Discretionary Retail: Reporting Season Wrap

About the author:

Author name:

By Alexander Mees

Job title:

Co-Head of Research and Senior Analyst

Date posted:

07 March 2023, 7:00 AM

Sectors Covered:

Gaming and Retail

• The median growth in EBIT in 1H23 across our coverage universe was 10.3%, beating our forecasts by 1.6%. Sales growth was generally positive and gross margins were well controlled in spite of extensive cost pressures. Across our universe, we trimmed EPS estimates by 0.6% this year and 2.2% next.
• The three key themes emerging from reporting season are: (1) trading conditions are likely to be in a controlled descent in 2H23, but they will not collapse; (2) the pendulum has swung on price and we are likely to see more discounting in 2H23; and (3) the pressure’s off on input cost inflation, which will support margins.

Marginally better

On average, the discretionary retailers we cover performed marginally better than forecast in 1H23. The median EBIT beat was 1.6%, though removing outliers, the beat was only +0.2%.

The most positive results included Super Retail Group (ASX:SUL) and The Reject Shop and the largest misses were at Adairs (ASX:ADH) and Domino’s Pizza Enterprises (ASX:DMP). The median y/y growth in 1H23 EBIT was 10.3%.

Our median EPS revision was a reduction of (0.6)% in FY23 and a reduction of (2.2)% in FY24. There was significant dispersion in our earnings revisions, with sizeable increases put through for Accent Group, Step One and Super Retail, while there were big reductions for Domino’s Pizza and Adairs.

We upgraded The Reject Shop (ASX:TRS) from Hold to Add and downgraded Breville Group (ASX:BRG) from Add to Hold.

Controlled descent

Consumers made up for lost time when lockdowns finally came to an end. A post-pandemic release of pent-up demand combined with the enhanced spending power resulting from the savings built up over lockdown to drive a surge in discretionary expenditure.

First half sales were generally better than we had forecast. Across our coverage universe, the median 1H23 sales growth was 8.7%, 1.4% higher than forecast. Despite rising interest rates and stubbornly high inflation, retailers report no ‘significant change to consumer spending’ so far.

It is widely expected that things will get worse in 2H23, especially as we hit the ‘fixed rate mortgage cliff’, likely to be felt most acutely in April. In our opinion, however, the decline will resemble a controlled descent rather than a precipitous collapse given low unemployment, rising wages and a moderation in the rate of inflation.

The most resilient retailers are likely to be those serving a younger consumer, like Universal Store, Accent and Lovisa. Those exposed to homewares, like Adairs and Breville, may come under more pressure.

The pendulum swings

In 1H23, Australian retailers faced a daunting array of inflationary cost pressures. The weaker AUD made imports more expensive, while sky-high freight rates made it much more expensive to get these imports to Australia. Once in the country, the higher price of diesel increased distribution costs.

Rent, if linked to CPI, rose sharply. Across it all, labour rates increased, boosted by a National Minimum Wage that is now the highest in the world. To offset some of these pressures, many retailers elected to increase their own selling prices.

This was generally accepted by consumers and it supported gross margins, which fell only 50 bps across our universe despite spiralling cost pressures. There is a growing sense that consumers may now have had enough.

Certain companies, notably Domino’s Pizza, reported strong pushback against higher prices and surcharges. Others, like Adairs, have noticed an increasing appetite ‘for a deal’ among customers. Discounting appears to have ‘normalised’.

Retailers with good price discipline, such as Universal Store and Beacon Lighting are likely to outperform those that find themselves ramping promotional activity.

Pressure’s off

There is good news. Although demand is softening and the consumer appears to be pushing back on further price increases, there is a lot of evidence that input costs are easing. This will mitigate the impact of reduced sales growth and help protect margins.

International shipping rates have fallen right back to pre-COVID levels (if not below), while a number of retailers report that overseas manufacturers are reducing their prices they charge and delivering faster. Even the AUD is helping, having rallied since October.

Retailers with the lowest gross margins are those with most to gain from a reversal of COGS headwinds. In our universe, these include JB Hi-Fi, Breville, Baby Bunting and The Reject Shop.

Find out more

If you would like more information, please contact your adviser or nearest Morgans office. 

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.