Retail Strategy: Discretionary retail reporting season preview

About the author:

Author name:

By Alexander Mees

Job title:

Co-Head of Research and Senior Analyst

Date posted:

25 January 2023, 12:00 PM

Sectors Covered:

Gaming and Retail

• Consumer demand appears to have held up well through the festive period. We think this will be reflected in generally positive 1H FY23 results from many of the discretionary retailers, especially against soft, lockdown-affected comps in the pcp. Two sources of positive surprise (JBH and SUL) have already ‘let the cat out of the bag’, but we think fashion companies Accent Group (ASX:AX1) and Universal Store (ASX:UNI) are also likely to have done well, alongside homewares businesses Beacon Lighting Group (ASX:BLX) and Adairs (ASX:ADH).
• Our key picks coming into reporting season are BLX, JB Hi-Fi (ASX:JBH) and UNI. We have downgraded our rating on AX1 from Add to Hold after a strong rally.

Solving the consumer paradox

Australian consumer sentiment has been in the doldrums. Preoccupied by the impact of higher home loan and rental payments on household finances already feeling the effects of the highest rates of inflation in 30 years, consumers indicated throughout 2022 that they intended to tighten their belts and pull back on their discretionary expenditure.

And yet, retail sales continue to rise faster than market expectations. The Australian Retailers Association recently commented that last Christmas saw ‘without a doubt the biggest festive spend on record’.

The rising CPI has played its part in lifting retail sales, but it is clear that consumers have been happy to keep shopping, buffered by low rates of unemployment and elevated household savings ratios that have yet to fully normalise post-COVID.

We do expect consumer demand to soften over the course of 2023, especially as a high proportion of fixed rate mortgages roll off. But with the prospect of inflation easing and with the possibility that the RBA will pause its relentless series of rate hikes, we think the market may have overestimated the extent of the weakness in the year ahead.

We could see earnings upgrades in the retail sector during February as analysts adjust to better than expected numbers in 1H FY23 and the emerging prospect of a more gentle decline in 2H FY23.

Reporting season highlights

We believe there could be a number of positive earnings surprises in February. Two large candidates for positive surprise (JBH and SUL) have already released preliminary 1H23 earnings numbers well above consensus.

We are also looking for positive surprises from fashion retailers AX1 and UNI and homewares companies BLX and ADH.

Where companies are likely to disappoint, we think this will be driven more by competitive issues or stock-specific problems. Baby Bunting's (ASX:BBN) trading update was a case in point, but we are also keeping a eye on the possibility of earnings coming in lower than expectations at Reject Shop (ASX:TRS).

Although we don’t expect DMP to miss market earnings estimates, the 1H FY23 weakness in new store opening activity (and the implied risk to FY23 expansion) may be a source of concern to investors.

Estimate changes

We have made some changes to our earnings estimates with this note. Among the more material changes, we have increased our FY23 EBIT estimates for AX1 by 7% and for BLX by 6%.

Looking into next year, our FY24 EBIT estimates move up by 7% for AX1 and down by 9% for ADH.

Recommendation change

We have downgraded AX1 from Add to Hold after a strong rally.

Shares are up more than 50% since October and we think there is better value in UNI.

Figure 1: Recommendations in discretionary retail

Source: Morgans

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.