Australian inflation rose 5.4% in the September 2023 quarter, with our calculation for retail price inflation at 3.4%. Retail inflation has slowed significantly in some categories, particularly food, furniture, auto parts and sporting goods. The lower inflation reflects lower input costs flowing through and may be supportive of gross margins against a backdrop of rising operating costs such as wages and rent. Even so, it is likely that inflation fades further and is another headwind for nominal sales growth near-term given volumes are also sluggish.

We have updated our retail sales forecasts, which are modestly higher over the next two years. We forecast FY24e retail sales growth of 1.7% (previously 1.5%). We estimate FY25e retail sales will rise 3.1% (previously 2.5%). We expect the worst of the deceleration in sales will be over by December 2023. The normalisation of volumes after excess growth during COVID-19 has played out. Households have handled the steepest period of interest rate increases by dipping into excess savings. Housing indicators are starting to improve and we have tax cuts on the horizon to support a mild recovery in sales growth for FY25e.

We are approaching the most important time of year for retailers where a successful festive season can make or break the year. For 2023, retailers are planning bigger and earlier events in November. Black Friday sales are likely to pull forward spending yet again. We expect the most noticeable boost to sales in electronics and recreational goods where supply has improved. While there is upside risk to consensus sales for 1H24e, the challenge will be profit margins. We are more cautious on margins and see a downside skew to risks given earlier discounting by retailers.

Bapcor’s AGM trading update revealed weaker sales trends and margin pressure early in FY24e. There are some macro headwinds, but not the only factor in our view. We also expect softer sales trends to persist as price inflation eases and new car sales recover. Bapcor is raising prices and cutting costs, which should improve the earnings run-rate for the remainder of FY24e. Even so, there will be a heavy reliance on cost savings to ensure a flat NPAT outcome.

Australian retail sales grew 1.9% for August 2023 on the prior corresponding month. The additional detail provided by the ABS revealed very weak sales in electronics, furniture and recreational goods. Non-food online went backwards too. Supermarket sales dipped to 4.5% growth, driven by deflation in fresh categories. We are approaching the trough in retail sales over the next few months. Even so, any recovery in 2024 may be longer-dated and weaker than hoped until tax cuts take effect later in that year.

Premier Investments FY23 result revealed a slowdown in sales and gross margin pressure in the second-half. The company found sufficient flexibility in its cost base to soften the 2H23 EBIT decline to only 4%. For FY24e, we expect weaker sales, lower gross margins and more cost inflation.

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.

The Australian National Accounts for the June 2023 quarter revealed that wages growth remains very strong and, despite a range of headwinds, households still want to spend their money. They continue to tap into stored-up savings to sustain spending habits. Wages grew 9.2%, disposable income only rose 2.1% and consumer spending was up 7.8%. The Australian economy is also benefiting from population growth of 2.4%, which should remain above trend for another 12 months. The headwinds for household will continue and retail spending is likely to remain weak give both a squeeze on living costs and a desire to spend elsewhere outside of retail. This weakness is likely to be most acute in calendar 2023, but we may not see a meaningful improvement in retail sales growth till 2025.