Predators circle as retail wheels fall off

With a little more than six weeks to go until the close of books for the 2012 financial year, a few listed entities have already warned of a less-than-flash profit season. But most have chosen to hold their fire.

It makes for an interesting situation as anecdotal evidence suggests things are worse than the official Bureau of Statistics retail sales figures for March, which showed Australian retail sales managed to break their six-month slide in growth with a 0.9 per cent month-on-month increase - its best in nearly a year, and well ahead of a consensus forecast of 0.2 per cent.

Indeed a well-regarded industry survey of retailers, wholesalers, consultants and suppliers conducted by Evans & Partners last month described the sales outcome for April as "alarming" and showing a significant widespread deterioration.

The findings of the survey, used by industry operators and high net worth investors to pick emerging trends in listed retail stocks, is consistent with the recent 16 per cent profit downgrade by JB Hi-Fi for 2012 and the 44 per cent profit fall in Harvey Norman's third-quarter results or a 24.8 per cent fall for the nine months to March 31.

It raises question marks over which retailer might be next. There is already speculation that Billabong is considering a profit downgrade after the chairman, Ted Kunkel, refused to discuss its profit guidance at an analyst briefing last week to announce a new chief executive.

The big white hope for the sector is that the dollar falling below parity, the cut in official interest rates and last week's move by the federal government to introduce stimulus measures via cash handouts might save parts of the sector from a round of profit downgrades.

The Evans & Partners survey asks participants to rate trading conditions on a scale of zero (weak) to 10 (strong), with five as the mid-point representing an "in line" result. The overall results showed widespread deterioration. "While we must take into account both variables caused by the timing of Easter and that April 2011 was relatively strong, the weakness in this month's sales outcome is alarming. Significant deterioration was widespread and consumer electronics was particularly disappointing off an already low base," it says.

The survey revealed that consumer electronics was particularly weak, with discounting more pronounced and customers more selective. In terms of profit margins, the greatest weakness was in the household goods segment, while the greatest improvement was in sports, leisure and entertainment.

In terms of sales channels and locations it noted only online delivered improvement last month, with shopping strips and airports suffering the greatest level of weakness.

In other segments, wholesalers reported a fall in supermarkets last month, discount department stores showed some relative improvement and department stores continued to disappoint on sales from branded wholesalers.

Most disturbing of all is that foot traffic fell off and the level of discounting intensified, after taking a breather last month. Worst hit was consumer electronics.

The knock-on effect of weak retail sales is profound across the supply chain. It can lead to a build-up of inventory, which is a profit killer for retailers, and results in tighter margins.

For Billabong the concern is margin risk and its retail strategy, for David Jones the risk is focused brand strategy, Harvey Norman the concern is mature and competitive consumer electronics exposure, for JB Hi-Fi it is growth but competitive consumer electronics exposure and for Myer the issue is perennial low sales growth.

Not surprisingly they have become the focus of some hedge funds who are punting that something radical will need to be done to arrest their falling share prices. In the case of Harvey Norman, its plunging share price will no doubt hit the screens of private equity looking to extract value by breaking up the company. With a market capitalisation of $2.1 billion, and an investment property portfolio valued in the books at almost the same, Harvey Norman has reached the point where something needs to be done to stop the rot.

While there is little doubt that macro-economic factors, such as weak consumer spending, the crisis in Europe and the internet, are challenging the entire retail sector, the reaction of most companies through discounting has become a race to the bottom.

The decision to buy sales by heavily discounting and leaning on suppliers to fund promotional activity is a vicious circle as it trains consumers to wait for sales. The rest of the sector is then forced to follow, and so it goes on.

But there are some segments that have managed to rise above it all and produce solid results. These include hardware, which, according to the Evans & Partners survey showed a solid month of sales and gross margins. It noted that Woolworths' Masters' suppliers reported slightly disappointing sales.

In the past year the retail sector has been littered with profit downgrades and collapses, including Borders and Angus & Robertson, Colorado and Fletcher Jones. The jury is out on what the rest of the year holds.