Consumer staples and retail – Amazonian risk or a sector on sale?

Here are the issues facing the consumer currently: 

This has all led to reasonably weak consumer sentiment and therefore spending. The state of the housing market is critical in our view, as it has been one of the few tailwinds supporting the Australian economy and therefore spending in recent years. Undoubtedly, some of the heat has come out of the market (especially in relation to pricing), however this had to happen and we expect reasonably solid conditions to persist from here, supported by historically low interest rates. 

In the background, the retail sector has de-rated significantly on fears regarding Amazon’s potential entry into Australia. We have reached a point where investors and market analysts are now trying to estimate the potential impacts (market share and margin losses) for businesses, particularly in the key categories at risk such as electronics, sporting goods/equipment, homewares, clothing and toys. 

While there will obviously be some impact to Australian retailer earnings, this is still largely an unknown at this point (and this is one of the key reasons the market has placed lower earnings multiples on the sector). We believe that periods of noise and volatility such as these present opportunities for investors who are willing to go ‘bargain hunting’ for high quality names that have defensible brands and established market positions. While Amazon has one of the best business models in the world, just like has occurred overseas, we believe the strong/category killer retailers will survive and potentially even prosper in a post Amazon world (unfortunately benefiting from the likely demise of small/ independent retailers). 

For supermarket operators, the big news recently has been Amazon’s acquisition of Whole Foods Market in the US. This is by far Amazon’s largest acquisition to date and shows it is serious about growing its grocery capabilities. Whole Foods’ 450+ store network also gives Amazon a much stronger physical presence across the US. Having this national presence gives Amazon many more consumer touch points and these store locations can act as micro-fulfilment centres over time where goods can be dispatched to consumers locally, allowing for even faster delivery times. 

While it will take some time for Amazon to bed down its grocery strategy following the Whole Foods acquisition, Amazon’s arrival in Australia will almost certainly mean higher competition for the Australian supermarket sector. Woolworths, Coles and Metcash are already seeing intense competition from Aldi and to a lesser extent Costco. Kaufland/Lidl has also flagged its intention to enter Australia over the next few years so life is not going to get any easier for the incumbents. This will put further pressure on earnings and margins and as such, we don’t see any compelling reason to be exposed to the sector at this stage. 

Overall, we remain cautious on the consumer and the retail sector more broadly. However, we also believe, as always, there are opportunities among the ‘noise’.