Resetting profit expectations

Another week, more bad news for retail.

Yesterday, Premier Investments rocked the market by announcing that it will close 50 loss-making stores within its Just Group retail empire.

Today on SmartCompany we look at a claim from Matt Sherwood, the head of investment market research at high-profiled financial fund manager Perpetual that Australian households are actually in recession, with retail sales growth at record lows.

The ugly conditions that retailers are experiencing show no signs of ending any time soon.

Rising living costs (including fuel, insurance and energy and utility costs), falling asset prices (particularly house and share prices) and rising online sales (led by Generation X and Y, who are seen as the most important slice of Australia’s consumer base) are all part of the problem.

The sheer size of and importance of the retail sector means that its struggles cannot help but filter through to the wider economy and it’s clear that related sectors such as transport, manufacturing and even construction are also doing it tough.

Which raises the question: When will this retail rout finally end?

SmartCompany‘s retail blogger Kevin Moore says things should get better around Christmas, particularly if the RBA decides to cut rates.

But here’s a worrying thought: What if the current state of retail profits is what we can expect into the future?

That idea was floated yesterday at the Property Council Congress in Sydney by Darren Steinberg, managing director of Colonial First State Global Asset Management.

“Australian retailers have been making super-profits in this country for about 40 years, that’s why they’re jumping up and down like they are,” he said.

“They have to embrace new technology, no one knows where this is heading.”

While I am sure many retailers would question whether they have really been making “super profits” since the 1970s, Steinberg does raise an interesting point about whether retailers should really expect a return to pre-GFC retail conditions.

The period from about 2003 to 2008 was pretty amazing for retailers. The economy was booming, house prices were soaring and Australians were spending like never before, often using the equity in their homes to spend up on goods. Online shopping was at best a background issue.

The retailers we’ve seen collapse in recent times (think Clive Peeters, RedGroup Retail and Colorado Group) responded by going big – bigger retail chains, bigger store footprints and more debt to pay for it all.

While consumers’ money was flowing, everything was good – profits were strong and loss-making stores could be carried with ease.

But in this post GFC period, that’s all unravelled. Household savings rates have risen, sales have plummeted and margins have been smashed by discounting. Retail profitability has been badly stretched.

Is it coming back? That’s not clear, but there are signs that some retail groups are having doubts.

For example, yesterday’s strategy update from Premier Investments will see the company work on boosting profitability by cutting costs. Loss making stores are to be shed, staff hours are to be “re-aligned” and rental and supply agreements will be reassessed.

Yes, there will be some growth of strongly-performing chains such as Smiggle and Peter Alexander, but this will mainly be a cost-cutting strategy.

Of course, it appears that new Premier retail boss Mark McInnes has found plenty of fat to cut. Many other retailers will say they are already running as leanly as possible.

If that’s the case, it really does appear they will have to get used to living in a world of much thinner profit margins. For now at least, the good times are gone.