Nobody doubts the retail sector faces immense cyclical and structural threats. But the best opportunities usually emerge when sentiment is unstoppably bearish and most stocks in a sector are sinking as investors fear the worst.
That is not to downplay the risks in retail stocks or the likelihood that many fallen retailers are “value traps” rather than good value. High exposure to consumer discretionary stocks is a recipe for wealth destruction in a slowing, uncertain economy.
My recent visits to a department store reinforced the carnage. A $99 shirt I liked was reduced to $49, but I was too busy to try it on, so came back a week later, only to find a 30 per cent discount on all sale items. I bought the shirt for a third of its original price.
I’m not a big shopper, but the breadth of price discounting was alarming. It’s hard to recall a mid-year trading season when so many items were on sale and discounts were so large. That says a lot about the struggle to sell clothing, even as winter ramps up.
The next day, I visited a popular strip-shopping area in Melbourne. By my count, at least one in 10 stores had a “closing-down sale” sign in the window, or was vacant. Trading was unusually quiet: lots of people in cafes and bars, but far fewer buying clothes.
Later that week, I read that fast-food chain SumoSalad was taking on several Westfield shopping centres over lease payments. As fashion sales stagnate, shopping centres are adding more dining precincts and increasing competition for food outlets. If any further proof was needed, food is clearly the new fashion in retailing.
That’s just the anecdotal stuff. The latest Westpac/Melbourne Institute index showed consumer sentiment slumped in June, a result that the bank’s economists described as “surprisingly weak”. Record-low wages growth is weighing on consumer optimism.
Then there’s the threat of Amazon ramping up operations in Australia and making life hell for retailers that still have decent margins. It’s hard to open a newspaper these days without another story on Amazon’s coming assault on Australian retailing. Some of it is hype, but Amazon will almost certainly disrupt consumer shopping habits in this market.
These factors explain why I favour Australian retailers that earn a growing proportion of revenue offshore – a position I have outlined in The Bull. Stocks such as Premier Investments, with its Smiggle empire, and Lovisa Holdings, a fast-fashion accessories chain, fit the bill. Kitchen-appliance-maker Breville Group is another.
Finding retailers that are less susceptible to online competition is just as important. A stock I favoured, Baby Bunting Group, has been hammered this year amid fears it could be roadkill for Amazon as price-conscious consumers buy baby goods online for less.
Brand and in-store shopping experience has never been as important. Kathmandu Holdings, another favoured retailer of mine, is holding up relatively better than its small retail rivals. Why? It has a loyal base of consumers who want the Kathmandu brand rather than generic substitutes bought online. Some big mid-year sales during a bout of colder weather have also helped Kathmandu, best known for its winter wear.
Bunnings, part of Wesfarmers, is another retailer well-placed to survive the Amazon onslaught. Amazon could be a formidable competitor in some hardware products, but many home renovators value buying products in-store and getting advice. Bunnings’ customer advice and service might well prove to be its key source of competitive advantage.
Beacon Lighting Group is another interesting retailer at current prices. Beacon sells lights, ceiling fans and light globes across a network of more than 90 stores in Australia. Most stores are company owned and the brand is popular with trade customers and homeowners.
Beacon listed on ASX in April 2014 through a $64-million Initial Public Offering (IPO). The company’s 66-cent issued shares soared to $1.05 on debut and hit $2.19 in May 2015. For a time, Beacon was among the market’s best-performed small-cap stocks.
Then the mood darkened. The shares tumbled to $1.26 in May 2016 after lower-than-expected earnings growth. After hitting $1.80 in May 2017, Beacon has slumped to $1.33.
Chart 1: Beacon Lighting GroupSource: The Bull
Some analysts believed Beacon would benefit from the demise of Woolworths’ Masters chain, which had slashed lighting prices to lure customers. Beacon struggled last year to compete with Masters’ 40 per cent price cuts in some lighting items.
But Beacon’s recovery was short-lived after a disappointing interim profit report in February and signs of margin contraction. Heavy share-price falls since May are most likely because of general concerns about slower retail earnings growth, Amazon-related fears and signs of a slowing housing-construction cycle and its effect on housing-products suppliers.
Make no mistake: Beacon has many challenges. But the business has a high (though declining) Return on Equity, low debt, and a solid market position. It is better placed than many small retailers to survive a competition onslaught in its market because it sources many products directly and has invested heavily in its brand.
Beacon is clearly well run. A return on equity of 32 per cent in FY16 is more akin to a fast-growing tech company than a long-established retailer. Beacon consistently ticks a lot of boxes for company quality and performance.
At $1.33, Beacon is on a trailing Price Earnings (PE) ratio of 18 times and yielding about 3.5 per cent. The average price target from a handful of analysts who cover the company is $1.50, suggesting some margin of safety at the current price.
From a charting perspective, Beacon’s ability to hold above $1.25 – an area where there has been previous price support – is encouraging.
• Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at June 20, 2017.