Endeavour Group reported FY22 EBIT up 3%. Even though the operating environment is now normalising, we expect pressure on gross profit margins to keep a lid on earnings growth in FY23e. Retail gross margins are likely to fall in 1H23e and higher gaming taxes will detract from the earnings recovery in Hotels.

Inghams had a difficult FY22 with EBITDA pre AASB-16 of $135 million, down 35%. The worst of its disruptions are likely in the past. However, both higher feed costs and increasing operating costs are likely to still weigh on earnings in 1H23e. We expect 1H23e EBITDA to fall 9% and there is a good chance that its net debt to EBITDA rises to above 2.0x.

Treasury Wines reported FY22 EBITS of $524 million, an increase of 3%. EBITS remains above FY20 levels, which is an important threshold given the loss of China earnings over this time period. The tone of management’s presentation signalled the worst of the company’s challenges are behind it and there are many layers to growth. We agree and were encouraged by the improvement in gross profit margins for FY22, particularly in the second-half.

Super Retail Group reported FY22 sales up 1% and EBIT fell by 18% (52-week basis). While a fall, earnings are still well above pre COVID-19 levels and sales trends have started FY23e strongly. We expect a good 1H23e but weaker 2H23e as broader retail spending trends slow. Gross margins are likely to fall a little further and negative operating leverage could be evident in FY24e.

JB Hi-Fi reported FY22 EBIT growth of 7%, with 2H22 EBIT rising 33%. Sales momentum has strengthened slightly in July 2022 and the first-half of FY23e should see good earnings growth. Based on our analysis, it is calendar 2023 where sales could fall and profit margins decline. We are increasingly cautious on the stock given sales trends are likely to turn negative in calendar 2023.

Link to report

PE ratios are depressed across consumer stocks reflecting concern about an earnings decline. However, bears will need to wait at least another six months for evidence. FY22e earnings are likely to surprise on the upside for just about all retailers, trading updates will be strong and inventory should be down on February levels. It’s less clear cut how stocks will react, but any downturn is unlikely to be evident.

A thought to challenge conventional wisdom about price inflation in retail. Perhaps inflation is now within a sweet spot where retailers have price rises to address rising costs, but inflation is not high enough to crimp demand. On our analysis, more than half the outsized sales growth in retail over the past three years was a function of price inflation. In other words, less than half of the sales growth was heightened demand (volume). See the chart below. Inflation is portrayed as evil. Yet deflation is an even bigger headache for retailers. As it stands, retail inflation is between 0%-5% depending on category. This is lower than the general level of inflation in Australia. We expect more price rises over the next six months, which may contribute to better retail sales growth than some expect even as interest rates rise and broader living cost pressures hurt households.

We expect a strong year of earnings growth for Australian supermarkets in FY23e. Higher food inflation is boosting sales and gross margins are also rising. We lift our FY23e EPS forecast for the major chains. Woolworths has the strongest sales growth, followed by Metcash, then Coles based on our feedback. In the full report, we address the cycle of price inflation and outlook over the next 12 months; and the outlook for Coles and Woolworths gross profit margins and EBIT margins.

Australian retail sales rose 12.2% year on year in June 2022. The three year compound annual growth rate for June was 7.8%, significantly above long term trends around 5%. Drilling down into categories, the strongest were cafes & restaurants and fashion. The only spot of weakness was fresh food specialists. In our view, retail sales will remain strong through the next four months lapping lockdowns from a year ago, with the first signs of weakness possible in November 2022. Retail sales are likely to be weak in 2023 given lower household income growth.

Australian inflation for the June 2022 quarter was 6.1% and retail inflation was 5%. Packaged grocery inflation was at its highest in more than 30 years and electronics, a category that is typically deflationary, showed inflation of 4%. The good news for retailers is that the inflation remains within a sweet spot with nominal sales growth supported by price rises and a very limited volume response. Expect more retail price inflation over the next six months.