Retail in the trenches; COVID-19 cuts

About the author:

Josephine (Jo) Little
Author name:
By Josephine (Jo) Little
Job title:
Senior Analyst
Date posted:
19 March 2020, 11:30 AM
Sectors Covered:
Consumer Discretionary, Industrials & Developers

It is an incredibly difficult time for the retail sector with various unknowns in these unprecedented times. Forecasting how this will all ultimately pan out is near impossible and we are sure investors will understand it is very difficult to recommend buying many consumer facing stocks currently.

As has been well reported, foot traffic in shopping centres has been significantly impacted in recent weeks due to COVID-19. While large format centres should be more resilient than traditional malls given the nature of the shopping experience, we doubt they will ultimately be immune.

Online sales growth/penetration should pick up meaningfully, but is unlikely to offset the impact in-store.

We actually think underlying trading conditions could be quite solid for some 2H20to-date as consumers bring forward purchasing decisions and brace for further Government restrictions. Less spending on offshore travel/entertainment/services and more time in our homes may stimulate demand for takeaway food, white goods, tech, aftermarket automotive and household goods spending for a period – with the caveat that stores actually remain open for business. We are mostly concerned with 4Q trading conditions and into 1H21.

Aside from lower foot traffic in mall/shopping centres for hygiene purposes, the more concerning future impact will be on confidence/sentiment (falling equity markets, rising job uncertainty, etc).

We think most will pull back on discounting (no foot traffic, no point) which will limit further GM pressure in 2H20. To manage costs, marketing budgets will likely be slashed as the easiest lever to pull.

Reduced rostering of casual staff and reduced trading hours may also be implemented, while wages and rent are largely fixed. Every cost lever possible will be pulled by retailers. We expect to see downward pressure on rents and an extension of payment terms requested by retailers – rental relief is likely.

The lower AUD/USD (60c at time of writing) poses an additional material gross margin headwind to most of our domestic retailers in FY21, should it persist here.

Being comfortable with balance sheet positions is also near impossible in retail when earnings uncertainty is so elevated, given large fixed cost bases. While most of our retailers have comfortable balance sheet positions currently, debt positions can increase quickly if/when trading stalls.

There is a risk all retailers breach banking covenants should stores close/activity grind to a halt. How the banks deal with this is uncertain. Final dividends are certainly at risk.

Change to forecasts

We lower forecasts across most of our coverage in 2H20 and 1H21 – but this doesn’t assume full retail store closures. Estimating the potential earnings impact is extremely difficult, if not impossible. We think retailers will wait until after the Easter period to provide trading updates. Earnings risk remains to the downside.

We see earnings risk as being most elevated for: Mosaic Brands (MOZ) (older customer demographic, shopping centre locations), Apollo Tourism & Leisure (ATL)(global tourism/travel shut-downs), Lovisa (LOV) (global foot traffic risk, less social events/demand, minimal online offering buffer), Accent Group (AX1) (multiple concepts/stores in shopping centres/malls), Michael Hill Jeweller (MHJ) (shopping centre foot traffic risk, high basket size/discretionary product) and Super Retail Group (SUL) (SCA should be resilient, while the leisure-related businesses pose a risk).

Conversely, we see the least downside earnings risk in: Dominos (DMP) (potentially a beneficiary assuming delivery/take-out is unaffected, market share gain potential, favourable FX), Bapcor (BAP) (more defensive product, although not completely immune), JB Hi-Fi (JBH) (potential beneficiary in tech/white goods) and Baby Bunting (BBN) (more defensive product, minimal shopping centre exposure). It goes without saying that if Australia employs stricter lock-down strategies (ie forces all non-essential retail stores to close), the earnings risk will be even more broad-based.

We have lowered ratings on MotorCycle Holdings (MTO) and Super Retail Group (SUL) to HOLDs in the short term. Despite very attractive valuations, both carry relatively high debt positions.

Our recommendation

We recommend treading very carefully with the consumer discretionary space given it is at the pointy end of any economic fallout, has high fixed costs and this situation is changing daily. Our preferred picks in this environment include: DMP, BAP, BBN, Collins Food (CKF) and JBH.

More information

Morgans clients can login to view our detailed retail sector update, or more generally browse all our research. Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: Analyst may own shares.The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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