While retail sales have started 2023 at a healthy run-rate, a downturn is looming. In this report, we detail our forecast for retail sales and emphasise that the June 2023 quarter is likely to be much weaker in non-food with food retailing propped up by inflation. The downturn is just commencing and likely to last until the end of 2024. We forecast retail sales growth of 2% in 2023, compared with 11% achieved in 2022 and long-term trends of 5%.

Australian inflation of 7.0% in March 2023 quarter suggests price rises peaked in December 2022. We think the same is true of retail prices. Inflation has dropped meaningfully in appliances and furniture prices are starting to fall.  Food inflation has also peaked albeit this is more a function of fresh categories which now have very low inflation such as vegetables and red meat. The unwind of elevated inflation will see retail sales slow. The drop is more noticeable in household goods with a more significant slowdown likely in other non-food categories later in calendar 2023.

What a roller coaster it’s been for anyone importing retail goods! The Shanghai Containerized Freight Index shown in the chart below peaked in January 2022 and was 5x higher than its 2019 level. As the world returns to “normal”, sea freight rates are dropping back to 2019 levels. We view freight rates as a barometer of both the supply chain strain and outsized retail demand witnessed during COVID-19. While supply chains are still recovering, inflation in import-driven categories has peaked in our view and may unwind as some of the sea freight savings are passed through. Lower inflation is one of the key triggers for slower retail sales growth over the next 12 months.

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A successful retailer has the right product, at the right price, at the right time. However, retailers regularly find themselves with the wrong inventory position. In Issue 6 of The Retail Mosaic, we assess the metrics used to measure inventory, the most useful red flags and the margin pain a retail with too much inventory may endure. A retailer with excess inventory can quickly sink into financial losses, but the impact usually lasts no more than 12 months. While some Australian retailers have excess inventory, the problems are being cleared quickly and inventory positions are likely to be more balanced in 2024.

Retail sales rose 6.5% in February 2023. The additional detail showed a substantial slowdown in electronics, and small declines in hardware and furniture. This is the start of the downturn, which is now impacting those categories that tend to have the quickest reaction to interest rate increases and had the greatest pull forward during COVID-19. While demand elsewhere looks to be holding up well, it is largely price inflation driven. Underlying trends are softening, and a broader retail slowdown will be evident in coming months in our view.

Premier Investments had a solid rise in 1H23 sales but retail EBIT margins fell by 303bp, largely due to a lower currency rate for product purchases. Peter Alexander had good sales growth despite a very high baseline. The brand has contributed more than two-thirds to the group’s earnings growth over the past three years and is the key share price driver in our view. The company is flagging store openings and offshore expansion for both Peter Alexander and Smiggle. Store openings should contribute quickly, but offshore expansion will be measured in our view.

Consumers love a bargain and retailers usually like giving them one. In Issue 5 of Price Watch, we profile the pricing tactics used by major Australian retailers, the legal boundaries for price tactics and where retailers can trip themselves up. There is a lot of wasted promotional money in retail and there is earnings upside in the order of 3% to 5% by taking an analytical approach to promotions. Super Retail Group and Woolworths have introduced new systems to manage promotions, improving the efficiency of promotional spend and lifting gross margins.

Treasury Wine’s recent US investor tour provided a reinforcement of its direction, rather than any change. The company is clearly focused on premium wine growth, with an increased emphasis on new product development and a desire for bolt-on acquisitions. The reality for the company will be very low volume growth and a continued mix shift leading to modest revenue growth. Marketing investment may rise once EBITS margins targets are hit in our view. We expect 16% EBITS growth in FY23e and 11% in FY24e.

Australian retail sales growth of 7.7% for January 2023 year on year is a healthy rate of growth overall, but under the surface shows a shift in the allocation of spend, away from housing-related retail, towards recreation and dining. The drop in growth for housing-related retail is inevitable given its two years of elevated growth combined with a fall in housing churn. Other categories will slow soon, but for the time-being they are benefiting from the normalisation of supply and consumer preferences.

The debate about Australian wage rates is about to flare up as submissions are made for the FY24e minimum wage determination. We think a result anywhere from 4%-8% wage rate growth is possible. At 4%, retailers are likely to manage decent margin outcomes given some variability in staff costs. At 8%, the impact on retailer EBIT could be a hit of 5%-15%. For consumer goods producers the earnings impact could be -20%. The retailers most vulnerable are Domino’s and the supermarkets, Coles, Metcash and Woolworths. Costa and Inghams have high fixed wage costs and could be hit too, but the impact may be smoothed over two years given enterprise agreements.