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Amazon threat to Australian retail sector may be overdone

Glenn Freeman  |  28 Mar 2017Text size  Decrease  Increase  |  

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Australian retail company performance was stronger than anticipated in the first half of fiscal 2017, according to Peter Warnes, Morningstar's head of equity research.

 

Wesfarmers, Woolworths and other dominant players in the Australian retail space have continued to deliver solid performances for investors, Warnes told Morningstar subscribers who took part in its second webcast of 2017 earlier this month.

On Woolworths (ASX: WOW), he says: "The supermarkets are trying to cut each other's throats--three of them going hell for leather, and don't forget Costco's in there as well. They've re-engaged with consumers, their basket sizes have improved, foot traffic's up."

"They beat Coles in the first and second quarter, it seems [Woolworths CEO] Banducci's got some momentum at the moment--that doesn't mean to say that the third quarter is going to be a continuation--but they to seem to be on the right track. The result was better than the market was looking for," Warnes says.

Analysing the performance of Wesfarmers (ASX: WES), whose flagship brand Coles has been coming under increasing pressure amid direct price-led competition from competitors Aldi and Woolworths, he says "they're trying to compete on price, and so margins come under pressure".

However, he also emphasises some key positive aspects of the business, including Kmart and Bunnings.

"Wesfarmers, the conglomerate that owns Coles, has got a couple of terrific franchises there--you can't believe how much Kmart and Bunnings are doing out there. They are just blowing the competition away," Warnes says.

"And of course, Woolworths has Dan Murphy's, which is similarly blowing Coles away in the liquor space. All those things are positive for both camps."

In the months ahead, he believes the price competition between the two retail giants will begin to ease, leaving them both in a better position to build better returns going forward.

"It's just a matter of 'when do these companies decide all bets are off, it's now time to make some money for ourselves'. I don't think that's too far away, I think the intensity in price competition is going to ease and you're going to start to see some better returns," he says.

Among other retailers, pizza franchiser Domino's (ASX: DMP), electronics retailer JB Hi-Fi (ASX: JBH), and pet care business Greencross (ASX: GXL) were also highlighted as strong performers.

"There's more and more money going into your pets. I know my two kids are gone, and the pet gets a bucket load," Warnes says, particularly pointing to the ageing demographic as a key driver of this space.

On Amazon, Warnes says: "Yes, beware--it's a behemoth. It's all well and good to say 'Amazon's coming,' but it's fair to say that the managers of these companies are aware of this and they're going to do something."

"They're not going to sit there like a duck and get shot. JB Hi-Fi are very active in that space, and they're saying now 'you can shop online, and come to the store and pick it up within 60 minutes.'"

"I don't think Amazon are going to be able to compete with that. First of all, you've got to get around Sydney traffic ... the incumbent management of these companies are not going to sit there and get blown out of the water."

"Yes, Amazon's a threat, but I don't think you should be suddenly running for cover and selling all your retail stocks because Amazon's coming. I think Australian management is intuitive enough, and bright enough to be able to sidestep a few of the issues that Amazon may present."

David Ellis, head of Australian banking research, covered the performance of Australia's financial sector during the half.

"The banking sector is highly competitive, but it has a big difference--the banks are highly profitable, they operate in a highly-regulated environment, and nothing has changed to put pressure on them in that regard," Ellis says.

"The season was pretty good, all four of the banks were trading at about one-and-a-half to two-year highs. We saw good volume growth, and credit growth is good, as is deposit growth."

Responding to questions about the threat posed by banks' large exposure to residential mortgages, Ellis suggests it would take a considerable property price downturn--which would be accompanied by much broader economic challenges--to have a significant affect, such are the cash reserves held by Australia's banks.

"In my opinion, if we saw Sydney or Melbourne house prices fall, that would be a good outcome, and that's typically what we've seen in the Australian housing market over the last 30 years or so [a pattern of price rises and gradual flattening]," he says.

"In my view, that would present absolutely no problems at all for the Australian major banks, the housing market, and the Australian economy [if house prices were to fall 5 to 10 per cent]."

"What would be of more concern is if prices were to fall 20-30 per cent in a short period. Now that would cause problems for the major banks, but they do all conduct detailed stress testing--they assume a 30 per cent fall in house prices, unemployment going up above 10 per cent, and recessionary conditions."

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Glenn Freeman is Morningstar's senior editor.

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