Why Australian retailers are doing it tough and that's unlikely to change

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Many Australian retailers are struggling right now.

Gross operating profits are falling, growth in income from sales has slowed and pricing power is under pressure from international competition.

Several high-profile retailers have gone into voluntary administration and jobs are being shed across the sector.

Conditions have clearly been better, and the question many are now asking — including shareholders of listed retailers — is whether they’ll remain like this, or start to improve.

That’s exactly what Jo Masters, senior economist at ANZ, has been looking at, releasing an excellent report looking at what’s been driving the recent weakness, and whether it will continue.

The news is not all that great.

Based on her analysis, Masters says recent weakness has been driven by two factors working in tandem — consumer demand for retail goods is soft and competition, partially as a result of foreign retailers, has been intensifying.

“Annual growth in both retail sales and retail spending per capita has been slowing,” she says, noting that retail sales volumes were up just 2% in the year to December 2016, well below the long-run average of 3.6%.

“In part this reflects shifting consumption patterns away from traditional retail goods in favour of services.”

This chart from ANZ shows the recent deceleration in annual Australian retail sales turnover in nominal terms, breaking down the contribution by changes in prices and volumes.

Source: ANZ

It’s been weaker in the past, yes, but there has been a noticeable deceleration over the past two years, bucking the trend in private consumption — which includes spending on services — that has been growing at around 2.5% per annum over the same period.

So demand has been weakening, but it’s not the only factor that’s led to difficult trading conditions,’ says Masters.

Pricing power from retailers is close to non-existent, thanks to intense, and growing, competition.

“Retailers’ pricing power is being constrained by both the rise of online shopping, and the trend by major global retailers to enter the Australian market with brick and mortar stores,” she says.

On the arrival of large foreign retailers such as Amazon, Costco and Aldi, among others, Masters says that they are attracted by relatively high margins in Australia and will continue to enter specific sectors as long as that additional margin is on offer.

And, based on the current trends, she says those factors will see retail conditions remain difficult for at least the next two years.

“Looking forward, we expect wage growth to remain weak, the decline in the unemployment rate to continue but at a more gradual pace, and house price growth to moderate,” she says. “In this environment, and given already elevated levels of household debt, we doubt households would be willing to rundown savings much further.”

Perhaps of more importance, she also expects that pricing power will to continue to be dampened by competitive pressures.

“These pressures may not intensify but are equally unlikely to dissipate any time soon.”

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