The anxiety over a serious economic downturn triggered by the force of 12 interest rate rises has seen investors flee from the consumer discretionary sector like it’s a burning building.
So does this mean now is the ultimate contrarian “buy low” opportunity for ASX retail shares?
According to Wilsons equity strategist Rob Crookston, ASX investors need to be careful.
“Retail stocks may appear cheap, considering the recent sell-off. However, a critical consideration is the reliability of earnings reflected in price-to-earnings (PE) ratios,” he said in a memo to clients.
“The concern is whether the earnings projections incorporated in these ratios are reasonable and sustainable.”
First the bad news
Unfortunately, Crookston reckons the retail industry is in a downward part of its cycle.
“We expect that both sales and costs could be impacted by an economic slowdown, while higher wages will hit costs,” he said.
“Soft trading updates [are] pointing to weaker earnings. We expect more downgrades to come.”
The coming August reporting season could get very ugly for the sector.
“Several macroeconomic indicators (retail sales, consumer confidence) indicate slower sales, which could further pressure retail earnings.”
The other factor counting against ASX retail stocks is that margins seem too high compared to how these businesses operated before the COVID-19 pandemic.
“Margins could be a significant factor in earnings downgrades… It looks like analysts extrapolate COVID earnings into the future,” said Crookston.
“However, they are not considering that margins expanded considerably over the pandemic as consumers were flush with cash and the low level of discounting.”
Now the good news
However, not all is lost.
There are still a couple of gems that Crookston would be interested in picking up for cheap.
He calls his first pick Wesfarmers Ltd (ASX: WES) “the least discretionary discretionary”.
“Wesfarmers has a well-established and trusted brand portfolio, including popular retail chains such as Bunnings Warehouse, Kmart, and Officeworks,” said Crookston.
“These brands have a strong customer base and tend to perform well regardless of the economic climate.”
Motley Fool analyst Andrew Legget agrees, calling Wesfarmers’ brands “category-killing quality retailers”.
“In Bunnings, they not only own one of the, if not the, highest quality retail brands in Australia but an Australian institution that arguably warrants religious status,” he said.
“Throw in its other diversified businesses and this is a company that should have few issues in the current climate and can continue to grow in the years ahead.”
The Wesfarmers share price has fallen more than 9.6% since 26 April.
Crookston said his team would add the stock to its focus portfolio upon a further dip.
Recession-proof retailer?
Lovisa Holdings Ltd (ASX: LOV) is another retailer attractive enough to qualify as an exception to the rule.
The rapid expansion is the ace up its sleeve.
“Lovisa’s store rollout strategy should help insulate it from a softening in like-for-like sales growth over the medium-term,” said Crookston.
“Wilsons’ analysts highlight that Lovisa’s store roll-out momentum is building and expect ~200 new stores to be added in FY23 (+32% YoY) and ~180 in FY24 (+22% YoY), which is expected to underpin resilient revenue and earnings growth even in a softening macro environment.”
Motley Fool contributor Laura Stewart also classified Lovisa as “a more recession-proof” business due to “the low-end price range of its products”.
“Emerging from the pandemic, consumers have an appetite for live events and dressing up for those events, which is likely to support demand.”
Motley Fool analyst Trevor Muchedzi pointed out that Lovisa enjoys “high gross margins mostly because of a very efficient supply chain”.
“Lovisa has one of the highest revenues per square metre of floor space due to their small store format.”
The Lovisa share price has plunged 32.2% since 24 April.
