Goldman Sachs' 5 key themes and most important stocks for the retail resurgence

Goldman Sachs Global Retail Conference 2023, held last week, drew 70 global brands in consumer staples and discretionary together for one day of insights ranging from the macro impacts of inflation on consumer spending to the micro of customer loyalty programs.

Before considering the implications for Australia, this wire considers the key themes and comments from Lisa Deng and James Leigh of Goldman Sachs Australia on how global stocks are approaching these issues.

5 key themes

A more resilient consumer: Despite the headwinds buffeting consumer budgets caused by inflationary pressures on grocery baskets, student loans and rising debt, there are also tailwinds coming from strong employment and drawdown of excess savings. Most of the 70 companies who presented were cautiously optimistic about the state of consumer spending.

“Category-wise, food and beverage and non-edible consumer packaged goods remained in positive growth 2023 YTD while General Merchandise is run-rating mid-single-digit decline," according to Deng and Leigh.

Income bifurcation: While consumer resilience exists, it isn't uniform across all income brackets, with income bifurcation evident amongst consumers. 

The period from January to June 2023 saw households with US$100,000 in income increase their spend by 5% in dollar terms to purchase 2% more in items. That resilience wasn’t evident in groups below that income threshold, who saw their spend decrease by 8% in dollars to purchase 10% less items.

“Anecdotally, strong aspirational brands including On Running (NYSE: ONON), Lululemon (NASDAQ: LULU), Canada Goose (TSE:GOOS) are still seeing strong growth, while discount stores such as Dollar General (NYSE: DG) is seeing a challenged consumer" say Deng and Leigh.

A normalised trading backdrop: With retailers reporting a return to normal trading conditions - supply chains are improving, global freight rates are declining back to pre-Covid levels - gross profit margin tailwinds and flexibility in pricing to drive volume growth are evident even as inflation moderates growth.

According to Deng and Leigh, "most are comfortable with the level and quality of inventory heading into holiday seasons, with speed and agility also back to normal if adjustments are to be made.”

Stronger operating capabilities: Improving execution to be more precise is also a focus for many retailers, given the pressure on costs from wage inflation. Retailers are investing in consumer data, digital, automation and loyalty capabilities to lift their operating profit margins back to pre-Covid levels.

Looking for more balanced growth and strategic plan execution in 2024: While Goldman Sachs sees year-on-year comparable growth as being driven largely by price in 2023, most of the retailers presenting at the conference plan for more balanced growth in 2024, so as to return to positive volumes. The key levers to be deployed are not only innovation via existing offerings but also seeking growth via category or channel expansion.

As Deng and Leigh note, "E-commerce has returned to growth and continues to feature heavily as part of the omni-channel strategy. Retail media and loyalty are key tools to continue to drive higher repeats and margin fall-through."

The same 5 key themes in Australia? Look at the sectors...

While the US and Australian economies are not experiencing identical symptoms, the factors driving the key themes noted above translate into different implications locally, especially when looking at specific sectors of the consumer market

Retail grocery: While food and beverage inflation is moderating in the US, Goldman Sachs notes that it has stayed elevated at high single digits through 2023, after double-digit inflation in 2022. Moderating inflation is not deflation, however. 

As grocery retailers shift their operating model away from a store-based model to an omnichannel, ecosystem-based model, retailers will think differently about their financials, according to Douglas McMillon, CEO of Walmart (NYSE: WMT) who spoke at the conference

“I'll describe it as the old income statement looks like a store P&L. It's got sales, gross margin, SG&A and an operating income percentage at the bottom. The new income statement's got gross merchandise value, GMV, marketplace, membership, advertising, fulfillment services, data monetization and other components.That second income statement required a period of investment to scale e-commerce, first party and third party relationships.”

In terms of Australian stocks, Goldman Sachs believes FY24 for food and beverage grocery retail will begin to moderate as inflation slows and sales volumes revert to positive growth. They anticipate mid-single-digit industry growth.

They prefer Woolworths (ASX: WOW) over Coles Group (ASX: COL) because they see the early investments in-store network, technology and automation, together with digital and omni-channel capabilities are beginning to pay off for Woolworths and that FY24/25 will see it increase its market share while expanding its EBIT margins. It’s more able to withstand ‘irrational pricing’ than Coles Group.

“We see that Woolworths is building towards an ecosystem model with multiple levers of growth and monetisation similar to Walmart and expect that the expanding quality/growth gap vs COL will justify an expanded valuation premium" says Deng and Leigh.

Home improvement: While the CEOs of three major US home improvement retailers - Home Depot (NYSE: HD), Lowe’s Companies (NYSE: LOW) and Floor and Decor Holdings (NYSE: FND) - have slightly different views on the macro environment for US housing, they see the market is shifting from its strong COVID growth phase into a period of adjustment.

Their response is to focus on growing their offerings to the professional building or "pro" sector by shifting their offerings to meet the more complex requirements of this customer base.  Morgan Stanley estimates this is a US$250 billion opportunity. For Home Depot this means a focus on "complex-pro" by improving their processes for order management, increasing their professional sales force, and improving their credit management capabilities. Lowe’s Companies typically is 75/25 DIY versus pro and they are focusing on "small-pro."

Goldman Sachs' read for Australian stocks is for largely stable sales growth based on macro factors: home prices and transactions are resilient, and that the return of immigration will also help to sustain demand. Looking at the DIY/Pro build income split, a market they value at around $25 billion, they see Commercial as the largest growth opportunity for Bunnings, owned by Wesfarmers (ASX: WES), given it already has more than 60% market share in DIY.

As for the various hardware brands owned by Metcash (ASX: MTS) in its Independent Hardware Group (such as Mitre 10, Home Time and Hardware, Thrifty-link Hardware, True Value Hardware, plus Hardings and a majority stake in Total Tools), Goldman Sachs considers any market share gains by Bunnings will put pressure on MTS given a well-penetrated market and as consumers become more conscious on value, independents would be less able to compete.

Discretionary retail: This is where the bifucation of income is most obvious, with discretionary retailers reporting dispersed performance based on the cohort income band they service. So in that US$100,000 plus band, retailers such as Antropologie and Free People brands owned by Urban Outfitters (NASDAQ: URBN) are doing well. 

With newness of offerings identified by many companies at the conference as critical to stimulate demand, Bath & Body Works (NYSE: BBWI) has found sales from its loyal customers, after it successfully launched a 38 million member loyalty program that has supported around 75% of the group’s sales since that time. 

Within the Australian discretionary retail space, Goldman Sachs continues to prefer Super Retail Group (ASX: SUL) over Premier Investments (ASX: PMV). This is not only because, as Deng and Leigh note, 

"auto and outdoor categories are likely to be more resilient in demand vs mass-market apparel and cyclical normalization of sleepwear" but because "precision execution leveraging consumer data to become more important, and Super Retail Group had this advantage given >70pct of its sales comes from members." 

They also believe Premier Investments' positive price gains "already fully reflect upside of potential accelerated global expansion following its recently announced strategic review. We believe that global growth will likely take time due to the competitiveness of the market as well as being margin and returns dilutive to existing ANZ business" they comment. 

They remain cautious on JB Hi Fi (ASX: JBH) and Harvey Norman (ASX: HVN) due to ongoing industry demand weakness and as they await for signs of category recovery.

Global brands: With most brands executing a product/innovation led growth strategy, their paths to achieving this differ.

• Smith & Nephew (LON:SN) is looking at speed to market, supported by reliability and value of its products
• On Running  and Canada Goose are going for category expansion into apparel, with Canada Goose also looking at offerings to women and footwear
• Lululemon, On Running and Canada Goose seek global expansion and include China as a core growth pillar, with a focus on cities where consumers remain resilient and have higher spending power. Market penetration will be key run-way to that growth, according to Deng and Leigh. 

“The wholesale channel for key brands remains challenged with retailer de-stocking and not having the capabilities to target a brand’s desirable cohorts," they caution. 

To counter this, global brands such as PVH Corp (NYSE: PVH), owner of brands such as Tommy Hilfiger and Calvin Klein, reported taking more control of its distribution network with On Running closing down wholesale doors that don’t align with the brands’ customer fit.

When looking at Australian stocks in the mid-high-end brands, Goldman Sachs is encouraged by the successes in innovation and newness of offerings in stimulating sales. Deng and Leigh like Treasury Wine Estates (ASX: TWE) with its 19 Crimes rebranding, One by Penfolds and its Multi-Country of Origin launch, as well as the Matua and Frank Family scaling, and Breville Group (ASX: BRG) due to is Barista Touch Impress, Vertuao Creatista, Joule Turbo Sous Vide and the Breville+ platform on gross product margins. As they note, 

“There continues to be strong demand and a penetration run-way for products that solve under-served demand, in less price sensitive categories. Given global freight cost normalisation and weak AUD, both these companies should benefit“

In contrast, changes in Chinese demand for its products and lower birth levels are less positive for A2 Milk (ASX: A2M). It also sees Japan continuing to ‘surprise to the downside’ at Domino’s Pizza (ASX: DMP) as the final relaxation of Covid restrictions in May 2023 resulted in lower take-out demand as cost inflation continues to eat into margins.