Investors can underestimate the strength and duration of structural trends. With so much short-termism, it’s easy to give up on trends that take decades to play out.
Start with online advertising. REA Group, Car Group and Seek always look expensive for a reason. They have the long-term tailwind of classified advertising continuing to migrate from printed publications to online.
This trend is well-established in Australia and over developed markets, and less so in emerging markets. Car Group, a favoured stock of this column, continues to outperform as it rolls out its online platform to other markets worldwide.
Online migration of advertising still has years, if not decades, to run in many markets. Within that trend will inevitably be years of slower-than-expected growth, causing investors to question whether the trend is losing steam.
Now consider online retailing. It’s a no-brainer that more consumers will buy more goods online in coming years. E-commerce will capture 47% of global retail sales by 2027, from 18% in 2017, estimates Boston Consulting Group.
In Australia, the proportion of online retail sales to total retailing (excluding food) was 19.4% in November 2023, Australian Bureau of Statistics data shows. In November 2019, the proportion of online sales was 11.7%.
However, the market is concerned that online shopping in Australia has plateaued. The dark blue (first) line in the chart below shows online turnover as a proportion of total turnover tracking mostly sideways (notwithstanding the spike in November 2023 from Black Friday promotional events).
Chart 1: Proportion of online retailing (to total retailing)
Source: ABS
There are two ways to read this. The negative view is that the huge gains in online retailing during COVID-19 have not led to higher growth after the pandemic. As consumers bought more goods online during the pandemic – many for the first time – it was thought that shopping habits would change, driving faster growth in online sales.
The positive view is that online shopping has maintained its gains from the pandemic rather than reverted to the mean trend. In February 2019 (just before the pandemic), online sales as a proportion of total retail were 10.9%, ABS data shows. Today, it’s 19.4%. Most industries would kill for this market-share growth.
A plateauing of growth in online retailing – after such strong gains during the pandemic – is no surprise. Nor is a period of slower growth in online shopping as retailers work harder to get people back to stores, where higher profit margins are earned.
Although the market expects stronger structural growth in online shopping, the long-term trend is clearly up. As I said earlier, expect periods of slower growth in these structural trends, within the context of long-term growth. No market rises in a straight line forever.
This brings me to online retail stocks. In the past few months, I have become more bullish on small- and mid-cap retail stocks. Sentiment now is horrible as consumers battle higher living costs and a slowing economy.
Retail conditions are brutal and likely to worsen. Witness this week’s weak retail sales figures and Godfreys, a well-known vacuum-cleaner retailer, entering voluntary administration. But retail conditions will slowly improve as interest rates are cut later this year. The key is focusing on the next 6-12 months for retailers, not today’s conditions. This week’s good news on inflation strengthens the case for the RBA to start reducing interest rates in the second half of 2024.
In the short term, interest-rate cuts could be the catalyst for online sales to deliver stronger growth. Longer term, consumers, particularly younger people, will continue to buy more goods online. Some teenagers I know rarely buy products in-store. More purchases are online, to get the best deal.
Here are two online retailers to consider. I’ll cover Cettire, the online luxury goods retailer, in a later column.
1. Kogan.com (ASX: KGN)
Investors couldn’t get enough of the online retailer during the pandemic, its shares soaring from around $4 to almost $25 in 2020. Kogan.com was a key winner from the pandemic as consumers had to buy more goods online.
Kogan.com plunged in 2021 and 2022 and now trades at $5.46. Like many online retailers, Kogan.com was coming off an artificially high sales base (due to the pandemic). Challenges after COVID-19 when economies reopened, and excess stock were other issues. Kogan.com’s 2022-23 result was particularly disappointing.
That’s the bad news. The good news is that Kogan.com in January 2024 issued a strong trading update. Adjusted underlying earnings (EBITDA) for 1HFy24 were $21.5 million, up from a loss of $4.4 million for the same period a year earlier.
Gross sales were 5.6% lower, but the positive was a 30% reduction in inventories year-on-year. Carrying lower inventories is a big positive for Kogan.com (provided it maintains sales growth) as it moves to more of a capital-light business model. This helped boost Kogan.com’s gross margin by 36% in the half, year-on-year.
Kogan.com had 2.74 million active customers at end-December 2023. Of those, Kogan First Subscribers totalled 466,000. For an annual membership, Kogan First provides free shipping and exclusive prices. That’s an impressive database for Kogan.com to market its goods and services.
The main risk is rising competition from industry gorilla, Amazon, and other online retailers. Kogan has done a good job of building its position as a pure-play online retailer and should continue to expand its subscriber numbers. With that will come higher sales, greater economies of scale and margin improvement.
Morningstar values Kogan.com at $10.70, suggesting the stock is materially undervalued at the current $5.46. I’m not as bullish, but like Kogan.com’s long-term prospects as the migration to online retailing continues.
Chart 1: Kogan.com
Source: Google Finance
2. Temple & Webster Group (ASX: TPW)
The online homewares retailer
rallied in November after surpassing market expectations with a strong jump in sales between July and late November (compared to the same period a year earlier). Somebody forgot to tell Temple & Webster that consumers are cutting back on discretionary items.
Temple & Webster is benefiting from two intersecting trends: growth in online retail and rising demand from younger consumers who buy furniture online. The firm’s low- and mid-priced contemporary offerings, and its clever online marketing, have hit the mark with renters and younger owners.
Younger consumers are more confident to buy homewares online without seeing and touching the product in-store. That gives Temple & Webster a big advantage over furniture retailers that need bricks-and-mortar showrooms.
Less than 20% of furniture and homewares purchases are thought to have shifted online, meaning Temple & Webster has a long runway of growth ahead. Developed markets in the US and UK are closer to 30%.
After rallying in the past few months to $9.06, Temple & Webster is due for a share-price pullback or consolidation. But there’s a lot to like about the well-run firm’s performance during tough retail conditions over the past 12 months.
Experienced small-cap investors could put Temple & Webster on their portfolio watchlist, with a view to buying at lower prices during any pullback.
Chart 2: Temple & Webster
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation, and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 29 January 2024.
