Not safe to re-enter still shark-infested (retail) waters
Since rates commenced rising, we have been tracking the consumer closely, waiting for the inflection point where inflation and higher mortgage commitments meet the end of government financial support and savings dry up.
We have been reporting our observations, and the observations of others including the management of discretionary retailers and analysts, here at the blog, over the course of the last twelve months. You will know that rather than believing in a residential property bloodbath (not a financial ‘cliff’ but a financial ‘gutter’ we’ll step over), we have leaned towards the idea belt-tightening will hit discretionary spending the hardest. We believe consumers under financial duress will double down on their mortgage repayments and energy and utility costs to keep their home and keep it warm but the balancing item will be discretionary spending. It’s the reason the Montgomery Small Companies Fund, The Montgomery Fund, The Montgomery [Private] Fund have been eschewing retailers generally and discretionary retailers in particular.
Recently, our friends at Barrenjoey indicated a regular survey of their retail contacts has turned sufficiently bearish to warrant the publication of a note on the subject. Like us, Barrenjoey note the Australian consumer is under “huge” pressure thanks to cost of living pressures and the removal of direct government stimulus. With the latter having a high propensity to be spent in retail the report points to the rapid withdrawal of government stimulus as the precursor to an imminent decline in retail spending.
Consumer financial support via, for example, JobKeeper, cost of living support and tax exemptions including the low and middle-income tax offset, has been rapidly withdrawn thanks to the post-pandemic economic recovery and associated inflation. Additionally, inflation has resulted in real wage growth that is 5.2 per cent below pre-pandemic levels.
The withdrawal of support has meant conditions for retailers will be leaner in the 2024 financial year. Without financial support for consumers, tax returns will not be the source of liquidity they were in 2022, and the legacy economic conditions include slowing economic growth, eroded savings, ultra-low fixed-rate mortgages rolling over to much higher variable rates, and significantly higher prices for inelastic goods and services such as energy, fuel and other utilities.
According to Barrenjoey, consumers benefited from approximately $11 billion in relief through their tax returns that won’t be repeated this year. And with 50 per cent of tax filings completed in the September quarter, another source of government support for retail spending has been removed.
Barrenjoey’s more interesting observation is their comparison of the current wave of stimulus withdrawal, to that experienced in 2011. Mind you, they also note the size of the support during the Global Financial Crisis peaked at seven per cent of GDP. The peal of support in the pandemic peaked at 19 per cent of GDP. The impact of the withdrawal could therefore be more acute.
While Barrenjoey note “no two retail cycles are the same”, they believe there are sufficient similarities between 2023 and 2011 for investors to be wary before venturing back into retail stocks.
Specifically, Barrenjoey reminds us 2011 was the year when retailers ‘confessed’ that trading during 2009 and 2010 benefitted from government stimulus. Consequently, during that year, retailers reported earnings downgrades, but the larger driver of share price falls at the time was price to earnings (P/E) contraction. Many retailers ended the year on single-digit P/E ratios.
By way of example, Barrenjoey notes Breville’s P/E contracted 22 per cent, Billabong’s P/E fell 58 per cent, JB Hi-Fi’s fell 32 per cent, Harvey Norman and Super Retail Group saw 22 and 24 per cent P/E contractions respectively, and Flight Centre’s P/E fell 43 per cent. In addition to the P/E de-rates, many retailers saw significant falls in their earnings per share. While Breville, Super Retail and Flight Centre reported EPS growth of 10, five and five per cent respectively, the others saw earnings per share declines of between 18 and 57 per cent.
When earnings decline and P/Es contract simultaneously, the impact on share prices is compounded. For example, if a company earning $10 per share and trading on 20 times earnings sees both its earnings and its P/E both contract 50 per cent, the share price declines 75 per cent.
Barrenjoey’s note reminds us it may still be too early to go back into the discretionary retail waters.