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2 ASX shares outperforming the retail downturn

Retailers are struggling as Australian households continue to tighten their purse strings in the face of economic uncertainty. Consumer spending is down, leaving a wave of retailers in sectors from clothing to fast food to shut up shop. Those that remain struggle in a highly challenging environment.

The annual rate of sales volume growth has been in steady decline since the start of 2018, reaching its weakest point since the 1990s recession in FY18–19. The falling Australian dollar has hiked retail inflation, providing a disincentive for shoppers looking to save, while the drought has increased food costs, putting further pressure on household budgets. 

Difficult conditions and downgrades

Rising costs combined with weak wage growth have combined to erode discretionary spending. Listed retailers have struggled, with the ASX consumer discretionary index (ASX: XDJ) sitting at similar levels to a year ago. The consumer discretionary sector covers companies selling goods people buy because they want them, rather than because they need them. Consumer discretionary stocks, therefore, tend to be more vulnerable to recession and downturns in household spending. 

Profit downgrades have been on the cards for companies exposed to discretionary spending. Nick Scali Limited (ASX: NCK) issued a warning on Tuesday that profits could fall by more than 30% in 1H20 following a drop of 10–15% in sales between July and October. Investors fled the stock as a result, with shares closing on Tuesday down 14% at $6.21. 

Southern Cross Media Group Ltd (ASX: SXM) blamed weaker advertising spending for its earnings downgrade on Tuesday. Revenues for the September quarter were down 8.5% compared to the previous year. The media conglomerate saw its shares pushed 23% lower over the course of the day, and now sitting at $0.87 at the time of writing. 

Upside surprises

Despite all the doom and gloom, there are some bright spots on the horizon. JB Hi Fi Limited (ASX: JBH) continues to perform strongly. Despite its status as the seventh most shorted stock on the ASX, the company has managed to shrug off predictions of its imminent demise. The JB Hi Fi share price has instead risen more than 60% over 2019 to sit above $33 today.

The retailer has performed strongly in the face of online competition. Sporting a healthy dividend yield of more than 4%, JB Hi Fi has so far defied the naysayers. The FY19 dividend was up 7.6% to $1.42 per share. Earnings before interest and tax were up 6.3% to $372.8 million despite store numbers increasing by only 1.2%. 

Sales in FY19 were $7.10 billion, up 3.5% from $6.85 billion in FY18 despite increased competition and a subdued spending environment. Sales of $7.25 billion are forecast for FY20. JB Hi Fi maintains a strong balance sheet with net debt of $320 million, down $77.5 million following a restructure of debt facilities in FY19. The company’s gearing ratio is a solid 1.0 with interest cover 26.1 times, up from 21.1 times in FY18.

Myer Holdings Ltd (ASX: MYR) is another retailer that surprised on the upside this year, reporting a full year profit for the first time in 9 years. The grand dame of department sales has been on short sellers’ radars for some time, and is the 35th most shorted stock on the ASX. Hovering around $0.60 today, the share price is well below its $4.10 debut, but the store is fighting back.

CEO John King has a plan to restore the department store’s fortunes by deleveraging the business and focusing on the customer. While total sales were down 3.5% in FY19, King partially attributes this to the business’ focus on profitable sales. The cost of doing business was reduced by $32.6 million over the year, reflecting renewed discipline in management of costs. Further opportunities to reduce costs have been flagged, particularly in Myer’s supply chain. 

Myer has made decent progress in reducing its retail footprint. Working with its landlords, Myer has either closed or announced the closure of 29,000 square meters of gross lettable area. A further 5–10% of store space is under active discussion. 

The balance sheet looks much healthier with net debt down $69 million to $39 million. The retailer’s net leverage ratio is down to 0.27x from 0.72x in FY18. The dividend, however, remains suspended. While Myer’s improved FY19 results were largely a result of cost-cutting and reducing floor space, as opposed to increased sales or customer numbers, the retailer is making progress as it seeks to bring the business back to health in challenging conditions. 

Conditions moving forward

Retail spending has ticked up a notch recently, increasing 2.3% in August compared to the same month last year. The government’s tax offset and the June and July rate cuts likely assisted by putting more dollars in the hands of customers. The October rate cut may further expand household spending power. The challenge of course will be to tempt those customers to spend at Myer, or JB Hi Fi for that matter, rather than elsewhere.

Myer is part way through the implementation of its ‘Customer First Plan’, which involves enhancing customers’ in-store experience, expanding exclusive distribution of brands, and improving the online store. JB Hi Fi is focused on realising efficiencies from its acquisition of The Good Guys and leveraging the increased scale of the group. 

The sugar hit of the tax offset will quickly fade and the impact of rate cuts may not be long lasting as borrowers turn to paying down their loans. Economic stimulus measures by the government including infrastructure spending may have some longer term, indirect, upside for retailers; however, this is not guaranteed. For now at least, it seems to be a case of survival of the fittest. 

Foolish takeaway

Retailers who survive (and even prosper in) the lean times should be well positioned to take advantage of an eventual retail recovery. Jobs and wage growth will lead the way to stronger consumer spending and an uplift in retailers’ bottom lines. The recovery in the housing market offers hope that as households feel wealthier, wallets will open more readily. Yet with the economy growing at a sluggish 1.4%, the slowest rate since the GFC, retailers have a tough job ahead of them. 

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Motley Fool contributor Kate O'Brien has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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