Shopping for blue-chip retail bargains

The discretionary retail space is mixed, but the big supermarkets still represent good buying value.

Summary: Consumer spending is higher, with household wealth at record highs. Even after a hard run, both Woolworths and Wesfarmers are still attractive stocks and offer value.
Key take-out: Woolworths has the earnings and proven management record to be a key beneficiary from any retail re-rating.
Key beneficiaries: General investors. Category: Growth.

Sentiment has rebounded sharply of late – a vast change from the mood late last year.

Aussie stocks are surging, the reporting season suggests analysts were probably too bearish in revising forecasts lower – and investors are increasingly looking at ways to respond. I suggested last week that readers not get too caught up in any re-rating of our discretionary retailers. There are some duds in that space and barring JB H-Fi, the good ones are already quite expensive. Having said that, though, the fundamentals for household spending are truly outstanding. It’s not something that is widely appreciated– and it’s not too late for investors to profit from it.

Consumers are still spending…

The Australian Bureau of Statistics’ national accounts figures have been telling investors for some time that consumer spending was robust – all through the debate about whether consumers had put their wallets away or not. Most seemed not to believe the figures. But look at the charts below; they show that, in nominal terms, spending is just below average while in real terms it is just above. The difference between the two simply reflects the fact that inflation is below average at the moment.

Why were we even having the debate then? Because sales growth has been declining in some of our largest and best known retailers – Harvey Norman, David Jones and Myer – for years now. Moreover, the monthly ABS retail survey suggests spending is very weak – and falling.

But, and in conjunction with the national accounts, other consumer stocks show solid sales growth. I mentioned Super Retail Group last week but we also see Woolworths with half-year sales growth of 5.6%, and Wesfarmers’ retail operations with something similar (5.7%). Back in the discretionary space, Country Road has recorded comparable store sales of over 10%, and Kathmandu has 13% growth.  

You get the gist; consumers are spending but it’s not a free-for-all. Not all companies have been positioned to take advantage of changing consumer preferences and spending habits etc.

… and growth is likely to pick-up!

One of the key ideas I’ve been highlighting to readers is the huge impact confidence was having on our market. There was never anything really wrong with our fundamentals, but perception is everything. We saw that regarding the performance, or underperformance, of the All Ordinaries. People thought it was the strong dollar last year– but the dollar is still strong and our market is now at 4 ½ year highs! It wasn’t the dollar– it was just confidence!

Now, while spending has been robust, I suspect this low confidence has been weighing a bit, at least acting to contain some of the very strong fundamentals. I’ve put up some charts below to show readers just how supportive the macro backdrop is.  Now they are fairly simple charts and many of you would be familiar with them - but I think it’s good to be reminded of the simple elegant facts about Australia sometimes. Things are actually quite good here – and now that confidence is improving, headwinds to the fundamentals have eased a lot.

Consider that household wealth is at record highs, and that financial assets alone are 200% higher than debt outstanding.  Total assets, including property, is 400% higher than debt. Obviously the wealthier households are, the greater the capacity to spend.

To see how powerful this impact could be, consider that a reduction to lower but still positive rates of savings (reasonable as sentiment improves) – let’s say to 3% over 18 months for illustrative purposes – would see consumption growth double from its current rate. Double!

Then we know the unemployment rate is low and household incomes growth is robust. Consumer confidence too has recently rebounded given that all the negatives of last year appear to have come to nothing. That the sharemarket has rebounded and the Reserve Bank has seen fit to hold rates steady also helps a lot. It should be noted though that weak consumer confidence over the last 18 months or so didn’t really seem to weigh on spending – car sales still rose to a record and people went overseas at a record clip. But it’s one less headwind as mentioned.

Think big blue-chip retailers

As I mentioned last week, there are some discretionary retailers who are making good coin, but those stocks are very expensive, they have a significant premium attached and, while I’m comparatively bullish on consumer spending, that’s not to the point where I would pay a premium for any stock in that space.

In the staples space it’s a different story, and when I look here I’m not seeing any premium for companies that still earn cash – surprisingly to be honest. Indeed, our largest retailers still retain decent value.

Take Woolworths (WOW) and Wesfarmers (WES).  Both have reported solid revenue and earnings per share growth consistently over the last couple of years and this performance certainly hasn’t been ignored by the market – both stocks have risen by about 25% and 36% since June last year.

However, even after such a hard run, both WOW and WES are both still attractive stocks and offer value despite these strong gains. Take a look at the table below showing P/Es for both stocks.

The table shows that even after such strong gains, WES’s current P/E of 21 is over the average P/E since the Coles acquisition in 2007. WOW, at a P/E of 17, appears to have more value as it is below the 10 year average of 18.4. Having said that, current earnings suggests lower multiples than that and WOW, which has had consistent EPS growth over the last three years of 9% or so each year, has a forward P/E (at June 2013) closer to 15. That’s cheap. For investors, this implies that there is at least 9% upside on WOW’s share price (on today’s P/E), or if this P/E moves closer to the average of 18.4, then that increases to about 18%.  The thing is, I think it more likely that we will see some multiple expansion (investors prepared to tolerate a higher P/E) as brokers run around re-rating the sector – at least to the average. And WOW has the earnings and proven management record to be a key beneficiary from any re-rating.

It’s the same general story for WES, perhaps less so as this stock is a bit more expensive. Although considering earnings momentum, its projected P/E could be in the cheap range. It’s a bit harder to estimate what would be a reasonable P/E year as its EPS profile is less consistent than WOW.

So to conclude my rap on the consumer sector, it’s clear that consumer stocks have had a hard run, but I think there is still some value to be found, especially (and luckily for investors) in some of our blue-chip retailers. It’s actually here where I think investors are best placed to take advantage of any re-rating in the consumer space.  Of the large staple stocks, WOW is my pick. 

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