Beware the retail rally – Forager Funds

We are currently halfway through this year’s reporting season and some of the market moves in the retail sector following results announcements have left investors a bit confused to say the least.

There is a lot of volatility in the sector and it is a little unclear about what is happening and what the market is pricing in.

Companies such as JB HiFi (JBH), Nick Scali (NCK) and Super Retail (SUL) are performing well, whereas Adairs (ADH) and Myer (MYR)  have seen share prices hammered.

To make sense of it all Gaston Amoros, Senior Analyst at Forager, and I sat down to discuss the retail rally and one stock we would own at a discount.

Edited Transcript

SJ: Hi and welcome.

I’m Steve Johnson, Chief Investment Officer here at Forager Funds and we’re halfway through reporting season with a lot of the retailers already out there reporting their results. We’ve seen some pretty big share price moves.

You’ve got JB hi-fi, Nick Scali and Super Retail Group all performing well on the back of their results and on the flip side of that A s and my art seeing their share prices hammered, gassed on what’s been happening out there and what we’ve seen so far.

GA: Well, it’s a lot of volatility and and a lot of confusion, I think –

SJ: We’re confused or the market is confused?

GA: I think everyone’s a little bit unclear as to exactly what’s happening and what the market is pricing in.

So if you take something like Nick Scali (NCK) they reported an FY23 which I think was OK. It was in line. It was a strong finish for a difficult year.

Source: S&P Capital IQ PRO

But when you actually go one layer deeper, when you look at sales they were up 15% year on year. But that’s because you have eight more months of Plus inclusion. When you actually start digging into the written orders, they were down 8% year on year for the full year. And if you look at the second half, they were down 16% year on year.

These are like the written orders when you go and buy a sofa. So clearly the backlog of orders has diminished, that’s not a great leading indicator.

Now, the stock is up 50% as you said. We’re wondering why, possibly because it’s a good business, incredibly well run for the short term and the long term by Anthony Scali. And I guess people just want to get behind these businesses when they can.

SJ: Yeah, I look at JB Hi-Fi (JBH), they’re talking a lot about the cost of inflation that’s still to come through over the next year as well. Even though they are reporting some pretty resilient sales numbers in a difficult environment, they’ve got wage inflation of 5-point-something-percent coming through and rents are going up. You should probably expect to see those margins retract there in the next 12 months or so.

GA: I think Adairs (ADH) was a very good example of that. I mean, there is a stock that again, traded up from June into results like with the rest of the sector and after they deliver results the stock is back to what it was in June.

Source: S&P Capital IQ PRO

Precisely because of that margin crunch that you’re talking about. Utilities are up, wages are up, rents are up and the product is quite a cyclical thing you’re selling. So, that’s at the other end of the spectrum.

SJ: We talked about this sector at our roadshow as a sector that we were hoping to get some great opportunities over the course of the next 12 months amongst a few others. A fair bit of pessimism out there about it at the time. We’ve dipped a toe in the water. We’ll talk about it in the coming month report – we’re buying a little bit of Lovisa, but it’s not a significant investment for us in the sector.

Still – have we missed our chance here with these share prices running hard Gaston?

GA: That’s a million dollar question. Look, it’s unclear. I still have a lot of doubts particularly as we highlighted in the road show you had, you have 50% of the fixed mortgage book that is coming up for refinancing in this half in between June and December. That’s a lot of mortgages that are going to reprice from 2% to 6-7% or thereabouts.

So that’s a wall of money that has to be redirected from other uses into paying back the bank that cannot help the discretionary retailers.

SJ: Just because there’s more pain to come that doesn’t always mean share prices have further to fall. I think a lot of people make the mistake of thinking that as the worst possible results are coming out, the share price is also going to be at its low. We’ve seen in some other sectors, the share price will recover well before the business starts to recover as people start looking forward into the future.

James Hardie (JHX) is one that you’ve done a lot of work on over the past 12 months and we really wanted to add that to the portfolio and it’s run away on us as well.

GA: Yeah that’s a very good example. Towards the end of 2022 we did a lot of work on James Hardie and you could see how it was going to be a difficult cycle for the US, particularly on the repair and renovation side with people locked up in their homes, but not doing big renovations because they’re not buying and selling houses. They’re just staying where, where they are. And yet the market didn’t care, the stock is up 50%.

SJ: That’s well and truly possible here as well. I’ll personally be surprised if we don’t see more distress in this retail sector, but if we don’t – errors of omission are far less important than errors of commission.

I think it’s a good sign you’re looking in the right place, looking at the right sectors if share prices do well, from that point in time, even if you don’t own it, and we’re still hopeful and confident that there will be opportunities to crop up in this sector over the next 12 or 18 months.

For the moment, the stock market in general is being pretty optimistic, particularly about the better quality businesses. I think there’s a small number of companies that everyone wants to own and they’re taking any sign of positivity that they can to buy those stocks. I hope you’ve enjoyed today’s video.

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