Two well-placed small-cap retailers well-placed

Financial Journalist
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Somebody forgot to tell the market’s leading discretionary retail stocks that Australia faces a cost-of-living crisis and lousy consumer confidence.

Some retailers have started the year strongly, extending their gains over the past few months. So much for all the economic doom.

JB Hi-Fi is up 27% in the past 12 months and near a record high. For now, the market can’t get enough of the electronics retailing star, its shares soaring in the past few months.

Chart 1: JB Hi-Fi (ASX: JBH)

Source: Google Finance

Super Retail Group, owner of Super Cheap Auto, Rebel, BCF and Macpac, is up 32% over one year. Super Retail rallied this week after announcing record half-year sales.

Chart 2: Super Retail Group (ASX: SUL)

 

Source: Google Finance

Temple & Webster Group, the online furniture and homewares retailer, is up 62% over one year. TPW leapt in November after reporting better-than-expected quarterly sales growth and healthy sales momentum.

Chart 3: Temple & Webster (ASX: TPW)

Source: Google Finance

These are big moves, even in the context of a rallying share market in late 2023. Not all retailers, of course, are rising. Many are still limping along, weighed down by the prospect of slowing sales growth as consumers jam on the brakes.

Also, share prices of retailers, such as Lovisa Holdings, have been volatile this year, underscoring the economic uncertainty. Other retailers have rallied after underperforming for much of 2023.

So, care is needed extrapolating a handful of good retail results to the broader retail sector. Big percentage price gains can deceive, when coming off a low base.

Still, retail gains so far this year reinforce four key investment points. The first is the danger of allowing ‘market noise’ to sway investment decisions.

For the past year, the market has been awash with bearish economic and market forecasts from a chorus of commentators. Consumer confidence is at its lowest since the recession in the early 1990s. But if you only followed macro-economic headlines – rather than analysing each company on its merits – you’d never buy retail stocks this year.

The second point is the danger of focusing on the present rather than the future with investment decisions. Some retail stocks are rallying because the market is looking ahead to interest-rate cuts in the second half of 2024.

Bearish media headlines on the economy are understandably based on lagging indicators; what happened this month or quarter. With retail stocks, the key question is: what will conditions look like in the next 12-18 months?

The third point is relying too much on top-down data to inform decisions. Retail sales rose 2% in November, but data is skewed by Black Friday sales. It’s likely that some consumers held back on spending in October – or brought forward their Christmas spending – to take advantage of the big sales in November.

The fourth point is the effect of population growth on retail earnings. The market needs to focus more on demographics. High expected net migration in 2023 means more people buying goods. That’s great for retailers (although less so for residents in congested capital cities, and on a GDP per-capita basis).

Will the rally continue?
My base case last year was that Australia would avoid recession, principally due to higher commodity prices and population growth. That view remains.

But it’s going to be a tough year for many consumers as the full brunt of interest-rate rises is felt and Australians collectively have fewer savings to draw on. For many, this year will feel like an economic grind with little respite.

It’s hard to believe our economy can breeze through 13 consecutive interest-rate rises and an ugly breakout of inflation without some serious damage. A recent spike in insolvencies in manufacturing and property is a portent of things to come.

Although inflation in developed nations is falling, the battle is far from over. Local inflation, particularly in services, is proving stickier than thought. The market might be getting ahead of itself on the timing of interest-rate cuts.

Disappointing news on inflation, here or overseas, would thump this market and halt the retail rally. Global equities markets have priced in falling inflation and interest-rate cuts in 2024, leaving little room for disappointment.

I wouldn’t buy JB Hi-Fi, Super Retail Group or other retailers that have soared in the past few months. The earnings risks in a challenged economy are too high.

Instead, I’m looking for quality retailers that have been left behind in the rally. Retailers that have leverage to an improving economy, but also a valuation that has lower risk if anything goes wrong. This is no time to chase retailers higher.

Here are two beaten-up small-cap retailers to consider at current prices:

1. Accent Group (ASX: AX1)
The shoe retailer has had a tough year by its standards, falling from a 52-week high of $2.61` to $2.13. Shares in the owner of brands such as The Athlete’s Foot, Platypus Shoes and Hype DC, fell in November after a trading update. Accent Group has since recovered those share-price losses.

As Australia’s largest footwear retailer, Accent is an obvious casualty in a slowing economy. Falling discretionary spending means weaker apparel sales, particularly among younger consumers struggling with higher rents and living costs.

Longer term, Accent faces the ongoing threat of disruption in bricks-and-mortar shoe retailing from online retailers. Rising competition from US sports-goods retailers is a risk, but Accent looks well-positioned to compete.

Make no mistake: it’s going to be another tough year for Accent. But prospective investors need to look through the next 6-12 months for Accent and consider what will happen when interest rates are cut and consumer confidence lifts.

Accent can continue to grow through store openings and modest same-store sales growth over the next year. Long term, the company has a terrific position in the footwear sector, a valuable portfolio of brands and a strong balance sheet.

Morningstar values Accent at $2.40, suggesting it is undervalued at the current $2.08. Accent is no screaming buy, but after falls in the past year seems reasonable value for long-term investors.

Chart 4: Accent Group

Source: Google Finance

2. Michael Hill International (ASX: MHJ)
The jewellery retailer has had a challenging 12 months. After trading at around $1.45 in early 2022, Michael Hill has fallen to 86 cents.

The stock rallied after COVID-19 as government handouts in Australia and New Zealand during the pandemic supported retail spending. But the return of higher inflation in 2023 and rising interest rates hurt jewellery sales.

Michael Hill battled inflation in wages and commodity costs (diamonds and gold) and suffered as consumers directed more discretionary spending to travel, foregoing larger purchases such as jewellery. Another problem was retail theft: Michael Hill had to spend millions to protect its stores, staff, and customers from thieves.

Despite these challenges, Michael Hill delivered the second-highest profit in its history in FY23 (its underlying earnings – EBIT – were down slightly, year on year).

The well-run company is highly cash-generative, has a good brand and scope for growth through store openings (organic and through acquisitions).

When interest rates are cut this year, and as inflation continues to retreat, Michael Hill’s many headwinds could start to become tailwinds. It won’t happen quickly, and market sentiment is against the microcap retailer for now.

But Michael Hill is a stock to watch at its current valuation – for experienced investors who understand the features, benefits and risks of microcap investing.

Chart 5: Michael Hill International (ASX: MHJ)

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 17 January 2024.

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