Will Santa smile on Australian retailers this Christmas?

What’s the outlook for retail stocks?

Reporting Season

It’s a delicately balanced question.

On the one hand, consumers look to be in rude health – employment is at record highs and household balance sheets are strong.

On the other, interest rates are starting to bite, and soaring inflation is putting pressure on everyday Australian’s cost of living.

And with the Christmas trading period looming as a critical test for the retail sector, there’s a third – and potentially more important – factor emerging that investors will have to keep an eye on: inventories.

“Last year, lifting inventories ahead of Christmas worked a treat.”

Reporting Season

Australian listed retailers have actively built up record inventories as they prepare for what they hope will be a big Christmas selling season.

Last year, lifting inventories ahead of Christmas worked a treat. Pandemic restrictions meant consumers had limited avenues to spend and retailers enjoyed a bumper Christmas as a result.

Reporting Season

However, this year, holding inventory is not without risk.

With the borders back open and pandemic restrictions lifted, there is a risk that consumers may prefer to spend their discretionary dollars on services or experiences, which would mean spending on goods could revert to levels seen in pre-pandemic times.

The implication of that would be a bumper January sales season instead as inventories are reduced to clear – great for consumers, perhaps, but problematic for the retailers and their shareholders.

Discounting to move excess inventories in January would put gross retail margins under pressure. In high fixed cost businesses such as retail, incremental gross profit falls straight through to the bottom line. Unfortunately, this also works in reverse.

So, what’s the right path for investors?

Retail company shares are trading at low earnings multiples, with some trading in the single digits.

“Despite some market pessimism, a difficult Christmas is not a given for retailers.”

Reporting Season

This reflects pessimism from shareholders who are discounting a tougher operating environment and, if not a tough Christmas selling season, then a slowing first half in the new year.

But having a low price/earnings ratio does not insulate a retailer from a market savaging if earnings disappoint. Baby Bunting Group Ltd (BBN) released data at its recent annual meeting showing gross margin compression and suffered an immediate 20 per cent share price sell off. As yet, there has been no bounce back and the share price languishes 30 per cent lower than it was prior to the AGM.

Despite some market pessimism, a difficult Christmas is not a given for retailers.

Cost of living pressures have increased in 2022 but Australians are an optimistic lot. Consumers are spending, unemployment is at alltime lows and banks remain sanguine about credit card bad debts.

Reporting Season

At Platypus, we believe quality will be the key for investors.

If the listed discretionary retailers do come under pressure from a tough Christmas and investors capitulate, Platypus will focus on stocks with strong balance sheets and most compelling valuations.

Disclaimer: Issued by Platypus Asset Management Pty Ltd ABN 33 118 016 087, AFSL 301294 (PAM). This material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. Prior to investing in any financial product, an investor should determine, based on its own independent review and such professional advice as it deems appropriate, the nature and extent of economic risks and merits, the legal, tax accounting characteristics and risk, and the consequences of an investment in the financial product. This material is not a financial product recommendation or an offer or solicitation with respect to the purchase or sale of any financial product. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given and no responsibility for the information is accepted by PAM, its officers, employees or agents. PAM is part of the Australian Unity Group of companies.