Edited Transcript
What was your key view when you wrote that piece and how have your views evolved since then?
McLean: To recap, we think the Australian consumer is going to be under pressure for a number of years, and that's driven by a few views.
Firstly, we think interest rates are going to be higher for longer. Inflation is proving more sticky than expected, especially service inflation. We think it's going to be later and probably less of an interest rate cut than most people are expecting.
Secondly, we think there's weakness coming in the employment market. If you look at job ads, they're declining at the fastest rate since the GFC, if you exclude the brief COVID blip there. That is generally a leading indicator that says employment is going to soften.
Thirdly, the excess savings that a lot of consumers built up over the COVID period when the government gave out all these stimulus checks, most of that has been run down. And if you look at the breakdown by age, it's only those people over 55 who are still seeing their savings balances rise. Everyone under that is seeing declines in their savings balances and it's having a commensurate effect on their spending as well.
And finally, we think migration is going to be curtailed and that has been a big tailwind to consumer spending over the last few years. As we sit here today, none of those views have changed. We think those drivers are still in effect.
Some economists say we’ve hit the low for retail sales and consumer confidence - two key leading indicators for identifying consumer-related opportunities.
Do you agree and how much would a shift in psyche influence your investment choices?
McLean: I understand what you're saying Hans, but if we look at the data, I don't think it's suggesting that. In September, we saw retail sales rise by about 0.1%. That comes after a 0.7% increase in August and zero in July, and that's meant to be in the period where the [Stage 3] tax cuts have come through and lifted consumer spending.
Remember, these retail sales include the effect of inflation and include the effect of migration. If we are to take these factors out and look at retail volumes on a per capita basis, they declined by 0.1% in the September quarter and that was the ninth consecutive decline in that measure, suggesting it's pretty broad-based. And that's coming to light in company results in the last month or two.
We've seen a wide range of consumer companies downgrade their earnings outlooks or miss expectations. Both in the consumer discretionary segment - we've seen the likes of Nick Scali (ASX: NCK), Super Retail (ASX: SUL) and Flight Centre (ASX: FLT) - and even in the Staples segment, we've seen Woolworths (ASX: WOW), Endeavour (ASX: EDV), and Domino's Pizza (ASX: DMP). So that suggests to us there's pretty wide-ranging consumer weakness.
Why is your fund so overweight discretionary names and what are some resilient consumer stocks that you are eyeing?
McLean: The nuance there, is that a lot of our exposure in consumer discretionary is not to retail. It is to the likes of gaming, which is also in that sector.
And the few discretionary stocks that we do hold are what we would consider ones with structural growth opportunities. These are companies that have ample white space to roll out new stores, which is going to drive their growth going forward as well. But for pure domestic-focused consumer discretionary, that is an area that we are underweight.
Is now the time to sell your discretionary holdings and pick up, say, the supermarkets instead?
McLean: Actually, I don't think it's the right time for either the domestic discretionary or staples retailers. If you look at the consumer discretionary sector, like you said, it's done very well but it's been driven purely by a re-rating.
The sector is now trading on about 25x P/E. That's well above the long-term average of 17 times. And in fact, it's at the highest level outside of the COVID period. At the same time, the earnings for the sector for 2025 are being cut by 5%.
We don't think it is a good outlook or a good risk-reward for that sector. But in the staples, at least the key segments in supermarkets and also liquor retailing, you have the pressure of deflation in food and beverage prices and also the additional pressure from the ACCC review into supermarket pricing as well, which is going to probably add to increased pressure on their top line at a time when costs are not abating. Labour cost is the key input and that's still rising as well. So, except for very few companies, we think it's a sector to avoid for now.
