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Are the glory days over for the retail sector?

Nicola Chand  |  04 Aug 2022Text size  Decrease  Increase  |  
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Retailers selling white goods and furniture should be struggling. But they aren’t. The standard narrative is that after years of COVID restrictions people are interested in experiences and not things. Rising prices typically result in delayed purchases of consumer discretionary items. Despite these perceived headwinds the consumer discretionary sector rallied over the last month with heavyweights reporting positive sales growth.

This rally followed a 11.41% fall in the consumer discretionary benchmark index (ASX: XDJ) since the beginning of the year. However, the index has been on the rise since mid July, increasing 13.4%, with the overall sector increasing 7.72% last month.

Rallies in the sector have been driven by two factors, a normalisation in price following a weaker June and promising business updates from companies within the sector. Kogan, Myer and JB HI-FI all released positive sales numbers last month.

The online e-commerce retailer reported a 0.1% increase in gross sales last fiscal year, while department store Myer posted an increase in sales between 16.5% and 17.3% in the last six months. Australian white good and technology retailer JB HI-FI released preliminary results showing Australian sales grew 10.9% over the last quarter.

The positive sales growth numbers posted by these companies all happened during a period of high inflation and elevated interest rates.

Morningstar’s director of equity research Johannes Faul believes that despite the RBA’s effort to cool the Australian economy, consumer spending is holding up.

“Some people will be pulling back [on spending] while others are still spending like crazy, but on average people are spending like crazy,” he says.

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Faul believes record high levels of household savings have allowed Australian consumers to continue spending in a higher interest rate environment. In 2020, the saving ratio for Australian households increased from 9.7% in March to 23.7% in the June quarter.

In her speech last month RBA deputy governor Michele Bullock said households have saved a large amount of money since the beginning of the pandemic, accumulating to around $260 billion.

Bullock also cited data that suggested over one-third of variable-rate borrowers have already been making average monthly loan payments sufficient to the amount required to service the loan if the cash rate was increased to 3%.

Faul also believes even though consumer demand for goods remains strong, the strength of the sales growth reported by the companies may be inflated due to the rising cost of inputs.

“We don’t know the price inflation versus the volume for those solid sales numbers,” he says.

The difference between Australia and the US

The consumer discretionary sector in the US offers a different story to Australia. Retail sales have been quick to react to rate hikes implemented by the Federal Reserve. Retail sales for clothing and clothing accessories have fallen 1.54% since April. US sales for retail trade and food serves contracted for the first time this year, falling 0.13% in May after climbing 6% since December 2021.

The inventory to sales ratio in the US has also increased, climbing 4.35% since January this year as consumer demand continues to drop and retailers struggle to sell their existing inventory.

American retail giant Walmart reported a 33.4% increase in inventory in the first quarter of this fiscal year which it attributed to the higher cost of goods, courtesy of inflation.

Where to from here?

The weakness in consumer sentiment in the US suggests what may be in store for Australia.

Australian consumers remain more interest rate sensitive than their American counterparts because of the differences in mortgage practices with the vast majority of Australians holding variable rate loans.

AMP economist Shane Oliver sees consumer demand softening as the RBA continues to hike rates and mortgage payments increase.

“The inflationary squeeze in that area will also start to weigh in and consumers faced with interest rate hikes and cost of living pressures will cut back on discretionary spending,” he says.

“I suspect it's going to remain a little tougher for the consumer discretionary stocks going forward at least for the next three or four months,” he added.

The view that consumer spending on discretionary goods will ease up in the future is a view shared by Faul.

“We are expecting a strong finish to fiscal 2022 for retailers. But then heading into fiscal 2023 we expect to see what is occurring in the US.”

Faul believes that food inflation will bite consumers and high mortgage repayments are going to reduce the level of household savings causing the overall sector to weaken.

is a wealth and finance journalist with Morningstar

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