PORTFOLIO POINT: Consumer spending has been strong for some time, and the factors that combined to erode the sales of the major retailers may be about to change.
When you look at the performance of Australian consumer stocks you can see they haven’t fared too badly this year.
By sector, consumer staples are up some 3.4% so far, compared to the broader All Ords decline of 0.8%. Consumer discretionary has outperformed even that – up some 4.5%. A new found love for retail? Not really. Over a longer time period, price gains are more what you’d expect in a defensive market. For instance, from a peak in 2007, staples are down 20%, which compares favourably to 40% for the broader index. Discretionary stocks are down 60%.
As a consequence, many metrics suggest retail stocks are very cheap, trading at some of the lowest valuations in decades. Consumer staples, as attractive as they have been for defensive plays, are still running a comparatively 'low’ P/E of around 16-17 times, which compares to the 19-20 range during the 2005-07 period. This P/E is even lower than what we saw through the 2002-04 period. Consumer discretionary stocks are worse off, with multiples some 12.5 times, compared to the low 20’s in the years prior to the GFC. You’ve really got to go back to the mid 90’s to see such low valuations and they don’t compare favourably to the broader All Ords at about 12.5 times now compared to the historical average of 14.3.
Chart 1: P/E of All Ordinaries, consumer staple and discretionary stocks
Now I know what you’re thinking. 16-17 times is still well above the market average of 12.5 times. Discretionary are spot on the average of the overall market. So what’s the problem? Stocks were simply overly expensive before and now have P/Es that more closely reflect reality – now that the credit-fuelled spending binge is over.
Well it’s a little more complicated than that. For a start, that view is only true if we can sincerely say there has been a genuine change in consumer behaviour. I’m not so sure it’s that easy and recent data emphasises the significant question marks hanging over the consumer sector. Up until recently, the market widely believed that consumer spending was weak. Some reports suggested the weakest in 50-years. Households were thought to be deleveraging and saving profusely. To be sure, consumers are saving, there is no question about that and the savings ratio has increased to multi decade highs.
Chart 2: Australian household savings ratio
But deleveraging? Well I’m not so sure. At the very least and according to this chart (from the RBA) below, we’re not adding to debt levels, but any deleveraging has been quite modest as you can see.
Chart 3: Household debt and interest paid (% of disposable income)
Nevertheless, high household savings and deleveraging were widely seen as weighing heavily on the retail sector and this was certainly the rhetoric that we were hearing.
Then came the March quarter national accounts. These figures really threw a spanner in the works, showing consumer spending was actually very strong, well above trend and a significant contributor to overall economic growth. Not what we’d been led to believe.
Chart 4: Australian consumer spending
It’s clear from the chart above that consumer spending has been strong for some time though, and at or above trend for about two years now. This latest quarter showed spending at its strongest in nearly four years – with retail and services spending both very strong.
So why the disparity? Well I think the problem is that there has been some confusion about what are turning out to be temporary trends affecting the bottom line of some retailers. Consider that there were actually some areas within consumer spending that had genuinely been hit hard. Clothing and footwear is a case in point. The national accounts show that spending on clothing and footwear (volumes) fell by nearly 4% from the March to September quarters 2011, the annual rate dropping from an above trend 4.3% y/y to a more recessionary like -3.7% y/y. That’s a huge drop whichever way you cut it. Nominal sales growth showed a similar drop in those three quarters. That’s your hit to DJ’s, Myers etc and explains a big part of the rhetoric from them – it is consistent with that.
But what drove it? High savings, consumer deleveraging? If that was the case, spending would have been weak elsewhere. But this isn’t what we are seeing in the data. Even big ticket items like cars have been very strong all throughout – this isn’t consistent with consumer deleveraging, caution or a shift in consumer preferences away from clothes or material goods toward services and the like.
Chart 5: Growth in car sales to the consumer market
Instead what I think influenced public perception was the growth in online sales and more importantly, price deflation – the former making a significant impact on the latter and, in the end, overall nominal earnings growth for some high-profile listed stocks. But, and for reasons I’ll discuss below, the forces driving this price deflation, or at least the pace of it, should subside somewhat. This should offer support to nominal earnings growth and public perceptions of consumer spending.
Indeed you can get a sense of this turnaround when you look at the jump in spending on clothing and footwear over the last two quarters. It’s been extraordinary. If price deflation and the threat of online were ongoing, it is unlikely we would have seen such a sharp about face in the trend.
Chart 6: Consumer spending (clothing and footwear)
To see why this trend should change, consider the story recently highlighted by Alan Kohler. It was about a new online retailer Iconic. What struck me most about Iconics’s strategy is that they seem to be making no attempt to compete on price – it’s all about service and convenience. This is a strange decision given online’s competitive advantage with regard to fixed costs. Lower prices would be a natural consequence - an easy offer.
It’s a doubly strange decision when you consider that price was most certainly a key factor driving the attraction of online retail away from your traditional bricks and mortar. Convenience featured, but where would it be without those lower prices. Online is, was, and will always be much more convenient and firms like Iconic will no doubt perform in this niche. However, I don’t believe we can overlook the huge attraction that lower online prices offered. Online can’t and will never be able to replace 'shopping around’. It can assist the research sure, but most consumers will still want to physically see and compare goods they purchase. Take away that price advantage and there is little incentive for consumers, having done the physical shopping, to then complete their purchase online. Online stores will score the convenience niche for repeat purchases, but make little headway into bricks and mortar overall without an incentive to complete the purchase online.
Anecdotally this does lend support to the idea that, in the Australian market at least, the price advantage offered by online retailing is slowly but surely being whittled away. Largely because of the growing unwillingness of global suppliers to supply the domestic market from online stores offshore, and for domestic online stores, only at prices which don’t undermine their traditional retail customer base. Major brands are leading the charge here. Price competition is the key casualty. That’s a two-tiered benefit to your traditional bricks and mortar. Higher prices and higher volumes.
The two other obvious factors that had also been driving prices lower were industry consolidation and the strong AUD. For example, in the electronics space you had Myer and Woolworths (through Dick Smith) exiting the electronics space. The removal of Myer and Woolworths as competitors should boost nominal sales and volume growth in the sector at stocks such as JB Hi-Fi. Most of the impact for the stronger AUD had already flowed through, even before the recent depreciation. A further lift in the AUD will probably be of little value then.
In summary then, ABS data shows that sales volumes have been robust for a while. If we do see price deflation ease off because of the factors I mentioned above, then we should start to see that translate into some strong nominal earnings growth for our listed retailers as well.
I would be very cautious in how you play it though. It’s not as simple as gobbling up the ASX 200 consumer discretionary index. This sector is actually a little more diversified than the name suggests – media stocks feature prominently, as do gambling, travel and the like. You only have to look at today’s announcement from Fairfax to see the danger in leaping in. But certainly for those who have avoided exposure to the sector, now is a good time to be looking for a good entry point.