Wesfarmers set to benefit as the retail honeymoon ends

Bunnings and Kmart owner Wesfarmers (WES) warns "the honeymoon is very much over" for retail but the conglomerate is benefitting as consumers chase value and trade down to cheaper options.

^{Wesfarmers' retail chains are set to benefit as consumers opt for value.}

Wesfarmers managing director Rob Scott says the group's value-focused chains are well positioned as cost-of-living pressures and high interest rates squeeze household budgets.

Scott says consumer spending is reverting to normal levels after a "highly abnormal" period for households and businesses during COVID with unparalleled government stimulus, constraints on supply chains and purchasing behaviour, and ultra-low interest rates.

He says some retailers that had been struggling going into the pandemic enjoyed a short-term boost, but the high cost of living is now making customers more value conscious.

"I'd say that now the honeymoon is very much over," he told investors and analysts at Wesfarmers' annual strategy briefing day on Tuesday.

Reserve Bank of Australia governor Philip Lowe says consumption growth is expected to remain soft, adding spending is slowing the most among low-income renters and homeowners who borrowed a lot of money in the last three years.

"The services spending in the economy is still strong and retail is weak, partly because retail was incredibly strong during the pandemic," Lowe told a Senate estimates hearing on Wednesday.

"It's hard to know but the assessment that we've reached is that consumption is going to be weak for quite a long time because the high interest payments are really biting."

Value-seeking consumers are trading down

Scott says consumers are again seeking value as cost-of-living pressures bite which will benefit Wesfarmers' retail chains, including Kmart, Target, Officeworks and its biggest earnings driver Bunnings.

He describes the COVID period as one of the only times in recent decades when value was not important to consumers, given high levels of accumulated savings and very low interest rates.

"More customers [are] trading down between categories and increasing their share of spend on more value-orientated products," Scott says.

"This benefits us not just by reinforcing the core of what our businesses do, but we're also seeing a trading down into some of our businesses which is improving the number of customers that are trading with us."

^{Officeworks owner Wesfarmers says consumers are trading down between categories. Picture: AP}

Morningstar director of equity research Johannes Faul says Wesfarmers' discount department stores are performing well in the current environment, with more customers shopping more frequently and spending more.

"They're actually benefitting in this environment at Kmart as more people are seeking value," he says.

"Some people have cut back on spending, but overall, there's more people now going to Kmart, which doesn't bode that well for other specialty retailers."

Faul says the smaller Target chain is also experiencing an influx of business where its products are a lot cheaper than specialty retailers for similar quality.

Australia's largest supermarket chains Woolworths (WOW) and Coles (COL) also say their customers are looking for value and are increasingly buying cheaper private label products as inflation and the cost of living squeeze household budgets.

Friday's Australian Bureau of Statistics data shows retail sales were flat in April, with ABS head of retail spending Ben Dorber saying retail turnover has plateaued over the last six months as consumers spend less on discretionary goods.

Spending slowdown hits some discretionary retailers

Gourmet food producer and hamper business Maggie Beer Holdings (MBH) is the latest ASX-listed discretionary retailer to warn slowing consumer spending is impacting sales and profits.

The company, which owns the food brand named after celebrity chef Maggie Beer, expects its earnings will likely more than halve this year.

"Macroeconomic factors, including rising interest rates and inflation, have continued to impact consumer spending patterns across the grocery retail sector and e-commerce channel," Tuesday's trading update says.

Higher energy, freight and labour costs have also had a dampening effect on trading earnings before interest, tax, depreciation and amortisation, it adds.

^{Some ASX-listed retailers are facing more challenges as shoppers pull back.}

Home fragrance products retailer Dusk Group (DSK) expects its annual earnings to fall as much as 40%, with key Mother's Day sales softer than anticipated.

Dusk CEO Peter King says while the home fragrance products retailer's full-year sales and EBIT will still be well ahead of pre-COVID levels, many consumers are feeling significant strain on their household budget.

"Trading conditions in the second half of FY23 have been impacted by an increasingly cautious consumer environment, driven by higher interest rates and mounting cost-of-living pressures impacting the disposable income levels of our core customer," he says.

After announcing a 15.2% drop in group sales for the 45 weeks to May 14, plus-size clothing retailer City Chic (CCX) is working to clear excess stock and return to profitable growth as economic conditions hit demand from its core customers.

While youth apparel retailer Universal Store Holdings (UNI) has forecast record annual group sales, its shares have fallen sharply over the past week after it warned the subdued trading environment is expected to continue for the rest of this year and into FY24.

Universal says there are increasingly clear signs that youth customers are seeing pressures on their discretionary spending levels, particularly from increasing rents and university fees, and some are reducing their spending.

Takeover target Best & Less Group (BST) has downgraded its second-half net profit forecast, following inconsistent trading conditions for the value apparel retailer in March and April before an improvement ahead of Mother's Day.

Temple & Webster (TPW) CEO Mark Coulter says the online furniture and homewares retailer has changed its range, pricing and promotional activity to reflect changing customer needs, and is "back in growth mode" despite the turbulent macroeconomic conditions.

"We recognised early that in this inflationary environment, customers would be looking for choice and value," Coulter says.

Outdoor apparel retailer KMD Brands (KMD), meanwhile, is benefitting from the revenge travel boom.

Its third-quarter sales rose 15.6% ahead of the key winter trading period for camping and hiking brand Kathmandu and northern hemisphere summer for surfwear brand Rip Curl and Oboz footwear.

KMD CEO Michael Daly says the group is well positioned to benefit from the return of international travel and tourism.