1. Discount retailers will also feel the pinch

JB Hi Fi (ASX: JBH) reported a lift in sales of nearly $10 billion up from $9.2 billion in fiscal 2022. Its underlying earnings-per-share was 13% better than Morningstar’s expectations. The business also outperformed its peers, gaining market share in consumer electronics and home appliances. JB Hi-Fi group CEO Terry Smart said he was “pleased to report the record sales” amid a “challenging retail environment”. He added that “with heightened uncertainty in the retail environment” its brands “were well-positioned to leverage their low-price market position as shoppers look to maximise value from their purchases”. Morningstar equity analyst Johannes Faul expects JB Hi Fi to retain the market share gains but also expects its profit margins to “revert to maintainable levels reflecting the lag effect of rising costs of doing business”.

Full year dividends of $3.12 was also ahead of Morningstar’s $2.74 forecast, representing a 65% payout ratio. While Faul expects the retailer to keep this dividend payout ratio level over the long-term, he forecasts lower near-term profits. “For the month of July, we calculate that JB Hi Fi’s Australian sales declined by 5%.

The company’s management also expects younger consumers to buoy future sales, however, Faul highlights data from the Commonwealth Bank that that revealed younger people (those 18 to 34 years of age) are planning to cut spending. “While we have seen consumers trading down, the others have been “trading out” and deferring discretionary spending, at least partially offsetting the positive effect for discounters and value-focused retailers”, Fauls said.

2. Employment to return to pre-COVID-19 levels

Australia’s largest online listing platform Seek (ASX: SEK) reported a 10% lift in revenue as well as a 7% increase in its dividend. Job listings fell 4% compared with the prior corresponding period with job ad volumes slowing following record levels in March 2022. The results were broadly in line with Morningstar analyst Roy Van Keulen’s expectations. In his note, this “deceleration has come in sooner than expected”.

Following the pandemic, Seek’s business was boosted by supportive fiscal and monetary policies as well as changing attitudes to work life balance. For Van Keulen this led to the “great resignation” and a “booming job market”. But that was then, and this is now. “Greater unemployment means advertisers are less likely to pay for higher tiers to make their listings stand out,” Van Keulen said adding that “one leading indicator supporting this assumption is the number of applications per ad, which were down almost two-thirds through COVID-19 but are now back to pre-COVID-19 levels”.

3. A building recovery on the horizon?

Fletcher Building’s (ASX: FBU) earnings are tied to construction activity in Australia and New Zealand. Underlying fiscal 2023 earnings before income and tax rose 6% to NZD 798 million in line with Morningstar’s expectations. Although sales disappointed, coming in 6% below Morningstar’s forecast, the group’s earnings-before-income-and-tax (EBIT) margin of 9.4% was stronger than anticipated for Morningstar analyst Johannes Faul. “A solid outcome given the cyclical challenges facing the New Zealand and Australia construction sectors”. On his assessment, resilience in Fletcher Building’s materials and distribution divisions was the driving force behind higher EBIT margins at the group level. In particular, the Australia business, which accounts for 21% of group EBIT, showed significant improvement in fiscal 2023.

“We now think we are further through the construction downturn than previously credited, and we bring forward timing for the anticipated cyclical upswing,” Faul said adding that he has upgraded volume forecasts for the materials and distribution divisions. He also acknowledges the sharp rises in interest rates in both Australia and New Zealand have placed those with mortgages under significant pressure. Fletcher’s residential and development segment which abouts for 17% of group EBIT saw housing unit sales fall by 8% compared with fiscal 2022. “However, we are beginning to see signs the housing market has hit a low,” Faul said adding that he continues to forecast a growth in housing unit sales representing a recovery for the business in fiscal 2023.

4. Bad debts not expected to mirror a rise in mortgage stress.

National Australia Bank (ASX: NAB) third-quarter cash profit of AUD 1.9 billion was broadly as expected with the major bank also reporting a bad debts rising from low levels. Morningstar Nathan Zaia believes that while these bad debts are low, it will likely be a drag on earnings in fiscal 2024.

Bad debt expense for NAB now represents around 0.14% of loans on an annualised basis. Arrears past 90 days increased to 0.71% from 0.66% in the previous quarter but are still low in comparison with 0.93% in the September 2019 half, according to Zaia.

He expects bad debts/loans to increase to around 0.19% in fiscal 2024 with households and businesses yet to face the full extent of higher rates and inflationary pressures, but then revert to Morningstar’s midcycle assumption of around 0.17% from fiscal 2026.

Similarly Commonwealth Bank (ASX: CBA) did not reveal alarming levels of rising bad debts.
Despite bad debts trending upwards, Zaia does not expects this to mirror mortgage stress a view he highlighted in his recent Industry Pulse on the banks.

Zaia believes that borrowers will just cut their discretionary spending to meet repayments and serviceability levels are still manageable. “We gain significant comfort that loans were made with a 3% serviceability buffer, labour and rental markets are tight, and housing demand has so far prevented significant house price falls. Few are forced sellers in negative equity”.