Retail bonanza can’t last, warns Morningstar

-- | 16/06/2020

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Glenn Freeman: In this edition of "Ask the Expert" I'm speaking with our Morningstar equity analyst Johannes Faul. And we're discussing the retail sector and particularly, how online retail has performed versus some of the bricks and mortar retailers.

Johannes, thanks for your time today.

Johannes Faul: Hi, Glenn. Thanks for having me.

Freeman: Now, there's been some interesting times for the retail segment. You've recently put out some research reports on both JB Hi Fi and Harvey Norman. What are the main things that you put up there?

Faul: I think what we've seen across many categories and for a lot of retailers is that their online sales have just been having an incredible boost. So, for many of these retailers we've seen online sales increasing by about 100% or more which is six, seven-fold higher, greater than what we've seen over the last few years for the overall Australian online channel. So, that's really the standout. And then, the question obviously is, how sticky is that and how far will this trend continue?

Freeman: Can you talk a little bit about Morningstar's broader view there as far as online versus traditional retail, if you like?

Faul: Yeah. So, if you think about the general spend – and our long-term forecast is that retailing spending in general has driven obviously by population growth, by increases or decreases in real disposable income and then obviously by inflation. So, those are the main drivers. And if you think that that's relatively steady over a longer period of time, then the question is, how will the consumer spend that amount of money and that growth, how will that growth be distributed across different channels and (really it should be) ones are obviously online and the other one is the brick and mortar, the traditional store, the physical store. And what this strong increase means for online is that there's obviously foot traffic at stores and there is less need for stores. So, our view has always been that as online generally ramps up over the next, say, decade that you will see less and less store rollouts and then at some point you will even see store closures for a lot of the big chains that we know in Australia.

Interesting longer-term trend that we've seen out of the COVID and all these disruptions, but other things that we've seen – you mentioned Harvey Norman and JB Hi Fi – really it was that they've actually had tremendous sales growth not only online but also overall group-wide, and that has really caught us by surprise. We had previously estimated that the discretionary spend will actually be toned down a bit. People will spend less. The consumer would be more cautious. Something akin to what we've seen in the U.S. actually, all this government stimulus that we've seen – JobKeeper is just one of them in Australia – that we think there's been some sort of distortion here and we just caution investors to not extrapolate all this growth that we're seeing right now which also has been quite volatile too. Extrapolating that strong growth too far into the future, I think, that's a risk and a lot of the retailers that we cover are now fairly priced or even overvalued and that's obviously in the stark contrast which what we've seen two months ago when the market was extrapolating the poor news and the poor outlook for too long and over this whole period our fair value estimates – our longer-term assumptions haven't really changed for any of the retailers. Our fair values might have moved up or down a few percentage points but not by much and I think now we're at a point where the market is just pricing in too much of this bonanza to continue into the future.

Freeman: And one of the stocks that – I think it's one of the latest additions to our coverage list at Morningstar is Kogan. What prompted you to pick up, for instance, Kogan? There are other online retailers out there. And what's your view for, say, the longer-term growth of this? They've seen some pretty remarkable share price growth in recent months, haven't they?

Faul: Yeah, absolutely right. So, Kogan is a pure online play and most of their business really hinges on online retailing of consumer goods. And as I mentioned earlier, we've seen this strong, strong growth in online sales and Kogan has been no exception to that. Their online sales are up over 100% in the last couple of months. They've done very well out of this recent trend. I think Kogan is in the right place as a pure online play. They are really in that retailing channel that where we see the most growth out of the next decade. But we think again that the market is baking in too much of this near-term boost to just last – these high growth rates last for too long, we don't see that. And also, keep in mind that Kogan is not the only retailer playing in online. A lot of the traditional retailers have invested heavily in their online capabilities. Wesfarmers is an example. They bought Catch Group a while back just to boost that and they have done really well. Catch Group has also had significant sales growth. And then, don't forget Amazon. They are in Australia. They've been here for a few years now. So, Kogan in the right place, in the right segment of the market; however, the market is just overestimating their long-term growth trajectory in our view.

This report appeared on www.morningstar.com.au 2020 Morningstar Australasia Pty Limited

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