If retail stocks have held your gaze on the ASX, you might have noticed a consistent trend in their full-year reports: decreased income as customers cut back on non-essential spending. Does this signify a lacklustre future for retail? Probably not!
Read more of our guide into navigating ASX retail companies before parting with your shares, as hidden facets might reveal a more promising future amid the industry setback.
Retail overview
Pre-Pandemic, Pandemic Lockdowns, Lockdowns Lifted, Post-Pandemic Pressures
Prior to the COVID-19 pandemic, the retail industry was undergoing a transformative stage, especially in transition to digital. Retailers were setting up an online presence, and internet shopping had become dependable and easy. However, brick-and-mortar stores still asserted dominance as the preferred choice for shoppers. Retailers were trying out short-term pop-up stores and immersive shopping experiences to craft unique and memorable interactions with consumers.
The pandemic acted as a catalyst for accelerating the digital transformation, so rapid that even physical stores could never keep up. Online sales and e-commerce thrived due to in-store shopping restrictions, and non-essential items (which might have been overlooked in the pre-pandemic setting), saw a remarkable increase in sales. Money typically used for travel and entertainment was redirected towards home improvements and electronics.
At one point during the lockdowns, retailers even grappled with shortages and supply chain disruptions in keeping up with extraordinary volume of sales and pandemic demand.
Lockdowns were bound to be temporary, hence the scenario evolved again as restrictions were lifted. Shoppers are back in-store to get back that physical interaction to see, touch, and try out products before making a purchase. The aversion to paying shipping fees remained a strong motivator for in-store shopping, leaving online retailers heavily overstocked when demand for online shopping was not sustained upon the lifting of lockdowns.
Moreover, the industry was hit again by the highest inflation in four decades while everyone was still coping with the pandemic aftermath. Shoppers became more conservative in their spending behaviour due to fear of inflation and recession, leading online sales to slow down and surplus inventory.
In FY23, Kogan.com for example managed to drop their inventory level by 57% to $68.2m in order to enter FY24 with an appropriate amount. However, this achievement came with a trade-off, as there was a 28.4% drop in year-on-year Gross Sales to $844.8m, suggesting that the retailer had no choice but to give discounts on excess products to cope with overstocking due to the post-pandemic sales plummet.
Though so, not all retail shares are being harmed. The necessity to purchase goods and services remains constant, thus specific sections of the retail industry, like essential items and discount retailers, typically maintain a stable position.
Why invest in retail shares?
The retail sector is diverse and dynamic —and susceptible to changing consumer tastes. However, it comes with benefits such as:
Portfolio diversification: Retail is a broad sector encompassing a wide range of industries, from clothing, personal care, electronics, food to home goods. Investing in retail shares promotes portfolio diversification and reduces risk by not being overly reliant on a single industry.
Constant source of income: Some deemed retail stocks less volatile than other industries, because retail companies generate a steady stream of source of income from their sales.
Resilience: Retail stocks can benefit from economic recovery periods. As economies bounce back, consumer spending often increases, leading to improved sales and profitability for retail companies.
Long-term potential: Many retail companies have established brands, customer loyalty, and long-term growth potential. If the brand is able to constantly adapt to changing consumer preferences, they could provide solid returns over time.
Dividend Income: Established retail companies with consistent cash flow and a consistent dividend payment history can afford to pay dividends even during market downturns.
Omnichannel Strategies: Retailers that successfully integrate online and offline shopping experiences through omnichannel strategies might be better positioned to attract and retain customers.
Cyclical Opportunities: Retail stocks can be cyclical, meaning their performance can be tied to economic cycles. Savvy investors might buy when retail stocks are undervalued during a downturn and sell when they are overvalued during an economic upswing.
On the other hand, investing in retail stocks also poses some drawbacks, such as the cyclical nature of the retail industry. During economic downturns, consumer spending on discretionary items may decrease, impacting sales and profits for retail companies and short-term investors. Moreover, some retail companies rely on seasonal factors such as season or weather to deliver strong performance during certain times of the year.
In the highly competitive and saturated nature of the industry, companies must constantly innovate to remain relevant to consumers. Intense competition can lead to pricing pressures and lower profit margins.
Things to look for when investing in retail companies:
Just as you would when evaluating companies from all industries, the company’s financial statements should be carefully reviewed, including the company’s historical earnings consistency. A track record of stable or growing earnings can be a positive sign.
Other things to look out for are inventory level, turnover, and efficiency, the company’s competitive advantage, digital presence, and supply chain strategy. For dividend-seeking investors, examine the company’s dividend history. Consistent and growing dividend payments can indicate financial stability.
Common terminologies used in the retail sector:
Comparable-store sales: Known as “same-store sales,” this metric monitors sales for established stores, excluding new openings and closures. It’s a specific retail revenue measure assessing the growth of stores operating for a designated period, usually a year. Successful retailers display healthy same-store sales and solid overall revenue growth.
Gross margin: This percentage is obtained by dividing gross profit by revenue. Retailers typically experience increased sales during the fourth quarter due to holiday shopping. Gross margin trends provide insights into profit shifts and market expectations.
A drop in gross margins, whether excluding holiday effects or year-on-year, signals potential issues like lower sales, higher expenses, or notable merchandise discounts.
Cost of Goods Sold (COGS): The direct costs associated with producing or purchasing the goods, including expenses like raw materials, manufacturing costs, and labour.
Inventory turnover: A measure of how quickly a company sells its inventory. It’s calculated by dividing COGS by the average inventory.
Inventory days: The average number of days it takes for a company to sell its entire inventory. A lower number indicates efficient inventory management.
Inventory/receivable trends: Ideally, inventories and account receivables (AR) should be increasing in line with revenue, sequentially or year-on-year.
If inventories are growing faster than revenue, it might signal an issue with the retailer’s product and merchandising strategy. In such cases, the company might have to choose between discounting the overstocked product or writing off the merchandise altogether. Earnings would suffer in either case.
Clara is a Business Reporter for The Sentiment.
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