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Doing it tough in Aussie retail

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Doing it tough in Aussie retail

Spare a thought for those in the business of brick-and-mortar retail in Australia. While never easy at the best of times, life is about to get a lot more challenging. From increasing costs of new distribution models, to slowing consumer demand: it’s a double-whammy of headwinds that have only just begun.

First on cost pressures. Typically, retailers would be worried about wage inflation and the associated expense of keeping sales attendants on the floor. But this probably won’t be an issue in Australia. (Sorry workers).

Instead, it’s the incremental cost of distributing online – a model that is now universally demanded by consumers – that is reducing profitability. And it’s not just the technology investments that are required to build and maintain an e-commerce website, app and data management system. It’s the incremental cost of shipping – which consumers are demanding becomes faster and faster.

Now, if you’re shipping small, compact, high-value items to your customers, then these additional shipping costs will be small and manageable. But if you’re shipping low-value items; or big and bulky items to customers, then these additional costs can materially impair profit margins.

“Omnichannel” retailers now have the worst of both worlds. They bear the fixed costs of operating brick and mortar stores; and then also the additional variable costs associated with shipping and delivery. And all of this is in competition with Amazon – an online native which has built a massive distribution platform with eye-watering scale.

As if this were not headwind enough, the Australian consumer will likely only weaken over the coming months and years. And a weakening consumer will naturally translate into slowing sales for retailers – particularly those that sell discretionary items. Housing prices in major cities such as Sydney and Melbourne have started to fall. As a result, owners of Australian property will naturally feel less wealthy and less optimistic about the future. Furthermore, it is no secret that a significant amount of consumption was being funded with mortgage refinancing at higher property valuations. Think of your neighbour who recently drew down another $100 thousand in borrowings to fund the renovations. These won’t happen in a declining property price environment.

And then there are mortgage rates which are experiencing upward pressure. Why? Because a significant portion of the Australian banking system is financed offshore – particularly from the United States. And interest rates in the US have started to rise now that its economy is operating above its capacity. Following President Trump’s enormous tax cuts nearly one year ago, the trajectory from here is most likely up further. And this is bad news for Australian borrowers.
As Australian mortgage rates raise, the disposable incomes of typical Australian households fall. Indeed, take a look at the Australian household savings rate recently. It has plummeted to approximately zero.

All of this says that Australian brick and mortar retailers will be doing it tough for some time. It’s a one-two punch in the guts from technology disruption – resulting in higher distribution costs – and a weakening Australian consumer – from the property turndown. And this is likely the best-case scenario. You see if retailers suffer too much, they will be forced to reduce headcount and potentially close stores. And businesses reducing investment and employment en masse typically leads to recessions. And a recession would only exacerbate the decline in many property markets and the weakening Australian consumer. This is a much worse scenario. But it is a possible scenario. Here’s hoping this is not where we end up.

Have the troubles for those in the business of brick-and-mortar retail in Australia only just begun? Click To Tweet
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Andrew Macken is the Chief Investment Officer of the Montaka funds and the Montgomery Global funds. He established MGIM in 2015 in partnership with Montgomery.

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.

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2 Comments

  1. That it is where we are, in fact, heading is now my base case – exactly what you describe, Andrew.

    And it is living in Brisbane – intuitively not the first city that one would imagine to show these stresses as house prices have risen much more modestly here over the last 6 years – but perhaps on deeper reflection that may actually be the reason – that has provided me with this insight…

    I wrote about some observations from around Brisbane last November in the comments section of a post by Roger, and he mentioned then it would be helpful if I updated you guys on my observations… At that time I noted an eerily empty car park in a suburban shopping centre with a number of restaurants on a Thursday evening, followed with the details of a chat with that restaurateur who described how poor business had gotten over the 2 years leading to that nadir (especially in the inner and middle rings of Brisbane), vacancies in that same centre, and then the closing of a large café in the very large Westfield centre that I frequent just at the beginning of the pre-Christmas period… Then I said in as much as Paul Keating famously worried for what was coming after seeing (too) many cranes in Australian cities, I feared what this portended…

    Well since then I have seen nothing that assuages my concerns… More spaces in the smaller centre have become vacant and none have been leased… The high proportion of vacancies in small centres and shopping strips has been recognised and discussed in various newspaper articles in Brisbane… As has been the closing of large numbers of restaurants… From speaking with several restaurateurs a common story has been takings down by around 30% from 5 or so years ago, while costs have continued to increase (often by over 10% in the last year as rents continue to increase)… Under these conditions many have not increased menu prices for 5 years… Of course restaurants are under similar disruptive pressures to retailers…

    The most marked changes that I have observed, however, are in the large Westfield Centre (one of the 3 largest in Brisbane)… Over a 1-2 week period at the end of January/start of February around 10 shops closed suddenly… I spoke with employees at a Jewellery store pasted in sales signs and they spoke of being frightened at how quickly it was happening and how they did not know what was happening to their own store… That store closed a few weeks later…

    Since the café closed last November, I have counted a total of another 29 businesses that have closed in this centre (that does not include store relocations, nor does it included small temporary stores or kiosks in the aisles of the shopping centre which are much harder to keep track of but are clearly much fewer in number than several years ago)…

    Most vacant spaces remained boarded up for months and some spaces – including that original café that closed – have remained vacant 6 months or more… And some businesses that opened in a space have then closed after trading for only a few months…

    In total I have counted 11 stores that have opened in vacant spaces, but that count stood at only 4 until mid-June, suggesting that the impending end of financial year may have caused a flurry of activity to acquire new tenants…

    Clearly many spaces have been boarded up or left abandoned at any one time over the last 6 months, and this has not gone unnoticed by shoppers and especially those working in the centre…

    In the mean time, the centre has increased its parking fees to customers by around 50%, which has not been mentioned in the local press, but one has to wonder whether that is going to further deter “consumers” from coming and “experiencing” the centre…

    Also cost-cutting measures being undertaken may not be conducive to enhancing that experience – for example it is clear that the centre has became less well-lit in recent months…

    This centre is a little unique in that it is 50% owned by a REIT in which it is the only asset, so I was keen to look at its financial year results… The only suggestion of deterioration in the results was a decrease in property income of 1.6%, but apparently the leased rate increased from 99% to 99.4%, and I could find no mention of the increase to parking fees… What I did also notice was that David Jones will only be re-leasing one of the two floors it currently leases from 2019, and the report suggested that this will have an impact on reporting for two years… so it will be difficult to ascertain the quality of earnings on the asset for a further 24 months…

    The final observation that I will make is that a number of the business closures have been in the food court and none of these have been re-tenanted… where there were kiosks they were removed, so what was once rather tight seating is now very spacious… I would suggest that the apparent lack of uptake of shop vacancies in the food court is a reflection of a lack of confidence, even with reduced competition, and that would be partly related to the lower level of confidence among workers at businesses in the centre who are fearful of losing their own jobs and are cutting back on expenses by bringing their own lunches, etc….

    Of course those aiming to downplay the pressure on households – from overleverage, improved bank lending standards (back towards prudent, sustainable practices), low wages growth and rising interest rates – apparently wishing not to dent”confidence” among “consumers” – have some factors available to muddy the waters as these industries are currently under disruption… But I think it is clear that what is occurring goes well beyond that…

    It remains unclear whether this period will ultimately be recorded as a recession… I am aware that most business people in Brisbane consider that they went through a recession in the early 2000s – interesting since it was ended by the arrival of the housing bubble – that was not recorded as such… However, even though the level of immigration and the Volume of resources exports may reduce the likelihood of an official recession being recorded, I can’t help but think that, once these stresses to households flow through to other cities as their house prices don’t just rise slowly (as in the Brisbane experience) but fall, these mitigants will be overwhelmed and we will indeed record an official recession.

    And, just as the lived experience of the majority of Australians is not as good as the GDP statistics alone would suggest, GDP will not accurately reflect the depth of the recession experienced by Australians.

    The real shame if it is that it is now unavoidable – our economy was pushed to extremes in certain areas that have made it unsustainable – and nobody in a position of power has had the courage to do anything about it (remember Joe suddenly realising negative gearing wasn’t a good idea – when he had quit as Treasurer and was leaving parliament?)… The GFC provided the greatest ever “cover” in history to deflate a bubble, and that’s what was happening, until the RBA began listening to those that said “we need a little more confidence in our economy”… even when they, themselves, were warning of the risks of providing that confidence through unsustainable leverage… Now the RBA seems to be in search of another “crisis” on which to pin another bout of arse-covering – like a trade war – but I suspect it is all too late and the system has become entirely unstable…

    In all honesty, there have been times when over the last year I have walked around feeling like the guy in “Margin Call” when he’s driving around and looking at all of the unsuspecting people hurrying about their lives…

    Having gone so long without tough economic times, this will be hard-felt by many… Already a loving father of one of the restaurateurs that I spoke of above is very concerned about the mental health of his son, suffering depression… he hopes his son manages to sell his restaurant (in one of the most affluent suburbs of Brisbane)…

    I can understand those in positions of power wanting to avoid recession – but doing so is always the best outcome, also, for those in power – and it really can’t be said to be for the betterment of our country if the tough microeconomic reforms required are not undertaken in the breathing space given by anti-recession spending… This was the case in our post-GFC period due a lack of genuine political-economic leadership and I fear Australians will now pay a heavy price…

  2. On youtube you can find numerous videos of enormous shopping malls in America abandoned thanks to Amazon, why would this not be the future in Australia, won’t it be a constant decline.

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