Competition for the Australian retail sector may bring upside

6 min read

The Australian retail sector is facing into an interesting period of time, with some retailers actively transforming to manage challenges from new market entrants or changing consumer spending habits. While investors may be watching the changing competitive environment with concern, there are still opportunities in this market segment.

The Australian retail sector has not been a totally happy place lately.

Retailers have faced increased competition, both at home and from foreign retailers – online, and through physical stores opened by foreign heavyweights. A prime example is how the arrivals of foreign apparel players Zara, Uniqlo and H&M have all increased price pressures on struggling department store operators Myer, David Jones and other traditional department stores and fashion chains.

As retailers have struggled with price deflation, margins have declined and retailers have had to respond by cutting costs. They have been battling the changing consumer spending patterns, driven by new technology, economic uncertainty, stagnant wage growth and rising utility prices that have in-turn weighed on consumer confidence. Now retailers fear a potential slowdown in the “wealth effect” should house prices stall.

International entrants to the retail space

Increased competition from overseas retailers has even affected the ‘consumer staples’ area, with local supermarket giants Woolworths and Wesfarmers forced to surrender part of their turf to foreign invaders such as Costco and Aldi.

More recently, many retailers have been negatively vocal over the arrival of US e-commerce giant Amazon, which launched its Australian Marketplace online shopping portal in December last year. Amazon’s arrival was accompanied by predictions that its Australian operation could severely hurt department stores and retail chains, in particular.

So far, Amazon’s launch has been reported as something of a ’non-event’. But the US raider only launched its Amazon Marketplace, which allows independent sellers and stores to list their products on Amazon and set their own prices. The real threat from Amazon is its Prime service, which is likely to hit Australian shores sometime this year.

Amazon Prime is a membership program offering exclusive benefits across shopping, entertainment and delivery, where members get free, fast shipping (even free same-day shipping), subscriptions to Amazon Prime Video and Twitch Prime (a live streaming video platform) plus exclusive discounts and preferential access to lightning deals, for the cost of an annual subscription.

This month, the head of retail for global technology giant Intel warned that all Australian retailers should be worried about Amazon Prime, describing it as a “critical competitive weapon.” Jon Stine said that Amazon Marketplace was an “elementary” offer compared to the threat of Amazon Prime. According to US research firm Consumer Intelligence Research Partners, there are 90 million Prime members in the US, or 75% of the nation’s 116 million households.

That is the threat that has the Australian retail industry almost existentially nervous. However, to give some comfort to the embattled retailers, investment bank Credit Suisse predicts that Amazon will not really disrupt the market until it reaches a 5% share of product categories – which could take about five years.

Adapt or perish

Local retailers are not all sitting around just waiting to have their business taken by Amazon. Ruslan Kogan, founder and CEO of online sales business Kogan.com, will be directly competing with Amazon for online shopping market share in Australia – but also points out that the US giant tends to expand the online retailing market wherever it goes. Kogan.com intends to compete with Amazon on price, while also selling a wide range of its private-label products through the Amazon online business.

Electronics retailer JB Hi-Fi (which also owns The Good Guys) is backing its staff knowledge and customer experience, its own growing online sales channel and adept use of its database to offer targeted deals to its customers, to maintain its market share against Amazon. Investors consider JB Hi-Fi one of Australia’s best-run and influential retailers: Christmas was reportedly stronger than expected for the company, and its shares were upgraded to “overweight” by broker Morgan Stanley this month (Macquarie broking rates the stock as “outperform.”)

Super Retail (whose brands include automotive retailer Supercheap Auto, outdoor and leisure retailers Rays and Boating Camping and Fishing and sporting retailer Rebel Sport) and Bapcor (which runs the Autobarn and Autopro retail car parts and accessories chains, along with a large trade business supplying to mechanics under the Burson banner across 850 locations), are other companies backing their expertise with discerning customers to help them flourish. Pet and vet care chain Greencross believes its integrated pet-and-vet care model, in-store experience and strong customer engagement will prevail.

Fast-fashion jewellery provider Lovisa is another company convinced that attention customer engagement – in Lovisa’s case, with young women – is its key to resilience in a market that contains Amazon. Furniture specialist Nick Scali – arguably JB Hi-Fi’s only rival for the title of best-run retailer in Australia – “owns” its space, which happens to be large items that cannot be delivered easily: it also says people like to “feel” furniture before they buy it.

(Lovisa also has the attraction of overseas expansion, like Premier Investments – which is taking its Smiggles stationery and Peter Alexander bedwear brands overseas, to diversify from the hard domestic grind of its local brands, Just Jeans, Jay Jays, Portman’s, Dotti’s and Jacqui E.)

There is no question that the local sector has been disrupted. Luxury handbag brand Oroton went into administration in November, before receiving a takeover bid from a major shareholder late last month. In January, Australian plus-size label Maggie T, which was founded in 1981 and fronted by actor Maggie Tabberer, collapsed into voluntary administration. News came this month that footwear brand Diana Ferrari would close many of its stores, while outdoor clothing company Mountain Designs will shut 13 of its 39 stores this year.

The troubles flowed over to the Australian Securities Exchange (ASX), where the retailing sub-sector of the S&P/ASX200 index lost 13% over 2017, in a year when the total index itself gained 7.6%. 

Is the gloom too overdone?

Australian retail sales unexpectedly surged in November, with seasonally adjusted retail sales up 1.2% on the previous month. That was three times the growth rate seen by the median estimate of financial markets economists, and the strongest growth rate since mid-2013. Annual sales growth rose to 2.9% from 1.8%. (However, some analysts cautioned that the iPhone X launch would have been responsible for up to half of the November growth.) Electrical and electronic goods sales rose by 9.3% in November, while household goods were up by 4.5%.

According to the National Australia Bank Online Retail Sales Index, online sales in Australia accelerated by 4.7% in November – the highest monthly growth rate since December 2014 – to be up 14.4% compared to last year. That means online sales are growing at almost five times the rate of physical sales. The homewares and appliances category grew by 24.9% from November 2016.

This growth is, in reality, only mirroring what is happening globally. According to digital commerce research firm eMarketer, worldwide online retail spending is expected to grow by 20% to US$27 trillion ($35.5 trillion) by 2020, to be 14.6% of total retail sales. The firm says e-commerce would grow by more than 60% in the next three years, three times the rate of traditional sales.

There is definitely good news emerging in the retail sector. For example, household products company Adairs (ADH) brought out a surprisingly strong market update in January. The company said like-for-like (LFL) sales surged 14.8% in the six months to end December 2017. The company’s guidance is for total sales for the first half of FY18 of $149.1 million, which would be a 19.8% increase on last year’s first half, while first-half EBIT (earnings before interest and tax) is expected to be between $21 million–$21.5 million, compared to $12 million a year ago. 

Women’s clothing retailer Noni B also posted a bullish update this month, saying that earnings before interest, tax, depreciation and amortisation (EBITDA) in the first half of FY18 will come in around 50% above the same period last year when it posted an underlying EBITDA of $14.3 million. Noni B is confident enough to expand its network from 614 outlets to 642.

Also, it has been reported this month that Munro Group – the largest player in the $3 billion Australian footwear market, with 285 stores nationwide and turnover of more than $300 million – is considering floating its shares on the ASX. Munro Group owns the Williams, Mathers, Colorado, Midas Shoes and Mollini brands, among others, and also Styletread, Australia’s most popular online shoe store. A share market float of Munro Group would be an emphatic vote of confidence in the retail industry.

Deutsche Bank research indicates that retailers reported solid sales growth in December. For listed retailers, the all-important December sales figures will come out in mid-February.

It is likely to remain tough for the likes of Myer, which is struggling and publicly so, with a messy difference of opinion between major shareholder (and supplier) Solomon Lew and the Myer board –  and with the company having issued a profit warning in mid-December, seeing worsening sales ahead of Christmas.

No-one could say that things are all rosy in the Australian retail patch, but as we begin to see smart companies evolve to what the consumer demands, it is a sector where there are opportunities for the investor who looks hard enough.

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