Time to go shopping – JB Hi-Fi and Woolworths

Chief Investment Officer and founder of Aitken Investment Management
Print This Post A A A

I think it’s going to be the best Christmas in many years for the right Australian retailers. I think the macro settings are very accommodative, and households will loosen the purse strings into, and over, the crucial Christmas period for retailers.

Recently, there has been commentary that low Australian household and business confidence readings were “structural” change. Similarly, high household savings rates and low corporate gearing levels, are also seen by some as “structural” change. I believe that will be proven completely wrong.

Elections and confidence

Confidence is cyclical, savings rates are cyclical and corporate gearing levels are cyclical. They are all set relative to confidence and clarity about the future, which in turn is a derivative of leadership. That is why I have always believed a decisive federal election result this weekend removes the final hurdle towards a broader confidence improvement.

Whatever your personal politics, I believe we will all look back with the benefit of hindsight and realize minority government was bad for Australian confidence – both household and business confidence.

If the betting odds are to be believed, and I take the view they most likely are, then we are in for a decisive federal election result on the weekend. My view at a behavioural economics level, is that it will be good for household and business confidence, and through time, those who believe Australian households and Australian businesses have become “structurally” low in confidence, will have to reassess their view.

What could easily happen here, is we, including bulls like me, are all surprised by how quickly and sharply consumer and business confidence turns up. In a world of instant information, confidence is like a virus. It’s contagious.

Australian business and Australian households have the balance sheet and free cash flow capacity to spend and all they need now is the will. Australians are not natural pessimists and not natural cash hoarders. They do not enjoy “austerity”. In fact, history suggests the complete opposite!

This also has ramifications for individual investor confidence, remembering 33% of the entire superannuation pool is run by SMSF owners, who set their investment strategy around the dinner table watching the 6.00pm news.

Investing habits

When Australians are confident, they save via residential property and equity market investment. The nuances of the Australian taxation system encourage home ownership (CGT free), ownership of investment property (negative gearing) and buy and hold equity investing (fully franked dividends, CGT concessions for holding over one year). Cash is the least tax-effective asset class in Australia, and it is highly unusual for Australians to embrace cash as an investment as much as they have over the last five years. Again, I think this is cyclical.

In the chart below from the RBA, you can see when Australians are confident the “savings rate” is 0% or even negative, as “saving” via rising residential property or equity prices offsets the need for holding cash. Equities are liquid (T+3 settlement).

Australians are also starting to feel a positive wealth effect, which is an essential ingredient of a broader confidence improvement. In the chart below, liabilities have been stable for six years and now we are seeing a rise in financial and dwelling asset prices leading to a rise in net worth.

Of course, house prices play the key role in both the liability and net worth lines above, and it is abundantly clear median Australian house prices are rising. This is one hell of a funny looking housing crash, reminding us all that offshore doomsayers on Australian housing/Australian mortgage banks truly have no clue about the underlying domestic dynamics of the sector. Is the sky falling or the land rising?

And in a textbook economic response, low interest rates are driving a rise in home loan approvals. Not so great for first homebuyers who are priced out of the market. They might be with mum and dad for a while longer.

Another point worth noting is that while household debt, as a percentage of household disposable income, is high at 148%, low interest rates have driven a fall in interest paid as a percentage of household disposable income, meaning households have free disposable cash flow. Recently, they have been saving that free cash flow, but that will change and it will be consumed.

And consumer sentiment is all that is missing now…When Australians are confident and spending, this reading is 120. It was 105.7 in August.

But this is where we must avoid over-complicating things. As much as this sounds blatantly obvious, overall discretionary retail spending is highly correlated to consumer confidence readings. In fact, it’s really all about getting the direction of consumer confidence right, then picking the right categories where consumers are going to discretionary spend.

Stocks to watch – JB Hi-Fi and Woolworths

The two categories I think look best into Christmas are food and liquor and electrical/electronic goods.

Food and liquor has grown by 3.8% over the last 12 months, led by supermarkets, while electrical/ electronic goods is up 2.3% versus the previous corresponding period, and up 2.7% month on month.

I feel Australians are going to discretionary spend more on food and liquor this Christmas and it seems that all kids and Gen Ys want, is the latest electronic gadgets. On that basis, my two high conviction plays on the strong Christmas theme are Woolworths (WOW) and JB H-Fi (JBH). Both stocks are very well leveraged to a broader confidence and spending pick up.

Some people have said the recent rally in JBH was all short covering. No doubt, some part of the rally was short covering driven, but in all reality, this is a fundamental rally because the analysts have been way too low on their earnings forecasts. That continues to this day, with JBH in a clear EPS upgrade cycle. Below is a chart of JBH share price and FY14 consensus forecasts. Note how the analysts all upgrade after a result or guidance from the company, but then keep their sells on the stock. Without being too rude, they have been completely wrong, yet persist with their negativity.

A genuine Australian confidence cycle is well overdue. I am absolutely convinced the conditions are in place for that positive cycle to evolve over the remainder of this year and beyond. It has started in residential property and parts of the equity market and it will spread to discretionary spending. You can feel there is pent up demand to spend some money.

On that basis, I am going to declare the end of “Australian austerity” and do what I should have done last week by officially adding Woolworths (WOW) and JB Hi-Fi (WOW) to my high conviction buy list. These are high quality companies about to experience a genuine tailwind.

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:

Also from this edition