Australian retail sales rose by 1.6% year on year in February 2024, adjusted for the leap-year effect. Sales trends are very weak, given population and price are still positive contributors to retail. As a silver lining, retail is now almost back to pre COVID-19 underlying sales trends. Perhaps the mean-reversion is done? The weakest categories in February were furniture, electronics and footwear. Pharmacy, cosmetics and apparel did well. We expect retail sales growth to continue to hover around 0%-2% over the next few months.

Many Australian consumer companies are likely to report weak 1H24e results. However, they are likely to be better than consensus estimates with slightly better sales trends and higher gross margins in some cases. While earnings should be fine this half, share prices have run in anticipation of results and the trading updates and outlook commentary are likely to flag higher operating cost growth as a headwind.

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.

The debate about Australian wage rates is about to flare up as submissions are made for the FY24e minimum wage determination. We think a result anywhere from 4%-8% wage rate growth is possible. At 4%, retailers are likely to manage decent margin outcomes given some variability in staff costs. At 8%, the impact on retailer EBIT could be a hit of 5%-15%. For consumer goods producers the earnings impact could be -20%. The retailers most vulnerable are Domino’s and the supermarkets, Coles, Metcash and Woolworths. Costa and Inghams have high fixed wage costs and could be hit too, but the impact may be smoothed over two years given enterprise agreements.

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.

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.