Australians like to holiday both locally and overseas. With locked borders over 2020 and 2021, reduced tourism spend has been a source of savings and some of the spare cash has also made its way into retail. As tourism recovers, will retail sales slow? In Issue 2 of The Retail Mosaic, we analyse the change in tourism spending over recent years and assess the possible recovery path and its impact on retail. The good news for retailers is that any recovery in tourist spending is likely to be gradual and centre on domestic trips. Given almost half of spending by tourists while on domestic holidays is in retail stores, then the recovery in holidays may prove to be a smaller drag on retail than some fear

Woolworths has provided a trading update to flag COVID-19 costs have had a bigger drag on earnings. Sales trends are solid, but even underlying cost growth looks elevated to us. We expect three-quarters of the one-off costs of $255 million to unwind, but we are concerned that online is creating a bigger drag on margins. Big W also has lower sales and margins.

Woolworths has made a bid for API, trumping Wesfarmers takeover offer. This battle has just begun. Both companies have the balance sheet. Both see improvements in Priceline’s sales and earnings. Wesfarmers is likely to place a greater value on both the Priceline loyalty members and the platform API may create for a Health division in our view.

Price rises for raw materials have been significant over the past year. In Issue 1 of Price Watch, we analyse these input cost pressures. We look at shipping, sugar, vegetable oils, cotton and semiconductors. While observers see the cost pressures as transitory, the length and extent of the path back to normalisation will significantly impact retailer and manufacturer profits. We expect it will take another 9-18 months for prices to normalise. As a result, retail inflation will rise and there will be profit margin pressure on some, mainly manufacturers, that fail to fully pass through the cost increases.

Australian retail price inflation has been low for a long time. However, input and supply chain costs have increased substantially in the past year. What if we had 5% inflation in both food and non-food in 2022? This is a hypothetical question to raise the debate about the implications of higher retail prices. High price inflation is likely to boost retail earnings in the first 12 months. If we have 5% price inflation, the upside to earnings is 6%-12%.

Coles (28 October 2021) and Woolworths (27 October 2021) will release 1Q22e sales next week. We forecast Coles to deliver 0.9% comparable sales growth in Supermarkets, with Woolworths at 3.3%. The gap will have opened in Woolworths favour given lockdowns favoured online sales and Coles had availability challenges given disruptions from COVID-19 in its DCs. We expect these issues are likely to unwind and the growth gap will narrow considerably beyond 1Q22e.

Australian online sales represent 13% of all retail sales. Even though growth has been very strong over the past five years, we expect online to continue to grow much faster than bricks & mortar. In Issue 1 of The Retail Mosaic, we size the Australian online market by category, compare Australian retailers with US and UK peers and provide a framework for online penetration growth over the next decade. Australian online penetration is likely to reach 21% in the next ten years. This level of growth online means mature retailers will need to eliminate net store openings, invest more in their IT and supply chain and improve their customer data.

Woolworths reported a solid FY21 result with EBIT up 14% to $3,663 million. Second-half EBIT growth was a little stronger with the unwind of COVID-19 costs and better earnings in Big W. While good earnings growth, underneath Woolworths had higher operating cost growth and elevated ongoing capex. Moreover, elevated capex will continue over the next two years in supply chain and IT.

We have a positive outlook for both revenue growth and profit margins for Coles, Metcash and Woolworths. Higher food inflation is likely to show through and offset the pressures from lower population growth and lapping COVID-19 induced sales growth. Higher inflation is not simply transitory, but has been evident since 2019. The market structure in both supermarkets and liquor add to the investment appeal. We also see a strong recovery for Endeavour Group and can make acquisitions in Hotels.