Is this a major turning point for ASX-listed consumer stocks?

It was a big week in the consumer discretionary sector this last week. Trading updates from Universal Store (ASX: UNI), City Chic (ASX: CCX), Treasury Wine Estate (ASX: TWE) and AP Eagers (ASX: APE) all suggested softer trading. Anecdotes of excess stock and a step up in promotional activity also created headwinds with most stocks in the sector down heavily last week. Time will tell if these trading updates mark a pivotal turning point for the sector or not. It has not all been doom and gloom though with an update from Webjet (ASX: WEB) suggesting travel spend remains robust for now.

Looking top-down from a macro perspective, overall employment conditions continue to be strong, so spending patterns and changes look to be driven by cost pressures and low consumer sentiment. How long this strength in employment conditions can persist, if spending continues to decelerate, remains a key question.

Interestingly, Commbank IQ published a great piece of analysis in early May which gave some early insights into the consumer across age groups and categories ahead of these weaker trading updates. 

Figure 1: Younger demographic spending softest

Source: CommbankIQ Cost of Living Insights Report May 2023

Contrary to the narrative of a few months ago, the younger age brackets have seen the softest spending; no doubt as a result of the huge inflation we have seen in rent and other costs. 

Figure 2. Apparel has been the key driver of under 35 spending cuts

Source: CommbankIQ Cost of Living Insights Report May 2023

There has been a significant dispersion in the category spend across demographics and while under 35s spend has been significantly lower than over 35s across the board, the apparel category (clothing, shoes and accessories) has been the key area with the largest decline. Aside from apparel, the chart below shows travel and accommodation has lifted its share of wallet at the expense of household goods (as housing activity has slowed).

 Figure 3. Travel and accommodation lifting its share of wallet

Source: CommbankIQ Cost of Living Insights Report May 2023

With cost pressures expected to increase further this year, we would expect trading updates to continue to soften. Retailers are notoriously difficult to forecast due to the significant operating leverage. Very small changes in assumptions to sales and gross margins can have huge impacts on the earnings of these businesses given costs related to staffing and rents are still seeing inflationary pressures.

Acknowledging no one has a perfect crystal ball, the market is notoriously bad at looking long-term even in highly cyclical sectors like consumer discretionary. Short-term headwinds are typically overplayed in valuations and conversely, strong results are capitalised as if they will last forever. Where we are in this cycle of expectations remains a key question.

There should be plenty of opportunities for alpha in this sector over the next twelve months. Here are some of the things we have been working on

1) Earnings: do analyst expectations reflect the broader macro backdrop or are they likely to be better or worse? How sensitive is the company to minor changes in assumptions?

2) Valuations: is the market capitalising a sustainable level of earnings or headwinds/tailwinds continuing in perpetuity? What’s the margin of safety?

3) Management: How have the management positioned the company for the various macro scenarios that could play out? what does the balance sheet look like? How much inventory are they carrying? what contingencies are in place around the cost base?

4) Positioning: where are people crowded around narrative or perceived safety, where are people significantly underweight/overweight and where will the marginal buyer or seller come from?

It's going to be a fascinating few quarters ahead!