Pent-up demand for travel, dining out and fashion drove annual inflation to a more-than three decade in December, cementing expectations for another interest rate rise when the RBA meets in February.

The pre-Christmas spending boom has boosted sales - and share prices - for airlines and retailers. This week, department store Myer (MYR) announced its strongest first-half sales in nearly two decades.

Myer

Myer's sales have surged in the first half, but the stock remains overvalued. Picture: AP

But as with all earnings, the results are backward looking, and reflective of previous market cycles. And while inflation has likely now peaked, Morningstar’s head of equities Peter Warnes says prices aren’t expected to fall, rather they just won’t accelerate at the same pace.

“Households now need to adjust to the higher prices of 2022 being permanent,” he says.

Those higher household costs, combined with higher mortgage repayments and reduced savings buffers are expected to hit consumer spending in 2023, according to Morningstar director of equity research, Johannes Faul, clouding the outlook for retailers.

Myer’s sales surge, but pullback expected


Unlike online retailers, large brick-and-mortar stores like Myer were hit hard during the pandemic as lockdowns and social distancing drastically cut foot traffic.

But sales have finally bounced back, Myer CEO John King said in a trading update on Tuesday.

“The results, which reflect our best sales on record for the first five months [since FY04], are particularly pleasing and more importantly also reflect improved profitability within the business,” King said.

“As with most retailers, we remain cautious on the macroeconomic environment for the remainder of the calendar year but are equally confident in the continuing momentum we have within the Customer First Plan and a range of initiatives we are executing.”

While acknowledging Myer’s sales result was stronger than expected, Faul says weakening consumer spending is expected to progressively take hold in calendar 2023.

Together with a high-single-digit decline in sales, he anticipates more intense competition and cost inflation to weigh on Myer’s profit margins.

“We upgrade no-moat Myer’s fair value estimate by 7% to AUD 0.75 per share, driven by a material lift in our fiscal 2023 earnings estimate,” Faul says.

“However, our longer-term earnings estimates are virtually unchanged from fiscal 2024 onward.”

He says shares in Myer are trading at a premium to Morningstar’s intrinsic valuation, which reflects the market’s more positive outlook on consumer demand and Myer’s inflated operating margins

“But we contend current consumer demand for apparel and homewares remains at untenable levels.”

Kogan remains Morningstar’s top ASX retail pick


Online retailer Kogan (KGN) is trading at a significant discount to its fair value estimate, with the company securing a place on Morningstar’s global equity best ideas list in January.

Faul ascribes the weakness in the share price to a material moderation in sales growth and earnings declining from boomtime levels, as well as management's decision to temporarily suspend dividends.

“We anticipate profit margins to expand as marketing expenses as a percentage of gross sales are scaled back and top-line growth reignites in fiscal 2023 after exceptionally strong coronavirus-induced sales growth is fully lapped,” he says.

As an online pure play, Faul says Kogan will benefit more than hybrid retailers from the continued shift towards e-commerce.