Why stocks in this sector are near an inflection point

The consumer discretionary sector is typically one of the market’s first casualties when the economic climate deteriorates.

But even as inflation started nudging upward last May, the sector has held up better than many expected (bar the odd troughs). The reasons for its resilience include the savings buffer many households amassed during COVID, persistent spending on services and travel since restrictions lifted, and low unemployment.

ClearLife Capital’s David Moberley wrote recently that we may have hit an inflection point now – something which will only be exacerbated by the shock of the inflation figure released this week.

“That higher inflation print puts upward pressure on a tightening bias at the RBA. The consumer sector is one of the most exposed to that in terms of higher rates and lower disposable income,” he says.

“It appears May has been a turning point. We don’t know how persistent it will be, but things have softened a lot. You’ve seen three or four companies already give trading updates and there’s further indications that cost pressures are hitting, so we’d expect further soft updates.”

Moberley emphasises there could be another big inflection point ahead in the form of a lift in unemployment.

“The big question is, when do we see unemployment start ticking up. We haven’t seen it so far, but we’ve seen pressure from a cost and sentiment perspective,” he says

“If we start to see unemployment going up, that’s a whole other layer of headwinds for the sector.”

In his recent Livewire article, Moberley called out the trading updates from these companies a week earlier:

• Universal Store (ASX: UNI)
• City Chic (ASX: CCX)
• Treasure Wine Estate (ASX: TWE)
• Eagers Automotive (ASX: APE)

Furthering Moberley’s view, the recent trading update from furniture and homewares retailer (Adairs ASX: ADH) shows a 7% decline in sales growth across the group, driven by rising interest rates, higher costs of living, and lower foot traffic in physical stores. As of writing (11am, Friday June 2nd 2023), shares are down a whopping 18%.

We spoke about this same topic around six months ago with Australian Eagle Asset Management's Sean Sequeira. Much of what he said back then has played out, including anticipated volatility in the sector.

Providing an update on his views now, Sequiera says deceleration of revenue lines is the main thing he’s watching at many of these companies.

“We see that from JB-HiFi (ASX: JBH). Between its February reporting results and the update at the recent Macquarie conference, the revenue line has slowed quite sharply in all areas,” he says.

But wide dispersion between companies in the sector is also very evident. Comparing the performances of several consumer discretionary stocks to the ASX 100 since the end of last year, Sequeira notes:

• Corporate Travel Management (ASX: CTD) is up 38.7%
• Flight Centre (ASX: FLT) is up 46.2%

On the other hand, several names have seen big share price falls:

• Dominos Pizza (ASX: DMP) -27.8%
• Star Entertainment (ASX: SGR) -37%
• Premier Investments (ASX: PMV) -12%
• Harvey Norman (ASX: HVN) – down 17%

For Sequeira, the ongoing demand for travel services is a standout – as confirmed by recent updates from Flight Centre and Webjet (ASX: WEB).

“What is important is who can weather this period well, who can come out stronger than competitors, and how long it will last,” Sequiera says.

One of his callouts in the sector remains Corporate Travel Management, which he regards as a quality company that should be able to weather the downturn.

Broker views

For a different perspective, here are some of the most recent broker ratings of some of the stocks mentioned:

Universal Store

Downgraded to OVERWEIGHT from Buy at Jarden on 25 May.

Citi downgraded it to NEUTRAL from Buy on 24 February.

City Chic

Downgraded to NEUTRAL from Overweight at Barrenjoey, and to NEUTRAL from Underweight at Jarden on 23 May.

Treasury Wine

On the other hand, Treasury Wine has seen a few broker upgrades in recent months. 

JPMorgan upgraded the stock to OVERWEIGHT from Neutral on 26 May, at the same time as E&P upgraded the company to POSITIVE from Neutral.

And CLSA upgraded Treasure Wine to BUY from Outperform on 13 April.

Eagers Automotive

The global automotive retailer was downgraded to NEUTRAL from Outperform by Macquarie on 14 May. And Bell Potter also downgraded Eagers to HOLD from Buy on 8 March.

The big end of consumer discretionary

Here are the latest broker changes among some of the largest stocks in the consumer discretionary sector.

Wesfarmers (ASX: WES)

On 9 May, Morgan Stanley picked up coverage of the Australian conglomerate – which owns brands such as Bunnings, Kmart and Officeworks – with an EQUAL-WEIGHT rating. Analyst Melinda Baxter set a price target of $47.50 for the stock – roughly in line with its $47.58 close on Thursday.

Aristocrat Leisure (ASX: ALL)

Goldman Sachs added the company to its CONVICTION BUY list on 12 April, analyst Darshana Nair Syama setting a price target of $45.70. Based on Aristocrat’s Thursday closing price of $37.79, this presents 22% upside.

The Lottery Corporation (ASX: TLC)

Citi initiated coverage of The Lottery Corporation on 29 May with a BUY rating. Analyst Adrian Lemme set a price target of $5.70. Trading at $5 at the close on Thursday, this presents a 14% discount.

IDP Education (ASX: IEL)

Bell Potter upgraded the stock to BUY from Hold on 31 May. But analyst Olivia Hagglund decreased her price target to $27.40 from $30. Even so, this leaves the stock trading at a 25% discount.

JB Hi-Fi (ASX: JBH)

Goldman Sachs upgraded the electronics retailer to NEUTRAL from Sell on 12 April, citing factors including the company’s market share gain. Analyst Lisa Deng also increased her price target to $44.50 from $40.70. With a closing price of $42.30 on Wednesday, this presents a 4.4% discount.