What is happening in the retail sector?
Asset prices are well-up on just a few years ago. No matter which way you cut the data, both the property and share markets have performed strongly. And so the economic theory goes: that if you feel wealthy, you’ll act wealthy and go out and spend. Exactly what a low interest rate envrionment – the one we are in now – is supposed to encourage.
But unlike past economic cycles, where the wealth effect has translated into the withdrawal of equity to be used on consumption of new furniture or a stereo for example, our listed retailers tell a different picture about the health of the Australian economy.
As we show above, of the eight consumer discretionary stocks we could readily identify, they have on average delivered negative 20 per cent plus share price growth over the past 12 months, collectively making them some of the worst performing businesses on the ASX.
So is it time to get interested? We generally steer clear of large investments in retailers and the reason is rather straight forward.
Like the products they sell, retailers are driven by changes in fashion. What’s trendy and what works today probably won’t be tomorrow. Not only do fads come and go, but the internet and an influx of global competitors are all bidding for a share of your wallet. Competition is increasing all the time and creating an oversupply of choice. This is leading to a further fragmentation of the market, making what is already a highly cyclical market place, one in which you have to reinvent yourself seemingly daily to remain relevant.
Despite this knowledge, making it clear that such businesses are unlikely to be attractive investment longer-term, we have noted a number of other investors trying for some time now, to pick the bottom of the cycle and continuing to add to their positions as share prices fall. A term we coin dollar crash averaging (DCA).
To us, this is just an attempt to try and be too smart by halves and whilst you may make some money for your investors, luck will play a significant part and getting your timing perfect – something that’s very hard to do.
We prefer to own businesses with bright prospects, purchased at a rational price, as opposed to buying those that currently look cheap but might get even cheaper waiting for outlooks to begin looking ‘less bad’.
As such, it doesn’t take a rocket scientist to conclude that we continue to avoid any wholesale investments into this sector preferring the safety of cash and knowing that our capital is safe, ready to strike the next obvious opportunity that will come along.
Whilst this almost ensures that we will get a marginal return on our investments in term deposits, the alternative is that we avoid having to be hopeful that our initial capital will remain intact. For a bad decision today will require a larger return to be made later just to breakeven and we prefer not to put such hurdles in front of us.
Indeed a quick a re-read of our investment process shows no mention of the fact that luck should ever play a part in our investment decisions and because of this, it never will.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
INVEST WITH MONTGOMERY
Wayne A
:
I think many of the executives running retailers are overpaid and out of touch. It has been my experience that those who possess large amounts of wealth have to work very hard to retain any genuine empathy for how the majority live. This is often reflected in poor judgements when making acquisitions or reinvesting profits.
They have forgotten what it is like to experience genuine hunger and need. Indeed given their often privileged backgrounds, some of them never have.
So don’t take it the wrong way Roger and co, but for this very reason I wish you considerable, but not ludicrous success in your funds management business.
Roger Montgomery
:
I understand completely Wayne. Thank you. And great timing ahead of Christmas too.
Daniel Rosenthal
:
Russel,
I thought you guys were big supporters of Kathmandu and Flight Centre…
Has the sectors recent under performance changed your view on these businesses?
Roger Montgomery
:
We are owners of both companies. We are simply saying near term challenges exist (for the Australian economy too).
Russell Muldoon
:
To further add to Roger’s comments, the post was not suggesting we don’t / would never own retailers. Moreso, the point was given their highly cyclical nature and general lack of enduring competitive advantages, that they will never be a significant part of our portfolios. Sorry for the confusion.
Patrick Poke
:
I hear similar comments about commodities businesses, and you exclude those altogether (from the Private Fund at least, and based on comments I’ve read here, I would be surprised if you held any in the other). Is there a reason you don’t apply the same logic to commodities as retail?
Personally I recognise the failings of retail and commodities business, but I also recognise that limited investments them, made with extreme caution, can be profitable.
Lets imagine a producer of a commodity. They have the lowest production costs in the business. Importantly, they have exclusive mining rights to very high quality ores, making it very difficult for a competitor to produce their commodity at a similar price. Wouldn’t this business have as good (or better?) a competitive advantage as any retailer can achieve through a sophisticated logistics chain?
Combine low production costs with no debt, and you have a business that can survive through a protracted downturn in commodity prices, and come out the other end in a position to benefit the most when the cycle eventually turns.
It’s the same logic I see applied here, and in Roger’s book, but looking at the advantage on the other side of the profit margin equation.
All that being said, I do agree with your comments that retail businesses are inherently cyclical, and neither retail nor mining would ever form a large part of my portfolio. However if a great opportunity presents (and admittedly, they’re few are far between in both sectors, but especially mining) I don’t want to be limited by a rule saying that I can’t invest in a particular sector.
david klumpp
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Russell: while I agree with your observations on the prospects for the retail (discretionary spending) sector, I think there are a couple of very good businesses mentioned in the article that are worth owning (at the right price). At least two are on my watch list as having been filtered out of the market for consistent great performance and likely bright prospects, plus good management and sound balance sheets. These are Flight Center and Breville. Should one ignore such good companies because they are in Consumer Discretionary sector?
Roger Montgomery
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You should not ignore good companies. Just remember there are three parts to our investment style; 1) Premium Quality, 2) Price, and 3)Prospects. It is the long term prospects that must be attractive also.
Russell Muldoon
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Hi David, absolutely not – and we do avoid taring all businesses with the same brush. The point was that the consumer retail sector is doing it tough with almost all businesses we could readily identify presenting via AGM commentary generally very soft trading conditions and outlooks.
When you can see a freight train coming, its best not stand in front of it.
Andrew Legget
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Have owned a a variety of retailers over the years but i have to say i have never held them for that long (say 1-1.5 yrs). JBH being the one that i have bought and sold the most. I think retailers can be good investments but are obviously not a set and forget type of stock as you have mentioned so you have to be prepared to take profits when the time comes. They do have a tendency to swing from undervalued to overvalued.
On the other hand, i think the overall quality of the Australian listed retail sector has greatly diminished so not too worried about missing out on any opportunities or trying to be too clever. This is especially so in the fashion/cosmetic retailing sector where increased international competition setting up shop will continue to put significant pressure on these brands.
Add to this the fact that i think some retailing company boards have little to no idea about what is happening in the industry. Just as investors need to be wary of changes in fashion and trends, boards need to be able to spot and adapt in advance. I am not particularly concerned about rushing back into this sector.
Roger Montgomery
:
Excellent insights Andrew