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Retailing Road to Riches Starts to Crumble

By The Noble Contrarian on February 14, 2012 in Other

Retail was once the road to riches in Australia. From stalwarts Gerry Harvey (Harvey Norman) and Frank Lowy (Westfield) to relative youngsters Brett Blundy (Bras N Things, Sanity Music) and Richard Uechritz (JB Hi-Fi), the rich list is full of people who made their fortune in retail.

The business has its advantages. You don’t need much capital to get started. And it’s scalable. If you find a concept that works in one location, it’s probably going to work on many.

The past year, though, was horrible for the Australian retail sector. The S&P ASX 200 Retailing Index fell 37% in 2011. The share prices of former darling stocks JB Hi-Fi and The Reject Shop fell 37% and 25% respectively and Harvey Norman fell 38%. For the most part the price drops have not been random market panic, but the consequence of disappointing results and dire predictions about future profitability.

That’s all taken place despite a relatively benign economic backdrop and 5% unemployment. Imagine where the sector would be with 10% unemployment and a housing crash.

There are three main issues facing Australian retailers. Firstly, the sector has too much capacity. The industry expanded rapidly while retail sales grew faster than disposable incomes. Thanks to five-year interest free periods, credit card debt and mortgage drawdowns used to fund retail consumption, the retail sector now has a level of infrastructure that is not justified based on a sustainable level of spending.

The second issue facing the sector is that retail property trusts – Westfield Group in particular – have been increasing their portion of the pie. In most cases, the retailers are making more gross margin than they were five years ago. They are marking up the sale price of their goods by more, yet making less profit, because the additional margin (and then some) is being confiscated by the landlords.

Finally, the issue that brings the former two to the fore is that today’s customer has an alternative to bricks and mortar retailers. From a competitive perspective, it doesn’t matter if your rent is high as long as everyone else’s rents are the same. Now that customers can purchase online, rent and high Australian staffing costs place the traditional retail sector at a competitive disadvantage. Even those that don’t shop online are usually doing online price checks and know what price they should be paying.

There is no doubt there will be a bricks and mortar retail sector in 20 years’ time. A shuffle through Sydney’s Pitt Street Mall in the lead-up to Christmas indicates ‘shopping as an experience’ is alive and well.

The question is not whether there will be traditional retailers. There will. The question is how the industry transitions from today’s excess capacity and high costs to one that is smaller, paying lower rents and focusing on the sectors in which physical stores have a competitive advantage.

I don’t have an answer to that question. Perhaps the strong, relatively low cost players like JB Hi-Fi will take even more market share from rivals and manage to grow despite industry-wide difficulties. Perhaps the property trusts will wear the bulk of the pain. They are the ones that have been generating the excess profits to date. Perhaps new businesses and business models will emerge and annihilate the existing players.

However it unfolds, the next decade is going to be a tough one for the retail sector. A few of those names will be falling off the rich list.