many realise.
At $14.01, Premier trades on a forecast PE of 16 times FY18 earnings. That’s about right for a company with terrific international growth prospects and two strong brands.
A median price target of $16.21 suggests Premier is still undervalued. That target looks a little optimistic given the Australian retailing climate, but Premier’s fall from its $17.92 peak has brought it back to value territory, even after this week’s price gain.
Chart 2: Premier Investments
Source: Yahoo Finance
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at February 7, 2017.
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