JB Hi-Fi provided a FY22e trading update with consistently strong sales and better gross margins in 2H22e. EBIT was 9% ahead of our forecast. The strength in sales, tightness of inventory and price rises make us more bullish in the near-term (FY23e) but more cautious on FY24e. With a net cash position, good dividend yield and low PE, we expect the stock to perform well.

Australian retail sales rose 10.3% in May 2022. While it is a slowdown from April’s growth rate of 11.1%, the moderation in growth is mild, particularly given the pressures on consumers from higher interest rates and petrol prices. The Easter boost to supermarkets, liquor and apparel has faded, but all categories did well in May other than takeaway food which was up only 2.5%. In our view, April 2022 was the peak of retail sales and growth will slow each month going forward. Negative headlines may hit sales briefly, but the more fundamental slowdown associated with lower household incomes is more a risk to 2023 sales growth.

As we enter the northern hemisphere summer, Australians are embracing travel again, but tourism spending is still far below pre COVID-19 levels. The drag on retail as consumers reallocate spending remains modest. Data shows airline capacity for Australia is still 15% below pre COVID-19 levels at June 2022 and much lower than that for international flights. The switch from retail to travel is likely to peak in 2023, in our view, adding to the headwind for retail next year.

Chart: Index of quarterly spending March ’22 vs December ’19 (selected items)

Source: ABS, MST Marquee. Shows quarterly data, seasonally adjusted.

Metcash reported FY22 sales of $17.4 billion and EBIT of $472 million. Adjusting for the 53-week in FY22, sales rose 4% and EBIT rose 16%. The results reflects higher price inflation across all divisions and a mix-shift towards the Hardware division, which has higher margins. Metcash has been able to hold onto much of its customer gains made during COVID-19. While we expect a lack of EPS growth over the next two years, the company’s competitive position has improved in each division.

There is much to debate about when retail sales slow, how far sales drop and how much margin downside will be associated with the sales weakness across the sector. We think the central driver of the debate is how quickly and far interest rates rise. In our base case (67% probability), the RBA reaches 2.5% cash rate by December 2022. In our downside case (33% probability), the cash rate reaches 4.5% by June 2023. There is downside risk to earnings for retailers over the next 18 months. We expect a volatile 12 months and advocate caution.

We expect the stock to perform well as the market better understands the benefits Metcash has from higher inflation, the fundamental improvement in its Food market share and multiple revenue drivers in Hardware. Metcash’s market share in grocery has been stable since 2018, a function of its retailers’ better relative price position and less aggressive store openings by rivals. In its Hardware segment, Metcash will benefit from Total Tools store rollout as an offset to a cyclical industry-wide decline in late FY23e.

Domino’s “rebasing” of sales is only one of the challenges facing the company over the next two years in our view. The company and franchisees face higher costs and store rollout could slow. The cost pressures that have built in the past six months are likely to lead to some margin pain for Domino’s as it preferences store rollout and market share growth.

While retailers and manufacturers have grappled with a range of cost pressures already, wage cost pressures are only starting to build now. In Issue 3 of Price Watch, we analyse the size and scope of likely wage pressure facing companies. As most retailers are inextricably linked to broader wage-setting mechanisms, we may see an additional 2%-3% higher annual wage inflation over the next two years. The companies with the highest sensitivity to wage inflation are Inghams, Costa Group, Coles and Woolworths.

Australian retail sales rose 11.1% in April 2022. This is a remarkable growth rate with a three-year CAGR of 9.1%. The detailed disclosure by the ABS showed a meaningful acceleration in supermarkets, liquor and department stores. We attribute this move to the rebound in domestic tourism given school holidays in April. Even though we are positive on retail spending, these growth rates are unlikely to persist. We think April is the peak with a gradual slowdown this calendar year and more noticeable one in 2023.

Wesfarmers strategy day was as comprehensive as usual but did leave us with a few unanswered questions about the finer details of its digital plans, capex outlook and Health ambitions. We expect growth in trade for Bunnings will be difficult without capex and the digital opportunity will take time to build traction. We remain cautious on Bunnings sales outlook.