Headwinds Persist In Consumer Sector

By Eva Brocklehurst | More Articles by Eva Brocklehurst

Australian consumer oriented stocks weathered significant headwinds over FY18 and brokers anticipate more of the same is likely in the year ahead, albeit there are some opportunities forthcoming.

The results for the consumer sector were, on the whole, better than UBS feared. Top-line trends were broadly in line with expectations. Nevertheless, there were some issues, such as online business, which drove 100% of like-for-like growth in the sector and was dilutive to margins. In the near term this is driving heightened expenditure as retailers adapt.

Moreover, housing-exposed retailers are reporting softer trading updates as the new financial year unfolds. Discounting was more rational, UBS observes, outside of electronics, with food retailers intent on reducing promotional breadth, and this is a positive for growth.

In FY18 online retailing contributed 45% of total retail sales growth. In household goods, purchasing through bricks & mortar retailers grew just 0.4% while online contributed 83% of the growth in total sales. Credit Suisse suggests, if current rates of growth are to be maintained, bricks & mortar retailing of household goods will shrink in aggregate in 2019, implying a significant reallocation of resources.

The broker is sceptical that picking and packing stock for online orders will support retail wages and rents, and expects increasing financial pressure on store-based retailers. Meanwhile, wages growth in retailing has accelerated and the award base rate of pay increased by 3.5% on July 1, 2018.

Credit Suisse notes a focus on expanding store networks featured in retailer strategies and FY19 guidance and suggests, while some consolidation of physical store networks would be rational in the medium term, it is possible that former Master sites are presenting an opportunity for retailers to open stores in homemaker centres.

Consumer Stocks In Focus

UBS flags three consumer stocks that should provide opportunities post the results. First is Flight Centre ((FLT)), which achieved the top end of guidance and its strongest international/online result ever. There are also signs its business in Australia is improving. UBS believes the earnings risk is to the upside and retains a Buy rating.

Metcash ((MTS)) is considered best positioned to benefit from improving top-line trends in the grocery market as it is the most leveraged to inflation and a reduced emphasis on price. Costa Group ((CGC)) has exposure to fresh food and China and is also one to watch, in the broker’s opinion.

Coca-Cola Amatil ((CCL)) has structural headwinds which are likely to become more evident when heightened investment ends in 2018 and this creates a risk to 2019, UBS suggests.

Macquarie lowers its stance on consumer based stocks to Neutral from Outperform following a significant re-rating of the sector amid growing headwinds for consumer spending. The broker was encouraged by the performance of both staple consumer stocks and retailers and notes the sector discount based on concerns around Amazon and housing has closed.

Features of the results included rationalisation of store networks such as with Myer ((MYR)) and Target ((WES)), cost inflation because of increased labour costs, such as Baby Bunting ((BBN)), JB Hi-Fi ((JBH) and Domino’s Pizza ((DMP)), and extracting value from property, such as Caltex ((CTX)).

The broker finds valuation for both Caltex and JB Hi-Fi compelling while Coca-Cola Amatil is considered expensive as the container deposit scheme benefit appears transitory and Indonesia problematic.

Freedom Foods ((FNP)) is Citi’s top stock in the China-oriented consumer segment. The broker is attracted to the prospect of margin expansion out to FY20 because of increasing operating leverage. Citi also envisages growth in international markets because of the exposure to increasing consumer consciousness regarding health.

The broker also has a Buy rating for Bellamy’s Australia ((BAL)) based on growing Chinese demand for organic infant formula. This drives the broker’s forecast for earnings growth of 15% out to FY23. However, Citi concedes short-term earnings could be volatile given the uncertainty about registration timing, while sales continue to be adversely affected by excess supply of competitor products.

Third in line in the broker’s pecking order is a2 Milk ((A2M)) with a Sell rating. Citi remains concerned that the domestic inventory has been growing throughout 2018 and believes there is downside risk to consensus earnings forecasts for FY19. Excess domestic inventory continues to affect daigou pricing, margins and demand.

Non-recurring Items

Morgan Stanley notes that just three out of 16 consumer/gaming companies had reports that were free of non-recurring items for FY18. The proportion of one-off items has been consistently high in recent years and the broker suspects that most of these costs are incurred in the usual course of business.

Over FY14-18 Harvey Norman ((HVN)) reported the lowest proportion of one-off items as a percentage of normalised profits and in the latest year Woolworths ((WOW)), JB Hi-Fi and Sky City ((SKC)) have had the cleanest accounts.

Morgan Stanley prefers those stocks with the cleanest records, as a relatively high frequency of non-recurring items implies lower underlying growth. Conversely, those with cleaner records signal their core businesses still have reasonable growth prospects.

Many companies have sought growth opportunities, presumably as core business prospects weaken, and the broker points out these have ended in impairments and restructuring costs.

About Eva Brocklehurst

Eva Brocklehurst started her journalistic career in 1993 as a financial reporter with RWE Australian Business News covering money markets and economic reports. She moved to Australian Associated Press (AAP) in 1998 as a senior financial journalist to cover money markets, economic analysis, Reserve Bank and Treasury. Eva became deputy finance editor at AAP in 2003. Started working online as a reporter on ASX-listed companies for RWE Australian Business News in 2005. Eva joined FNArena in 2012 and has been covering stockbroker analysis of ASX-listed companies since, as well as writing general news stories.

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