Improving Manufacturing Prospects and Decent Resilience Witnessed in the Consumer Discretionary Sector

I. Sector Landscape

Australia’s consumer discretionary sector broadly encompasses household products, food retailing, clothing, footwear & accessories, department stores, and food retailing. Amidst surging disposable income and robust consumer spending, Australian retail activities generated 4.5% of total gross value added (GVA) in 2020, calculated to ~$81.36 billion. Consequently, the wholesale and retail trade industry secured $61.5 billion, 6% of foreign direct investment in Australia in 2020.

Key Macro Factors Supporting Growth

Improved Disposable Income: In September 2021 quarter, the household gross disposable income advanced by 4.6%, the fastest surge witnessed since the December 2008 quarter. The government support payments to unincorporated businesses and households, coupled with improved dividend payments, contributed to the rise in household income.

Figure 1: Quarterly Household Gross Disposable Income

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Growth in Compensation of Employees (COE): Public COE surged by 3.3% in September 2021 quarter, the fastest rate witnessed since June 2010 quarter, reflecting an increase in government support to manage the COVID-19 outbreak. Private COE slipped marginally by 0.3%, a considerably smaller decline than June quarter 2020 (national lockdown period).

Key Developments in Retail Trade

Lockdown Recovery Driving Quarterly Growth: The Australian retail sales volumes surged by a record of 8.2% in the December 2021 quarter. This follows a 4.4% fall in September 2021 quarter. High spending levels in discretionary industries drove the quarterly surge. Clothing, footwear & personal accessory retailing jumped by 43.1%, followed by a +18.8% increase in cafes, restaurants & takeaway food services, +9.0% increase in household goods retailing, +25.0% in department stores, and +6.8% in other retailing.

Figure 2: Monthly Total Retail Turnover

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Online Retailing at Elevated Levels: The total online retailing sales stood at $3,607.3 million in December 2021. Seasonally adjusted sales slipped by 4.9%, a third straight monthly decline. Total online retailing stood by 20.5% PcP and clocked $614.6 million growth on seasonally adjusted terms. In December 2021, food online sales stood at $1,062.2 million, and non-food online sales stood at $2,545.1 million.

Increased Business Turnover: In December 2021, business turnover in the retail industry advanced by 5.4% PcP and business turnover in wholesale trade advanced by 9.2% PcP. During the period, retail trade clocked 117.9 business turnover index points. Consumers have enthusiastically returned to their discretionary spending following the continued easing of restrictions.

Index Performance

The ASX 200 Consumer Discretionary (GIC) have generated a 2-year return of ~13.79%, compared to ~2.40% return by the ASX 200 Index. Increased penetration of smartphones, changing population demographics, higher disposable incomes, wage growth and favourable government support has led to positive gains in the sector.

Figure 3: The ASX 200 Consumer Discretionary (GIC) outperformed ASX 200 Index in the past two years by ~11.30%.

Source: REFINITIV as of 17 February 2022

Key Risks and Challenges

Household spending shrunk by 4.8% in September 2021 quarter (QoQ), and consequently household saving ratio surged to 19.8% from 11.8%, amid detraction of private demand by 2.4 ppts from GDP growth. For September 2021 quarter, gross value added by retail trade slipped by 3.4% sequentially, driven by unfavourable consequences of containment restrictions. Retail support from online platforms is gradually fading away, as manifested by a 4.9% decline in online sales in December 2021. Supply chain constraints and shortage of semiconductor chips have already disrupted consumer electronic products’ production.

Figure 4: Key Drivers v/s Key Constraints

Source: Analysis by Kalkine Group

Outlook

Improved Private Capital Expenditure: The new private capital expenditure in buildings and structures by retail trade has advanced by 8.8% in September 2021 quarter on a QoQ basis and 15.0% PcP. The improved capex influx directs to improving growth prospects for retail.

Considerable Support to Manufacturing Activities: Australia’s manufacturing in the discretionary consumer sector seeks growth opportunities in smart manufacturing, innovative products, and reasonable business strategies to pass on inflation impact to consumers.

Intact Non-Cyclicality of the Sector: Considering the decent online position of retail businesses, the sector has remained stable during the COVID-19 scenario relative to other sectors, considering their large market volatilities witnessed at a global scale.

Positive Discretionary Spending: Consumers have successfully returned to elevated discretionary spending following the impact of containment restrictions in October 2021. The Australian retail sales volumes have pent up by a record growth of 8.2% in the December 2021 quarter.

Improved Labor Supply Supporting Manufacturing Prospects: In January 2022, the unemployment rate stood low at 4.2%, and subsequently, the participation rate edged up to 66.2%. Recovery in the labour market has turned into a favourable signal for the industry.

II. Investment theme and stocks under discussion (ALL, SGR, HVN)

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ multiple method.

1. ASX: ALL (Aristocrat Leisure Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$27.44 billion)

ALL is an Australian gaming provider and game publisher. Product categories include casino management systems, electronic gaming machines, and digital social games.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of 16.34% on 17 February 2022. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple) given potential travel restrictions and potential hurdles in acquisition of Playtech plc. For valuation, peers such as Jumbo Interactive Ltd (ASX: JIN), Tabcorp Holdings Ltd (ASX: TAH), Retail Food Group Ltd (ASX: RFG), and others have been considered. Given the substantial topline improvement, strong profitability, decent liquidity position, curtailed financial leverage, current trading levels, and upside indicated by valuation, we give a “Buy” recommendation on the stock at the closing market price of $40.300, down by ~1.660% on 17 February 2022. In addition, the stock has delivered an annualised dividend yield of 1.00%.

ALL Daily Technical Chart, Data Source: REFINITIV 

2. ASX: SGR (The Star Entertainment Group Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$3.52 billion)

SGR is an Australia-based business that provides gaming, entertainment, and hospitality services.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 17.83% on 17 February 2022. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple) given potential COVID-19 challenges and cost pressures. For valuation, peers such as Jumbo Interactive Ltd (ASX: JIN), Aristocrat Leisure Ltd (ASX: ALL), Flight Centre Travel Group Ltd (ASX: FLT), and others have been considered. Given the record EBITDA growth in Gold Coast Hotel, cash influx from asset sale strategies, current trading levels, and upside indicated by valuation, we give a “Buy” recommendation on the stock at the closing market price of $3.550, down by ~4.055% on 17 February 2022. In addition, the stock has delivered an annualised dividend yield of 5.77%.

SRG Daily Technical Chart, Data Source: REFINITIV

3. ASX: HVN (Harvey Norman Holdings Limited)

(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$6.62 billion)

HVN is engaged in business activities of the integrated franchise, retail, property, and digital enterprise.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 9.56% on 17 February 2022. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple) given high competition from pure-play players and COVID-19 uncertainties. For valuation, peers such as Wesfarmers Ltd (ASX: WES), Reject Shop Ltd (ASX: TRS), Myer Holdings Ltd (ASX: MYR), and others have been considered. Given the organic growth prospects, low financial leverage, rising profitability, current trading levels, and upside indicated by valuation, we give a “Hold” recommendation on the stock at the closing market price of $5.250, down by ~1.316% on 17 February 2022. In addition, the stock has delivered an annualised dividend yield of 6.57%.

HVN Daily Technical Chart, Data Source: REFINITIV  

Note: All the recommendations and the calculations are based on the closing price of 17 February 2022. The financial information has been retrieved from the respective company’s website and REFINITIV.  

Investment decisions should be made depending on the investors' appetite for upside potential, risks, holding duration, and previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and is subject to the factors discussed above.

Disclaimer

Kalkine New Zealand Limited is authorised to provide general advice only. The information on this website does not take into account any of your investment objectives, financial situation or needs. Before you make a decision about whether to acquire a financial product, you should obtain the Product Disclosure Statement from the product issuer. You should consider the appropriateness of advice taking into account your own objectives, financial situation and needs and seek independent financial advice before making any financial decisions.