Consumer sentiment for October 2022 is 19% below the long-term average, suggesting consumers are worried. However, consumer sentiment is at odds with consumer spending. Most of the time what consumers say and what they do disconnect. Instead, we focus on measures of consumer behaviours in order to gauge the retail outlook. Restaurant and café spend has a 3x stronger correlation with retail spending than consumer sentiment. Restaurant bookings are up 23% on pre COVID-19 levels in October. Housing churn is up 80% on pre COVID-19 levels. Food inflation is 14% higher than 2019 and retail spending is up 25% on 2019 levels. There are no signs of a slowdown in spending behaviours on the near-term horizon.

Measures of consumer behaviour and sentiment

Retail sales are a function of volume, price and mix. While volume and price receive plenty of attention, mix is often mis-understood, or not disclosed. In Issue 4 of Price Watch, we explore mix and its impact on sales. Successful businesses drive mix higher through their deliberate product and price decisions. Consumers will also make conscious choices about their basket mix depending on income, convenience, demographics and the cost of living. In the limited disclosure on mix we have, we find that it accounts for anywhere from one-quarter to half the sales growth for large retailers, with a higher contribution over the past two years. More disclosure on mix would lift perceptions about the quality of sales growth as pure price rises or excessive volume growth are often seen as unsustainable.

As global trade tensions build and geopolitical risks rise, we think Australian retailers are going to need to diversify their supply chains. Australia imports ~86% of its non-food consumer goods and we estimate 57% of these imports come from China. The productivity of China has led to a concentration of sourcing that represents a real risk on a 5-10 year horizon as Chinese wage rates rise further, supply chains face further disruptions and trade tensions rise. Electronics is the most at-risk category entirely imported, with 56% of imports from China, followed by clothing and accessories at 94% imported, with 55% from China.

Australia is an open economy and over the past twenty years, its retailers have increasingly imported consumer goods. In Issue 4 of The Retail Mosaic, we explore the extent of imports by retail category, the significance of China in supplying goods and exposure various companies have to direct imports from China. China provides the most efficient source of production and for many companies represents more than 70% of their offshore sourcing. The risk is that any increase in costs, supply disruptions or trade tensions could impact sales and margins. The companies sourcing most of their goods from China are Wesfarmers, City Chic, Woolworths, Premier Investments and Super Retail Group.

Australian supermarket industry sales only rose 3% in July 2022. The slowdown is not a reflection of customers retaliating to higher prices, its merely the normalisation from lockdowns last year. In this report, we analyse the likely normalisation path in sales. Coles is likely to grow faster than Woolworths in the September quarter. However, the real winner is Metcash which is holding onto the vast majority of its customer gains. Since 2018, the fundamental shift from the majors to reduce promotions and open fewer stores has provided a better operating environment for Metcash.

Woolworths reported FY22 EBIT down 1%. However, 2H22 was encouraging with EBIT up 8%. Australian Food had higher gross margins and improved cost management. Food inflation remains a tailwind for sales and earnings. We expect a tough 1Q23 in sales for Australian Food but then a recovery, and profit margins should rise substantially this year given lower COVID-19 costs and gross margin gains. There are partial offsets from weaker EBIT in NZ which is largely COVID-19 related and much higher overheads.

PE ratios are depressed across consumer stocks reflecting concern about an earnings decline. However, bears will need to wait at least another six months for evidence. FY22e earnings are likely to surprise on the upside for just about all retailers, trading updates will be strong and inventory should be down on February levels. It’s less clear cut how stocks will react, but any downturn is unlikely to be evident.

We expect a strong year of earnings growth for Australian supermarkets in FY23e. Higher food inflation is boosting sales and gross margins are also rising. We lift our FY23e EPS forecast for the major chains. Woolworths has the strongest sales growth, followed by Metcash, then Coles based on our feedback. In the full report, we address the cycle of price inflation and outlook over the next 12 months; and the outlook for Coles and Woolworths gross profit margins and EBIT margins.

While retailers and manufacturers have grappled with a range of cost pressures already, wage cost pressures are only starting to build now. In Issue 3 of Price Watch, we analyse the size and scope of likely wage pressure facing companies. As most retailers are inextricably linked to broader wage-setting mechanisms, we may see an additional 2%-3% higher annual wage inflation over the next two years. The companies with the highest sensitivity to wage inflation are Inghams, Costa Group, Coles and Woolworths.

Woolworths has announced its intention to acquire 80% of MyDeal for $243 million and a substantial takeover premium of 63% compared with its prevailing share price. MyDeal is loss-making and we expect losses to continue over the next 12 months. The rationale for the deal is to build marketplace capabilities. While understandable, this only heightens our concern that Woolworths, Wesfarmers and Amazon will all battle it out over the next three years for the upper-hand online. We are not sure who will win, but we are confident that it will be costly for all involved.