This chart pack provides subscribers with insights about the retail operating environment and outlook for wages, floor space and profit margins. The chart pack has been compiled post the FY23 reporting season across the retail market providing fresh insights about the sector.

Retailers and investors perceive certain retail categories as defensive. Typically, the implied definition of defensiveness centres around the stability of demand, as measured by volumes. However, this perspective is far too narrow given the impact price and cost structures can have on a retailers’ profitability. In Issue 7 of The Retail Mosaic report, we analyse the volatility of volumes, price and dissect the cost structures of the retailers. We also analyse the share price volatility of retailers. Moving beyond just volume as the measure of defensiveness reveals a very different list of companies that are truly defensive. The most defensive retailers, taking into consideration, revenue, earnings and share price are Premier Retail, Wesfarmers, Woolworths and Bapcor.

Retail theft is reducing retail profits. Crime losses amount to 1.3%-1.4% of sales, or $4.5-$5.0 billion, across Australian retail. The issue has ramped up globally over the past year, with some of the increase year-on-year simply a return to normalisation post COVID-19. Reported Australian east-coast retail crime for FY23 is only up 2% on FY19 levels. The drive towards self-checkouts has exacerbated crime rates and retailers with challenges, like Coles, need to implement changes. As economic conditions tighten, crime rates may rise and prevent Coles from achieving any discernible margin recovery in FY24e in our view.

Woolworths reported FY23 sales up 6% and EBIT up 16% and the result  was characterised by a return to more normal trading patterns. EBIT was up 3% excluding the impact of an unwind of COVID-19 costs in the prior year. The Woolworths Food division had a strong improvement in margins, which bodes well for FY24e and its investments in adjacencies is supporting higher margins than major peer Coles. We expect elevated capex to continue over the next two years given supply chain investments, which should deliver a return.

Australian supermarket sales are at a record low as a share of total food spending. Dining out is winning share of spend and the same is true for the US and NZ. Our research shows that employment growth, inbound tourism and savings tend to be well correlated with dining out spending and all still point to solid growth. Supermarket prices have also risen faster impacting its relative affordability. Dining out is bound to slow, more so in 2024 than now and unfortunately for supermarkets any uptick in volume may be more than offset by a fade in inflation.

Woolworths hosted a tour of its Melbourne South Regional Distribution Centre (MSRDC). This highly automated DC opened 2019 but COVID-19 delayed any inspection of the site. Woolworths spent over $560 million, including capitalised lease costs, and we estimate the return on investment at 7%-9%. While Woolworths has a different partner to Coles, we expect a similar outcome in terms of cost per case in the automated DC and a similar return on investment. The shift to automation comes at an important time for the supermarkets given escalating wage cost growth. While these DCs are impressive, they are more likely to offset to wage pressures than lift profit margins.

Tobacco may be somewhat inconspicuous in supermarkets but it has a meaningful impact on sales and margin outcomes given demand has dropped significantly in the past year. Metcash faces the biggest headwind given tobacco could account for 15% of group sales. The drop in tobacco is partly driven by the rise of illicit tobacco and vaping.

The Fair Work Commission’s decision to increase wages for FY24e by 5.75% will create a headwind for retailers. The magnitude of the pressure will depend on the sales run-rate and given we are already in decline in non-food categories, the squeeze from rising costs and falling sales could lower earnings in FY24e by 8%-14% for many non-food retailers. Our review of consensus expectations suggests the market is too low on cost growth for Bunnings, Super Retail Group and Premier Investments. We also note that the Fair Work Commission suggested that future pay rises are more likely to be above inflation, which adds to risks in FY25e.

Woolworths reported an impressive 6.6% comparable sales growth in Australian Food in 3Q23. While Woolworths sales growth is good there are some challenges. Its superior growth is more a function of eCommerce and new stores, which has additional costs. Moreover, growth rates are likely to slow as food inflation fades over the next 12 months. We expect good earnings growth in FY23e, but growth is likely to slow next year.

A successful retailer has the right product, at the right price, at the right time. However, retailers regularly find themselves with the wrong inventory position. In Issue 6 of The Retail Mosaic, we assess the metrics used to measure inventory, the most useful red flags and the margin pain a retail with too much inventory may endure. A retailer with excess inventory can quickly sink into financial losses, but the impact usually lasts no more than 12 months. While some Australian retailers have excess inventory, the problems are being cleared quickly and inventory positions are likely to be more balanced in 2024.