Amazon has made some noteworthy decisions in Australia. It now has a massive 200,000 sqm distribution centre (DC) operating in Western Sydney and has held back on raising the price of Prime, unlike the US. Is this a sign of more aggressive customer acquisition in Australia? Why is Prime so much cheaper here than in the US? In our view, Amazon is simply in its infancy. It will need to expand its same day delivery service before lifting the price of Prime. In order to offer same day delivery, Amazon probably needs 3-4x the DC capacity that it has today.

We have refreshed our forecasts for the retail sales outlook. In short, sales growth has started 2022 stronger than we anticipated and good conditions should last another six months. We forecast 4.5% sales growth in calendar 2022 (prev 3.0%) and 2.3% in 2023 (prev 3.0%). The overall two-year growth is virtually unchanged. While higher interest rates will impact spending, wages growth will be higher and the savings rate will cushion the impact. Higher inflation should also help retail sales.

Australian households and companies have not dealt with an interest rate increase for more than 10 years. However, higher rates are imminent. In Issue 3 of The Retail Mosaic, we assess the impact that higher rates may have on spending, company earnings and share prices. It takes, on average, 18 months for a rate hike to impact spending, but for furniture it can be in as little as six months. We expect housing churn will slow as rates rise, placing further downside risk on household goods. Retailers have limited debt and some hedging that will moderate the earnings risk from higher rates. However, PE ratios could derate by 10-20%, particularly for high PE defensive stocks such as supermarkets and conglomerates.

Australia’s 2022 wine grape harvest has been picked. The effects of China tariffs on the Australian wine sector are likely to show through as a sharp fall in grape prices this year. We see a drop of at least 15% for red wine grapes. While difficult for growers, we expect an earnings benefit for Treasury Wines over the next three years. We estimate a cost saving from lower grape prices of $75-85 million, or 12% of EBITS by FY25e. There are a number of drivers for Treasury’s earnings including a recovery of higher margin channels, supply chain savings and lower grape prices. We forecast three-year EBITS CAGR of 10% to FY24e.

Premier Investments 1H22 result was well flagged. The more interesting perspectives are that its gross margin remains high and rents are resetting as a lower share of sales. Sales trends so far in 2H22e are solid, which should provide EBIT growth in the half. The major share price driver for Premier from here is likely to be the ways it utilises its net cash position.

Treasury hosted a meeting with Treasury Premium Brands MD, Peter Nielson. The message was very clear about driving a higher EBITS margin. However, the path there is dependent on many factors. A better channel mix towards on-premise, more sales to Asia and leveraging 19 Crimes, Wynns, Pepperjack, St Huberts The Stag and Squealing Pig were all called out as drivers. We also see lower COGS as a factor in supporting margins over the next three years. Treasury Premium Brands accounts for 9% of our enterprise value. We expect the key business drivers to remain as Penfolds and the Americas.

Costa held a site tour of its expanded Guyra, NSW tomato growing facility. The company has added technology in propagating, growing and packing that will improve yields and lower costs per kg. The medium-term opportunity is growth in snacking tomato sales which generate a much high price per kg and could add up to $40-60 million to revenue on our estimates. See the report for more insights about its expanded facilities.

JB Hi-Fi provided a sales update revealing accelerating sales trends in February and March 2022. Given the high sales hurdle from last year, the trends are impressive and set the company up for a very strong 2H22e. We expect the sales strength to carry-on until late calendar 2022.

City Chic has a strong sales growth outlook but profit margins are likely to remain near current levels. Premier has a modest sales growth outlook from here and profit margins may fall. However, we see optionality given the company’s balance sheet. Premier may accelerate Peter Alexander store rollout, acquire a controlling stake in Myer or acquire a fashion business in youth apparel or accessories.

Higher petrol, coal and gas prices are a growing risk for retail, food and beverage companies. The magnitude of earnings downside would be in the order of 5%-10% if the higher prices continue for a full 12 months. We see near-term risk around transport costs for food retailers. For consumers, higher petrol prices may take away up to 0.7% from consumer spending. It’s equivalent to a 60bp interest rate increase. However, the price increase is still within the scope for households to absorb by lowering their savings rate rather than lowering spending.