Reporting season across the retail, food & beverages sector is likely to highlight the resilience of profit margins for FY24e, despite weak sales. The strength of margins is a function steady gross margins and cost reductions. While good news, consensus expectations already reflect this outcome. We are above consensus on Inghams and Woolworths and below on Lovisa for FY24e EPS. We expect trading updates to influence share prices meaningfully with the risk that FY25e consensus needs to be downgraded for many. We are below FY25e consensus on Bapcor, Premier Investments, Super Retail Group and Wesfarmers.

Accent Group provided a trading update and details around the planned closure of 17 stores operating under the Glue Store banner. The company highlighted strong second half like-for-like sales trends at 4.1%. This strong performance into the second half of the year was ahead of consensus at -0.4% for 2H24e. The store closures will lower group sales but we lift our gross margin expectations and see improved cost of operations from exiting a portion of the higher cost Glue Stores.

Australian retail has had a challenging 12 months. We expect we are past the worst for this sales cycle with a gradual improvement in growth over the next 12 months. We forecast retail sales growth of 2.9% in FY25e, up from 1.8% in FY24e. The sectors likely to see the strongest recovery are household goods, supermarkets and online. Some categories are still vulnerable to a correction in volumes such as liquor, cafes & restaurants and fashion. While there is an upswing, it will be mild and leave growth rates below trend for the next three years in our view given the low household savings rate and decelerating population growth.

Over the past decade, retail rental growth has been less than sales growth for many ASX-listed retailers. Can this trend continue? In Issue 8 of Price Watch, we analyse floor space supply and demand. We expect retail supply per capita to fall by 0.7% p.a and retail demand to rise by 0.5% p.a. This is a meaningful disconnect placing upward pressure on rents. We expect half the gap to be solved through productivity initiatives by retailers and landlords to work floor space harder and reduce anchor tenant space. The retailers with the highest exposure to the top 30 shopping centres are Accent Group, Premier Retail, City Chic and JB Hi-Fi.

Australian retail sales rose 2.1% year-on-year in May 2024, which is the best underlying rate of growth since November 2023. The glass half-full would suggest we may be past the trough for retail. The glass half-empty is that the rate of growth is still very weak and indicative of per capita declines in retail volumes. We do think we are now past the trough in volumes, but we don’t expect a swift recovery in retail spending.

The proposed merger between Chemist Warehouse and Sigma will create a business with close to $760 million of combined annual EBIT with growth of 12%-19% over the next four years. However, the first hurdle is ACCC approval which may be a drawn-out process. While there is an impressive growth profile, the prospects for rollout beyond Australia and New Zealand is still in its infancy. The upside case would see continued elevated like-for-like sales growth and a seamless integration of the Chemist Warehouse contract.

The spike in spot sea-freight rates is likely to remain topical over the next few months and add to concerns about retail profit margins in FY25e. Our feedback is that spot sea freight rates for Australian importers are now close to 3x the low point seen only 12 months ago. The good news is many retailers have 12-month contracts. The bad news is that it looks like a step-up in freight rates is coming either way as we move through FY25e and adds risk to earnings. The retailers most exposed to higher sea freight rates are Nick Scali, Wesfarmers and Super Retail Group.

Myer’s proposed merger with Premier’s Apparel Brands is a convenient solution for two ex-growth businesses. For Premier, the inferred multiple is only 4.1x EV/EBIT, which is low. Premier shareholders could receive 8.2 Myer shares, with upside through an estimated $55 million in synergies. The majority of the synergies will come from adding Premier to Myer stores in concession space and improved terms on sourcing product. The merger raises the prospect that a further Strategic Review for Premier is unlikely to crystallise much value.

Metcash reported FY24 EBIT down 1% and, adjusted for acquisitions, it was a similar result in both the first and second-half. The company is actively managing costs to offset weak sales trends and this thematic is likely to be a feature again in FY25e. Metcash’s performance relative to market growth remains impressive and is the primary reason for our positive stance on the stock.

City Chic’s exit of Avenue and capital raising conclude an incredibly painful experience of global ambition and then retreat. The City Chic brand has a strong following in Australia but has been impacted by excess inventory. The company is addressing its cost base but more savings will be needed to restore profitability. Moreover, store openings seem unlikely at this stage given the poor sales productivity.