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Amazon's low-key start a positive for retail stocks

Amazon's low-key start a positive for retail stocks

By Tony Featherstone 11.12.2017

In cricket terms, Amazon’s launch in Australia this week seemed more like medium-pace bowling than a barrage of bouncers at jumpy retailers. After a year of hype, consumers and investors expected an aggressive attack from the e-commerce giant.

Commentators and analysts argued that Amazon’s product depth and price discounting was tame. Some rivals said the launch was a “non-event”. Amazon said the launch was its biggest-ever international opening, attracting tens of thousands of visitors. 

I am not an avid online shopper. So, for this story, I spent a few hours on Amazon, checking products and comparing prices with bricks-and-mortar retailers.  

It felt ho-hum: some good bargains, but not enough to change shopping habits. And not nearly enough impact from the site to dent the critical Christmas trading period for retailers. If anything, the launch creates an opportunity in retail shares.

That said, it would be foolish to discount Amazon’s threat. Australian retail has never faced a competitor with a US$552-billion market capitalisation that can lose money in this market for a decade as it builds market share, without creating a blip on its balance sheet.

My guess is Amazon deliberately took a low-key approach, its soft launch used to test the platform and systems, before a larger assault in the next 18 months.   
Amazon’s product range in Australia will surely deepen and its pricing will become more aggressive. If Australia follows international trends, Amazon will eat into market share and inflated margins of many retailers.

But the hysteria about Amazon in Australia, at least for now, is overdone. Several retail stocks were smashed on fears that Amazon would create retail Armageddon. Retailers from pet-accessories to car-parts providers were hammered on Amazon-inspired fears.

As I wrote for The Bull last month, the fact that Amazon had signed only one fulfilment centre, on the outskirts of Melbourne, reinforced its limited short-term impact on retailing. 

Online retailing is hardly new in Australia. Consumers here are used to buying goods online and several retailers have developed extensive e-commerce platforms. Again, they are far from immune to Amazon’s threat – it’s just that the market priced in too much future bad news.

Amazon’s launch removes a significant amount of uncertainty and the early evidence, scant as it is, suggests Amazon’s arrival won’t spark retail carnage (for now).

As argued in The Bull, my preferred way to play the sector is through retail Australian Real Estate Investment Trusts (AREITs), principally the owners of “fortress” shopping centres. Westfield Corporation, Vicinity Centres and Scentre Group are my preferred AREITS. I note that some property analysts are starting to recommend retail AREITs more aggressively.

Like retail stocks, retail AREITS were sold off on fears that Amazon’s growth would lead to more department and discount stores exiting space in shopping centres. But the best shopping centres in Australia are near full occupancy and have maintained rents as leases have expired. Prime shopping centres are fabulous, hard-to-replicate assets that continue to attract more shoppers as they morph into entertainment precinct and de facto “suburban CBDs”.

These REITs rallied last month and I see further gains over the next 12-18 months as the market revalues their assets based on recent transactions in private shopping centres (notably in Queensland) and as it becomes clearer that demand for space is holding up.

I preferred retail property owners to retailers because of sector risks. Better to own the property owners than those renting the space. But Amazon’s launch in Australia creates more confidence to focus on oversold retail stocks.

Harvey Norman Holdings stands out. The prominent retailer, a target of short sellers in recent years, has critics over its reporting and governance policies. Harvey Norman has fallen from a 52-week high of $5.24 to $4.12 in line with the broader retail sell-off.

Some good judges who have not touched retail stocks for years are starting to buy Harvey Norman. With JB Hi-Fi, Harvey Norman was viewed by the market as a key loser from Amazon’s arrival in Australia, principally through its sale of small electronic goods.

The market views Harvey Norman as a traditional bricks-and-mortar retailer without a vibrant omni-channel offering that covers online sales. Critics say its business model is being overtaken by e-commerce platforms and emerging digital rivals.

The market has a knack of writing off Harvey Norman, only for it to report record sales and earnings growth and surprise doomsayers. 

The retailer in November reported strong sales momentum from its franchisees for the first four months of FY18, but it is likely that growth will slow and margins contract a little, amid worsening retail conditions and consumer nervousness. 

Against that, Harvey Norman is an obvious beneficiary from above-trend population growth. As a population the size of Canberra is added to Australia each year, demand for its furniture, white goods and electrical products has tailwinds.

Harvey Norman’s valuation reflects its challenges. At $4.12, the stock trades on an expected FY18 Price Earnings (PE) multiple of 11.6 times, based on consensus analyst forecasts, and should yield a bit over 6 per cent, fully franked.

Those are reasonable metrics given the company’s market position and excess franking credits. It may take time for Harvey Norman to be re-rated given the retail malaise and concerns about the online threat, but the yield should suffice in the interim.

Still, there is no rush to buy Harvey Norman or other retailers right now. Value investors should watch and wait for better value – retail will get worse before it gets better.  Flat retail sales growth in September, announced this week, reinforces the retail malaise. Economists a small rebound in sales growth after a savage fall in August. Apparel was especially weak.

Chart 1: Harvey Norman Holdings 
Source: The Bull

• Tony Featherstone is a former managing editor of the BRW, Shares and Personal Investor 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 the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/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 December 7, 2017.


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