James Gruber: Let's cover the key trends that you see in the retail sector. First, e-commerce. What's happening in that segment? 

Johannes Faul: Yeah, e-commerce is an interesting one. That's been a channel that's been grown really strongly and especially in COVID and then it went into a period where it was tough times for that channel. And we're actually seeing that now changing again and e-commerce starting to grow and growing a lot more than brick and mortars going forward. So, for any retailer with a strong e-commerce channel and great exposure to that channel, they should be doing well and should be taking market share in our view.

Gruber: What about the outlook for the consumer which everybody wants to know about?

Faul: Well, I'd probably add something to the key trends first, if I may, James.

Gruber: Sure.

Faul: So, another trend that we see right now is that wages and other costs are looking to eat into margins, especially in the first half of 2024 and we expect that for the entire industry that that's going to be a key headwind for them.

Gruber: Probably in a couple of ways in that it crimps the consumer but also affects their own costs.

Faul: Exactly, and that's a great segue into your second question on the consumer and the consumer is doing tough at the moment. So, what we're seeing is that the consumer sentiment continues to be bearish. So, the first readings we're getting are that not much has changed from late last year. The consumer is still bearish, and we also saw that in the trading update that I just mentioned with Super Retail Group that – the company stated that especially towards the end of the December quarter, trading conditions became tougher. So, the consumer looks like still to be in a tough spot. That's obviously the cost of (living pressures), a.k.a. inflation, and also higher mortgage rates are weighing. So, for now, the near-term trading outlook looks tough.

Gruber: Can we break it down a little bit with the different retail categories and what the impact will be on them?

Faul: Yeah, and that's quite different. I think as you point out, there's essential goods that need to be bought, food, liquor is part of that, and then there's the discretionary items, like leisure or fashion, that the consumer has been already raining in on, especially household items like furniture have been – demand for that's been really weak lately. And also, what the consumer has been doing is dipping into savings, if you like. So, the savings rate in Australia is way below where it used to be. And overall, households are essentially not saving any money at the moment, so aren't putting away anything for the rainy day. That was the September quarter data. And we expect the December quarter to show a very similar dynamic.

Gruber: So, a tough environment focusing on essentials rather than discretionary. How does all of that feed into your picks for the retail sector?

Faul: When we think about our stock picks, the long-term really matters and matters most for the valuation. So even though we see a tough environment at the moment for discretionary retails, we do see opportunities. And in the discretionary space, our top pick is Kogan. It's a pure online play. And as we mentioned at the very beginning, for e-commerce, we see that channel is going to do well, actually a lot better than brick and mortars. That's our expectation. Hence, Kogan, a company that had had it tough as that really rapid growth in e-commerce reverted and unwound, we expect them to do better as we see that e-commerce growth reemerging.

And in the consumer staples space, our top pick there would be Endeavour, with liquor demand staying solid, not growing massively, but it's a staple, and we believe that demand is going to stay robust in the near term and also long term. So, Endeavour at the moment is screening as undervalued and our top pick under the consumer staples.

Gruber: On the other side, what are the stocks you're most cautious on?

Faul: That's also a very good question. So, the consumer staples, to stay with that segment of the market, we see Woolworths as very overvalued and prefer Coles. Coles is trading at around our fair value estimate. So, within the two supermarkets, for any investor looking at exposure to that segment of the market or that sector, we prefer Coles over Woolworths. And in the discretionary space, Wesfarmers screens as overvalued at the moment. So, that's a big Australian conglomerate. We see quite a few earnings headwinds near term that aren't really priced in. A big one of that is lithium. So, they're going to ramp up production at the lithium mine, and lithium prices, as most investors do know, have absolutely tanked in the last few months. And we expect that division to struggle to post the profit.