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.

Our view on retail sales is more positive over the next six months, but more cautious on calendar 2023. While the “fear” of higher interest rates makes headlines, the reality is the impact takes more than a year to show through as weaker spending. Near-term, higher wages, stored up savings and retail price inflation will support sales growth. We forecast retail sales to rise 3% in FY23e, down from 6% growth in FY22e. We expect FY23e household goods sales to fall 2%. Electronics, furniture, hardware will find it most difficult given the high baseline. Supermarkets should do well with food inflation driving 6% growth in FY23e. Two important swing factors are savings and inflation. A drop in savings to pre-COVID levels will help spending and inflation will partly offset lower volumes.

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.