Rapid changes in buying behaviour — exacerbated by rising rates and inflation — mean challenges for equity investors focused on ASX-listed consumer cyclicals.
But there are opportunities if you know where to look, says Sondal Bensan, an analyst with Pendal’s Aussie equities team.
Companies selling goods and services to households are facing the twin headwinds of rising inflation and higher interest rates — even as they adapt to the post-Covid reopening.
This unusual confluence of events is causing volatility in stock prices and making it tricky to predict how the sector will ride out the cycle, says Bensan.
“There’s a big shift going on — in revenue and in costs.
“We are seeing shifts in the mix of what people are spending money on, and there’s a huge pressure wave of costs coming through that’s hitting margins.”
The Covid years were characterised by increased spending on household-related activities like homewares, renovation and electronics. But as economies revert to normal, people have shifted their spending to out-of-home experiences.
“During Covid you could barely get hold of a laptop,” says Bensan. “Now it’s almost the opposite. Now retailers are running out of luggage and they are being stuck with stock in the categories that did well during the pandemic.”
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The impact of the shift is that many consumer cyclical companies are reporting above-trend revenues even as the cycle turns because of the extra purchasing pulled forward by the pandemic.
“Some of the retailers’ revenues are 30 per cent above what they were pre-COVID. In a normal market, they might grow 8 or 9 per cent in a two-year period so they are way above trend,” he says.
“The dilemma for investors is that the next move may not be back to trend — it may be that because of the excesses you end up moving below trend.
“People that found themselves with two or three televisions during the pandemic won’t need to replace them for some time.”
At the same time, companies are facing the headwind of rising inflation.
“You’ve got cost pressures across the board. Supply chain costs due to fuel, due to capacity constraints, due to domestic supply chain because people are off ill with Covid.
“You’ve had all these negative forces on supply chain costs coming through at the same time revenue could start to go below trend.”
And now households now face rising interest rates, with the Reserve Bank lifting the cash rate to 0.85 per cent on Tuesday, raising the prospect that household themselves could start to come under pressure.
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“Every 50 basis points in interest rate rises is about 0.8 per cent off household income,” says Bensan.
“And then there’s inflation itself — food inflation, petrol prices, gas and electricity prices. These are big movements in prices for households and they clip incomes.
“An extra 1 per cent on the CPI means there’s 1 per cent less money for households to spend.”
So far, households are holding up well.
Bensan says the pandemic prompted people to save more than they used to: the household savings rate is up to 11 per cent of income from 4 or 5 per cent pre-Covid.
“And the other component is incomes. The last data showed household wages growth at 5 per cent which is above inflation and a net positive.”
“There’s heaps of buffer. That’s why so far even though you’ve had all these things happen, revenue for discretionary stocks is holding up — even for the ones that had benefited from COVID.”
Bensan says ultimately the direction of the cyclical stocks will depend on the trajectory of interest rates.
“Another 1 per cent on rates and you’d still be fine — households have enough buffer there.
“But if it goes beyond that — NZ is talking about mortgage rates getting to 6 per cent — than it could be challenging. That would be a big drag and eat up all the buffer that’s there.
“But on balance, there’s more pessimism than what the reality probably is right now.”
Bensan says one path for investors is to find companies that took the opportunity through the COVID period to restructure their businesses and reduce their cost bases.
He points to Qantas and Nine Entertainment as examples.
“A lot of companies that look like they are doing well are just pulling revenue forward from future years. If anything, they will end up worse off than they were before,” he says.
“But some others who have used the COVID period to reform will actually end up far better off.”
He says companies with variable costs bases that can be adjusted down as revenues fall will be better off than those unable to reduce costs.
And companies with resilient, subscription-based revenues will be better placed to weather a downturn in household spending than traditional retailers.
“It’s not just the revenue falling, they have inventory as well. When you have excess inventory, you have to clear it and discounts affect margins.
“Those kind of stocks have probably got a lot more earnings risk ahead of them.”
Sondal Bensan is an Australian equities investment analyst with more than 19 years of experience covering the retail, telecom, media and transport sectors. Sondal holds a Bachelor of Commerce (Finance) and a Bachelor of Science (Maths and Statistics).
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