Australian retailers have begun to experience a slowdown in retail spending and it’s going to get tougher over the next 4-6 months. We expect FY24e retail industry sales to rise 1.5%, a slowdown from 9.0% growth in FY23e. While this may sound gloomy, a glass half full perspective is overall sales may not slow any further from the trends as at June 2023. The glass half-empty view is that we may not return towards trend sales growth until 2025. The willingness of households to tap into excess savings shapes our view that the downturn will be shallow. We also note that food inflation will prop up that sector until early 2024. The path of price inflation is likely to have a greater bearing on sales outcomes more so than retail volumes, which are already in decline.

The Fair Work Commission’s decision to increase wages for FY24e by 5.75% will create a headwind for retailers. The magnitude of the pressure will depend on the sales run-rate and given we are already in decline in non-food categories, the squeeze from rising costs and falling sales could lower earnings in FY24e by 8%-14% for many non-food retailers. Our review of consensus expectations suggests the market is too low on cost growth for Bunnings, Super Retail Group and Premier Investments. We also note that the Fair Work Commission suggested that future pay rises are more likely to be above inflation, which adds to risks in FY25e.

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%.

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.

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.

While it is difficult to precisely forecast Australian retail sales given the uncertainties in the economy, we are confident enough to predict another solid year of growth. We expect retail sales to rise 3% in 2022, which is a strong result on top of 7% growth in 2020 and 5% growth in 2021. We estimate food sales will rise 4% and non-food sales to increase by 1%.  In our view, the three issues that will influence retail sales the most are the magnitude of price rises, the pace of wages growth and the extent to which consumers reallocate spending away from retail. Given COVID-19 is still with us, retail is likely to outperform once again.