Retailers delivering the goods
Summary: Consumer discretionary stocks have been among the best performers on the sharemarket over the past year, with an average total return of 38.6%. That compares with the market’s total return of 10.5% over the same period. With consumer confidence on the rise, the hope is that retail spending levels will continue to pick up, and that will translate into earnings per share growth. |
Key take-out: Eureka Report has seven “outperform” calls in the consumer discretionary space, with the average total return of the seven currently around 25%. |
Key beneficiaries: General investors. Category: Shares. |
Consumer-related companies have arguably handed in the most pleasing results of all sectors during this reporting season, as the group continues to be among the most celebrated on our market.
This will surprise many given the challenging operating environment, with retail spending relatively flat and the growing threat posed by fledgling online players.
But results from the sector have so far been very warmly received, as seen by the “profit announcement effect”, which measures the share price performance of a company on the day of its earnings release relative to the performance of the broader market.
ASX-listed consumer discretionary stocks that have reported results to Feb 18 | ||||
Company | Code | Period | Date of result | Announcement effect* (%) |
Country Road | CTY | Half yr | 2/03/2014 | 44.99 |
Webjet | WEB | Half yr | 13/02/2014 | 26.42 |
Kip McGrath Education Centres | KME | Half yr | 13/02/2014 | 22.75 |
Enero Group | EGG | Half yr | 13/02/2014 | 18.01 |
Domino's Pizza Enterprises | DMP | Half yr | 2/12/2014 | 11.37 |
Noni B | NBL | Half yr | 2/12/2014 | 8.09 |
REA Group | REA | Half yr | 2/04/2014 | 6.68 |
Slater & Gordon | SGH | Half yr | 2/12/2014 | 5.89 |
JB Hi-Fi | JBH | Half yr | 2/03/2014 | 3.12 |
Navitas | NVT | Half yr | 30/01/2014 | 2.96 |
Nick Scali | NCK | Half yr | 2/12/2014 | 2.95 |
Ardent Leisure Group | AAD | Half yr | 17/02/2014 | 2.83 |
RedHill Education | RDH | Half yr | 14/02/2014 | -0.26 |
Reef Casino Trust | RCT | Full yr | 2/12/2014 | -1.00 |
GUD Holdings | GUD | Half yr | 20/01/2014 | -1.04 |
Tabcorp Holdings | TAH | Half yr | 2/06/2014 | -2.04 |
Academies Australasia Group | AKG | Half yr | 2/06/2014 | -2.15 |
Automotive Holdings Group | AHE | Half yr | 14/02/2014 | -2.26 |
STW Communications Group | SGN | Full yr | 13/02/2014 | -2.36 |
Tamawood | TWD | Half yr | 14/02/2014 | -3.04 |
Fleetwood Corp | FWD | Half yr | 17/02/2014 | -4.85 |
Echo Entertainment Group | EGP | Half yr | 2/05/2014 | -5.54 |
Pacific Brands | PBG | Half yr | 18/2/2014 | -10.45 |
*Difference between share price and ASX All Ords on day of profit announcement | ||||
Source: Eureka Report, Bloomberg |
A pleasantly surprising result should trigger relative outperformance, while a disappointing report should see the stock lag the market.
Stocks in the consumer discretionary sector have enjoyed an average positive announcement effect of 5.3%, while the stocks outside the sector have only managed to pull 0.8% ahead of the ASX All Ordinaries Index on the day their results.
The consumer discretionary sector is broad, and if you looked at stocks that are more directly related to retail the results would be even more impressive. The companies that have disappointed – judging by the magnitude of the negative announcement effect – are not retailers in the strict sense. They include the gaming company Echo Entertainment Group (EGP), caravan and accommodation maker Fleetwood Corporation (FWD), and home builder Tamawood (TWD).
While most companies have yet to release earnings figures, and despite notable sinners in the sector – think Pacific Brands (PBG), The Reject Shop (TRS) and Super Retail Group (SUL), the overall strong share price movement is very encouraging for those who bought into the sector months ago on the belief that the retail industry was about to turn a corner.
Consumer discretionary has been the best-performing sector on the ASX All Ordinaries Index over the past 12-months, with an average total return of 38.6%. In contrast, the index has generated a total return of 10.5% over the same period.
Believers in the retail sector have every right to be feeling nervous this month. The robust gains have been driven by a re-rating of the sector, where price-earnings (P/E) ratios expand. The P/E expansion is a first stage of a recovery, but it needs to be followed by a material pick-up in earnings per share (EPS) growth.
As the chart above shows, the estimated P/E for the sector stands at 18.3 times, when its long-term average is 14.5 times.
As I have mentioned, it’s too early to say if we will see upgrades in EPS growth for the sector as most companies have yet to report their results, but current expectations are still fairly subdued.
In fact, many analysts do not believe EPS upgrades are imminent and are encouraging investors to take profits now because of the expected increase in joblessness and the very benign wage growth outlook (also see Lighten the retail property load).
It’s hard to escape the doom and gloom, with headlines reminding us daily about the thousands of jobs that are going to be lost in manufacturing and mining. Alcoa is the latest to announce mass layoffs as it closes its Victorian aluminium smelter, and it hasn’t helped confidence that Australia’s unemployment rate has just hit a decade high of 6%, even though wages grew a little more than expected in December.
But we might not actually need a tightening job market and an acceleration in wages growth to see a robust pick-up in retail spending. Don’t get me wrong; rising disposable incomes and the abundance of jobs are potent tailwinds for the retail sector. But consumers are already harbouring a large capacity of spending power.
I am referring to the household net savings rate, which is defined as net disposable income less final consumption expenditure. According to the Australian Bureau of Statistics (ABS), household net savings are hovering close to a record high of $26.8 billion, with households putting away over 10% of their disposable income for a rainy day.
The very sharp pick-up in the savings rate occurred during the dark days of the global financial crisis as retail sales growth slowed. Retail sales have started to increase again in recent months, with the savings rate stabilising. The chart below puts the retail spending to savings trend in perspective, with the ratio between total retail turnover and net household savings falling to 2.5 times from over 16 times.
This means that for every $1 households spend at shops and restaurants they are putting 40 cents away, when they typically saved little more than 6 cents for every dollar spent prior to the GFC.
If the household savings rate returns to long-term averages, total retail spend could theoretically jump by approximately 15% on an annualised basis without a contribution from wages growth or falling unemployment.
I am not suggesting this will happen in the short or even medium term, as Australians are not likely to lose their newfound fiscal conservatism in the current environment. But thinking that higher salaries and job vacancies are must-have ingredients for retail sales growth is missing the point.
The more important sales driver for retailers is confidence, and we are already seeing signs of improvement in recent months. Confidence will lift further as the job market stabilises, and Rio Tinto’s (RIO) historic workplace agreement with the Australian Workers Union, where workers at the Bell Bay aluminium plant will sacrifice automatic wage increases for job stability, could hopefully set a promising precedence and loosen purse strings.
It may sound over-optimistic to some, but I believe we will get the EPS upgrades this year and that will support consumer discretionary stocks. But I don’t think investors should expect the sector to lead the charge for 2014 after posting such robust returns in the last year. As I’ve stated before, this year belongs to resource-related stocks, although double-digit total returns are still probable, particularly for the stocks we have highlighted as “buys”. Adam Carr also refers to a likely pick-up in industrial stocks in his article today, Industrial zone set to rebound.
We currently have seven “outperform” calls in the consumer discretionary space, and while not all of these stocks have performed to expectations so far, the average total return of the seven currently stands at around 25%.
Consumer discretionary stocks with Eureka Report's "outperform" recommendation | ||||||
Company | Code | Date of rec | Price* ($) | Article Name | Total rtn* (%) | Alpha** (%) |
eBet | EBT | 26-Jun-13 | $1.13 | Small cap with biggest earnings upgrade | 179.86 | 161.23 |
Collins Foods | CKF | 7-Aug-13 | $1.76 | The next dividend dazzelers | 23.89 | 12.15 |
Pentel | PTL | 22-Jan-14 | $0.03 | Pentel cleans pp | 10 | 8.28 |
Retail Food Group | RFG | 30-Oct-13 | $4.58 | Small consumer stocks at Christmas crossroads | -2.18 | -3.16 |
STW Communications | SGN | 30-Oct-13 | $1.58 | Small consumer stocks at Christmas crossroads | -5.08 | -6.06 |
Specialty Fashion Group | SFH | 18-Sep-13 | $0.93 | Small cap surprises for 2014 | -7.53 | -12.38 |
AMA Group | AMA | 6-Nov-13 | $0.37 | AMA chief's double plan | -26.03 | -26.99 |
*On or since date of article **Difference in share price performance and ASX All Ords since recommendation | ||||||
Source: Eureka Report, Bloomberg |
The worst performer on the “buy” list is automotive services and accessory supplier AMA Group (AMA), with the stock shedding 26% since I recommended the stock on November 6.
The high profile and slow demise of the car manufacturing in this country, along with the fall in new car sales in January, is weighing on the stock, but AMA has little if any exposure to local car manufacturing.
The bulk of its operations are in the aftermarket, such as smash repairs, bull bars and service centres. Not only is AMA not affected by the woes confronting local manufacturers, its Australian bull bar fabrication business is the most profitable division.
Its chief executive Ray Malone told Eureka Report that he aims to double group earnings before he steps down in four years. This target is not in the share price, as consensus estimates forecast a 24% lift in earnings before interest and tax to $11 million by 2015-16.
AMA should appeal to income as well as growth investors, as the stock is tipped to generate a yield of 7% to 8% once franking credit is included.
Women’s apparel retailer Specialty Fashion Group (SFH) is also yet to come good. Heavy discounting and the falling Australian dollar (which drives up its import costs) are some of the factors weighing on the stock.
As I wrote two weeks ago, there is a risk Specialty Fashion could disappoint when it releases its half-year result on February 25. But any sell off would be a buying opportunity, as the challenges facing the group are more cyclical than structural.
Further, at least some of the risk is factored into its share price given that it is trading at a more than 30% discount to its peers on a price-earnings multiple basis. The cash generative business should also have little trouble growing dividends. The yield is forecast to rise to around 10%, with franking in 2014-15 from its current level of around 7.5%.
Think big, go smalls!
* This article is part of the 'It's Time' series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.