It is hard to get excited about discretionary retailers in this market. Several look cheap, but weak consumer confidence, volatile retail sales growth, and a sluggish Australian economy are a terrible backdrop for the sector. Business and consumers lack confidence to spend more.
Then there are structural threats of higher competition from foreign and online retailers. Buying turnaround stocks that face intense cyclical and structural headwinds is usually a recipe for disaster.
I cannot see much joy for retailers this year – a stabilisation of current trading conditions is probably the best the sector can hope for.
This week’s tame budget might help by not heaping more bad news on consumers, and record-low interest rates, a lower dollar, and lower utility bills will eventually lift confidence. But there is still a modest risk of Australia sliding into recession if iron ore prices keep falling and business investment stalls.
This column has mostly avoided retailers in the past few years. Exceptions were electronics retailer Dick Smith Holdings, featured in The Bull in April, Kathmandu Holdings, featured in August 2014, and Retail Food Group, which this column has had a strong positive view on for two years.
Retail Food has soared, Dick Smith has rallied from $2 in April to $2.20 in a falling market, but Kathmandu shares have halved over one year. I underestimated its sales challenges, competitive pressures, earnings volatility and management changes.
Other retailers, thankfully avoided, have been hammered. Myer Holdings, for example, has slumped from $2.50 in September to $1.55. It traded above $3 in early 2013. Like Kathmandu, Myer is seemingly trading at bargain prices, this week announced better-than-expected sales growth for the third quarter, and may be a takeover target if the sell-off continues.
Other retailers look more interesting. A theme at the recent Macquarie Equities Australia conference was retailers saying conditions remained difficult, but were at least stable. “The environment does not appear to have deteriorated further over the past 12 months, nor are companies expecting conditions to worsen from here,” wrote Macquarie.
Perhaps a trough is emerging for retail trading conditions. If consumer confidence can have sustained lift next year, some retail stocks appeal at current valuations.
Super Retail Group revs up
I prefer two old favourites, Super Retail Group and RCG Corporation. It is a good sign when stocks can rally in a falling market and go against sector trends. As bargain hunters look for beaten-down stocks, the smart money chases those trending higher.
Consider Super Retail Group. The provider of motoring accessories, boat and camping equipment, and sporting goods fell from $13.92 in 2013 to $7 late last year. It has since rallied to $10.27 after a solid half-year result, and it looks to have plenty of momentum.
Chart 1: Super Retail Group
Source: Yahoo Finance
In its latest presentation, Super Retail said auto sales were flat, leisure sales were slightly higher year-on-year, and sports sales were sharply higher. The leisure business had stronger like-for-like sales in the second half of 2014-15 and sports performed well across most categories.
Super Retail could have two strong growth engines heading into 2015-16 and store rollouts, refurbishment and promotions could help the Super Cheap Auto business improve. Watch for the leisure and sporting goods division to outperform market expectations and drive Super Retail higher in the next 12 months. It is due for a pause after recent gains, but there is a lot to like about the well-run retailer and its strong portfolio of retail businesses.
RCG sprints higher
Another well-run retailer, RCG Corporation, has also shot higher. The shoe retailer and wholesaler rallied from 72 cents in March to $1.16. The acquisition of New Zealand company Accent Group for $180-$200 million more than doubled RCG’s size and put a rocket under its stock.
Chart 2: RCG Corp
Source: Yahoo Finance
It looks like a smart deal. Accent is the exclusive distributor of Skechers, Vans, Dr Martens, Timberland (outside New Zealand) and other popular brands. The deal is materially earnings-per-share accretive, a reason why the share price raced higher.
RCG ticks plenty of boxes: astute management that can integrate a company-transforming acquisition, an ability to grow sales in weak markets, solid return on equity and barely any debt. I also like the long-term prospects for sporting and fashion shoes, despite online competition, as younger consumers spend more on footwear and as an ageing population lifts demand for walking and other exercise shoes.
If RCG and Super Retail can make solid gains in a challenging retail climate, they can surely make new highs when retail conditions start to improve next year, and the market rotates into undervalued consumer discretionary stocks with leverage to an improving economy.
Both retailers, due for a pause or share-price pullback, have terrific long-term prospects.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at May 13, 2015.