Australian retail sales growth of 8.2% for March 2022 year on year may be as good as it gets. The three-year cumulative growth is as strong as the dizzy heights seen back in November 2021, which proves once again, when COVID-19 cases drop, consumers clearly want to spend. The reality is that higher inflation and interest rates will take the edge off retail spending. However, the moderation in growth is likely to be gradual over the next 18 months as retail sales also benefits from some inflation.

Woolworths 3Q22 sales results show the company is holding onto market share gains in supermarkets and managing COVID-19 costs more tightly. The pace of inflation is picking up across the board, but the drag on volume is small. We expect supermarket sales trends to be consistent in 4Q22e and Big W should return to growth as it laps an easier baseline with less COVID disruptions.

Amazon has made some noteworthy decisions in Australia. It now has a massive 200,000 sqm distribution centre (DC) operating in Western Sydney and has held back on raising the price of Prime, unlike the US. Is this a sign of more aggressive customer acquisition in Australia? Why is Prime so much cheaper here than in the US? In our view, Amazon is simply in its infancy. It will need to expand its same day delivery service before lifting the price of Prime. In order to offer same day delivery, Amazon probably needs 3-4x the DC capacity that it has today.

Australian households and companies have not dealt with an interest rate increase for more than 10 years. However, higher rates are imminent. In Issue 3 of The Retail Mosaic, we assess the impact that higher rates may have on spending, company earnings and share prices. It takes, on average, 18 months for a rate hike to impact spending, but for furniture it can be in as little as six months. We expect housing churn will slow as rates rise, placing further downside risk on household goods. Retailers have limited debt and some hedging that will moderate the earnings risk from higher rates. However, PE ratios could derate by 10-20%, particularly for high PE defensive stocks such as supermarkets and conglomerates.

Woolworths reported sales up 8% but EBIT down 11% in 1H22. Even though COVID-19 disruptions added costs, underlying cost growth was also elevated, which we attribute to higher online sales. The company noted that food inflation had accelerated 2%-3% in early 2022, which is a good sign for earnings. We expect Woolworths to proactively work on lowering costs over the next two years.

Amazon Australia recently released its financial accounts, providing an interesting perspective about the battle online. We calculate that Amazon grew gross transaction value by 48% to $2.6 billion in 2021. Catch Group and Kogan had broadly flat sales. Amazon’s EBITDA margin was 1.9%, which is better than Catch and Kogan. There is an increasing intensity of competition between Amazon, Wesfarmers and Woolworths to capture customers in their “digital ecosystem”. It is not clear who will be the winner. What is clear is that it will take time and money to be successful. The costs will likely outweigh the revenue gains over the next 1-3 years.

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Chart: Sales for online retailers for 12 months to December 2021

Sales for all only represent Australian online sales. We exclude Woolworths NZ as we focus on purchases by Australian residents. Source: Company reports, MST Marquee

The February 2022 reporting season for retail, food and beverages is likely to show a wide dispersion in performance amongst companies. While sales trends have been good across the board, some have converted that to earnings better than others. We expect good results from household goods retailers like Harvey Norman but are below consensus on earnings for Domino’s and Endeavour Group. We expect stocks to be influenced by trading updates for January 2022 sales and commentary about price inflation and cost pressures. The full report provides a preview of major ASX-listed retailers potential earnings results.

The prospect of higher price inflation could significantly impact a retailer’s sales, earnings and valuation over the next three years. In Issue 2 of Price Watch, we analyse the impact price inflation has on supermarkets and non-food retailers and assess the likely volume response to price rises. The good news is even in non-food retail, price inflation 2-3 percentage points higher than average will lead to better sales, earnings and a PE re-rate.

The outlook for Coles and Woolworths in 2022 is looking better. The risks around COVID-19 costs are now well managed. We expect upside from consumer stockpiling near-term will lift sales earnings and higher food inflation over the next 12 months will be positive for earnings. In this report we look at how the COVID-19 costs may unwind and the impact that higher food inflation will have on the supermarket sector.

Our feedback from a range of contacts is that Christmas 2021 trading was solid, particularly given the high base from 2020. The strongest feedback comes from the furniture sector. Whitegoods were strong and supermarkets had a late rush in sales. While a good festive season, the debate is going to shift quickly to the impact that COVID-19 has had on January 2022 trading. Sales could be down 10%-20% for the month leading to 3%-5% full year EPS risk in our view.