A Perfect Retail Storm Is Brewing
Australian retailers generally fared well over the last 18 months during the COVID-19 pandemic, despite temporary store closures as part of government-imposed lockdowns, although headwinds may be on the horizon.
Inflationary pressure on consumer discretionary spending, supply chain disruptions and elevated inventory levels, which tie up a retailers’ net working capital, are set to create the perfect storm for retailers that do not have a strategy in place to ensure they are well positioned for the choppy market conditions ahead.
Government subsidies such as the JobKeeper payment scheme and rent relief regulations for retail and commercial tenants has kept some Australian retailers afloat and provided support to retain staff. Omni-channel retailers benefited from an increase in online sales with non-food online sales alone increasing by 29% in the last 12 months ending June 2022. However, online channels usually have lower profitability margins compared with traditional brick and mortar stores.
Ongoing Supply Chain Issues Compound Current Retail Challenges
Despite the government subsidies, the ongoing global supply chain crisis has resulted in delays in inventory orders and a significant increase in freight costs. In response, many retailers pre-ordered inventory, which resulted in some retailers now carrying significantly large amounts of excess inventory, which is already exacerbated by stores holding excess inventory following the 2021 lockdowns.
On a positive note, the Shanghai containerised freight index, which measures worldwide sea freight rates for imports from China, has been declining over the last few months and may provide some cost relief to retailers soon. Additionally, congestion at the Port of Shanghai, the largest port in the world, appears to be easing. Recent data showed there are approximately 130 vessels awaiting berth compared to more than 300 vessels only a few months ago. The average waiting time across all vessel types, including tankers, bulkers and containers, at Shanghai has reduced to 28 hours, which is down considerably from its peak average waiting time of 66 hours during the lockdown in China.
Shanghai Containerized Freight Rate Index from January 2019 to August 2022
Macroeconomic Factors Signal Trouble Ahead
As stores are reopening, many retailers are experiencing manpower shortages. Workers are seeking new challenges, creating both a labour and a skills shortage. Additionally, the wage increases established by the Fair Work Commission as of July 1 are affecting retailer operations and costs. With landlord abatements now coming to an end, some retailers are also reporting rental increases of around 5% for specialty stores and 4% for large store chains.
Household savings were 7% of disposable income at the end of 2019. This savings rate peaked at 23.7% in June 2020. By March 2022, the savings rate had fallen back to 11.4%, although it is still much higher than pre-COVID-19 levels. This is expected to decline further through the remainder of the year as revenge spending continues, particularly as the borders opening for travel. With the annual inflation rate in Australia surging to 6.1% in June because of new dwellings and rising fuel costs, many expect inflation to continue and potentially peak at around 8% in the coming months.
Australian Retail Sales and Consumer Price Index (CPI)
Source: Australian Bureau of Statistics (ABS), Reserve Bank of Australia (RBA)
Consumer sentiment fell by 3% to 81.2 in August, the nineth consecutive monthly decline, and remains well below the long-term average. A significant plunge in consumer confidence can be a sign of weaker spending to come. The ANZ-Roy Morgan Australian Consumer Confidence reported a slight decline of 0.6 points to 85 in the weekly consumer confidence report released August 29, which is now 16.8 points down from the same week a year ago. Overall consumer confidence also remains in deeply negative territory.
Australia Westpac Consumer Sentiment Index
Retail sales increased by 1.3% month on month in July and are 16.5% higher than July 2021, driven by a 3.8% increase in department stores and a 3.3% increase in clothing, footwear and personal accessories. Retail sales are still well ahead by 16.5% from the prior year.
Australian Retail Monthly Turnover by Industry July 2022
Source: Australian Bureau of Statistics (ABS)
Overall household spending increased 10.2% through June. Non-discretionary household spending rose 9.8% in June driven by spending on transportation, while discretionary household spending was up 10.8% driven by spending in recreation and culture.
Household Discretionary and Non-Discretionary Spending
Source: Australian Bureau of Statistics (ABS)
With inflation and operating costs increases, online channel growth, lower demand and excess inventory, retailers may choose to discount their inventory, sacrificing margin to maintain or increase working capital. Many retailers will face liquidity issues as working capital is tied up in inventory. Gordon Brothers expects midsized retailers will be hit first, creating mergers and acquisitions opportunities for larger organizations. We predict retailers in the fast-fashion apparel and footwear sectors within consumer discretionary goods could face significant headwinds over the next few months.
Considerations for Retailers
Retailers will need to look at ways to lower costs, streamline operations and reduce disruptions to avoid losing their competitiveness. With increased wage costs, lack of manpower, and continued investment in digital platforms and data infrastructure with the growth in online shopping, retailers must act.
Despite some retailers reporting strong sales because of the growth in online sales, net profits declined. Total sales for the Super Retail Group, one of Australia and New Zealand’s largest retailers, increased by 2.8% in the 2022 fiscal year supported by record online sales, which increased by 44% while net profit fell by 20%. Westfarmers, one of Australia’s largest employers, recently announced plans to renew its portfolio, which include optimising its store network following a 2.9% decline in net profit after tax.
Some traditional retailers may have too many stores or are over spaced. Retailers that deliver a remarkable consumer experience and have purpose in their product or company, regardless of channel, are closing very few stores. In fact, some are expanding their brick-and-mortar footprint, but it is about rightsizing the portfolio whether internationally or locally by way of location, size and footprint. We have already seen major national retailers like David Jones and Myer reducing their store occupancy space, while other retailers like the Super Retail Group are expanding their store network to create brand scale and awareness.
Reevaluating the business is key for future growth, and sometimes it is a matter of transforming credit and financing. There is a range of solutions to consider, including identifying, unlocking and optimising unrecognised value, whether this is through revaluation, inventory optimisation or lending. These solutions can realise additional capital for growth or support a restructure when current lenders may not be able to advance additional funds and need to deleverage their exposure.
For example, a retailer’s assets could take the form of tangible assets, such as inventory, cash, property, or plant and equipment, and intangible assets, such as intellectual property, including trade names and patents. Revaluing these assets can increase the value of the retail business and enable access to more credit. If a retailer has a lot of relatively lower-value assets in the form of inventory, the business will need to have a well-thought-out strategy to realise assets most effectively and maximise their value with special situations financing.
Time will tell what the coming months will bring for retailers facing a perfect storm of challenges never seen before. The only certainty is change and retailers will need to adapt to weather the storm.
As your partner through strategic change, Gordon Brothers helps retailers realise the full potential of their assets. Our solutions are designed to meet the specific needs of our clients, whether we provide funding for liquidity and expansion, freeing up additional capital from lenders through detailed appraisals, improve working capital through realising inventory and assets, or assist with store closures and country exits. We partner with our clients to maintain brand integrity and protect customer goodwill allowing them to focus on their core business.