Analyst insights: 2 retail stocks set to defy gloomy outlook
Households are expected to tighten their spending in 2023 as higher interest rates bite, but there are opportunities on the ASX in the retail sector according to Morningstar's Johannes Faul.
Johannes Faul: The key theme really for the retailing sector heading into the next year is that we're expecting a slowdown in sales growth across the sector, and what's really driving that is not the consumer becoming weaker. We actually don't expect household spending in total to really collapse just given the high amount of savings that Australians have accumulated. So, what's going to make retail sales weaken, in our opinion, is just the shift from what people are going to spend on. They're going to spend more on services and less on goods. Most likely, they're going to spend more on things like rent, transport, electricity, things like that, and basically, divert the expenditures away from retailing, away from goods and into services. That's our expectation for the new year overall for retailers is that we expect the top-line growth to be nothing like F '22, and that's going to have an impact on profits and also the profitability of sales. So, that's our outlook for the sector in general.
Yes, the two stocks we see as undervalued at the moment is Kogan (KGN), that's our top pick in the sector and also, Domino's Pizza (DMP), which is also undervalued at the moment. And we just spoke about momentum slowing heading into 2023 for retailing sales. But for these two companies, we've already seen that happen. And on the back of that their share prices have come off dramatically, from being, in our opinion, overvalued to now being undervalued.
What we've seen for Kogan? It's a pure online retailer with all the stores that we see, the physical stores, brick and mortar stores reopening, people have shopped a lot less online, which means a lot less online sales and that has impacted Kogan. So, their top-line has been shrinking. That has impacted profits. But we see change in 2023 and basically, Kogan to establish a maintainable level of sales. So, that decline we've seen in sales, that's going to stop, and it's going to start growing again gradually from a rebased level. And that means profits are going to come back, and that's what we see as the catalyst for the share price of Kogan to rerate.
For Domino's, they're a big international franchisee selling pizzas. And again, during COVID, they've done really, really well. People love pizzas, especially in Japan. That growth has slowed in some jurisdictions. They've actually seen sales come down. At the same time, a lot of the ingredients for pizzas unfortunately have gone up by quite a bit. So, the inflation we're seeing as customers in the retail stores, Domino's is seeing on the cost side, where if you think about labor, but especially ingredients like cheese and the like. So, near term, that's a headwind for their earnings. But what really matters for Domino's valuation and what we see attractive for investors is a long-term pipeline. It's the solid pipeline of a lot more stores being rolled out globally, I should say, and that will continue. That's not really been impacted by this near-term cyclical weakness. So, for Domino's, as I say, that cyclical weakness we've seen is a great opportunity for investors to have a look at it at a company that has a moat and has a lot of growth ahead of it over the next decade.