What valuation do you put on sentiment? 

Retail stocks were on the nose for some time amid fears of recession, the impact of rising interest rates, the cost-of-living crisis and inflation’s impact on the cost of doing business. 

The recent HY24 reporting season, however, revealed much of the fear was misplaced. Aggregate revenue growth tended to beat estimates despite moderating slightly. Meanwhile, even though earnings before interest, tax, depreciation and amortization (EBITDA)margins compressed as the cost of doing business grew, this was somewhat offset by gross profit growth. Companies were able to pass on higher prices and more, and in the face of those price increases, consumers were surprisingly resilient. 

Leading retailers, including Nick Scali (ASX:NCK) and JB Hi-Fi (ASX:JBH), caused many investors to reconsider their bearish stance, with JB Hi-Fi’s Australian business performing better than expected and Nick Scali impressing with a demonstration of scale benefits from its strategic acquisition of Plush and a reacceleration of trading momentum during the December quarter.  

Digital retailers like Cettire (ASX:CTT) and Temple & Webster (ASX:TPW) also delivered stellar performances, with both companies surpassing market expectations.  

Surprised by the news, analysts lifted sales assumptions amid the gradually improving consumer backdrop and revised their earnings growth projections for 2024 and 2025 upwards. In addition to an improvement in the earnings outlook, one year forward price-to-earnings (P/E) multiples expanded, in aggregate, for discretionary retailers. 

The question now is whether there’s more upside for investors. The answer to that appears to be in now, with broker Barrenjoey revealing the results of a second survey of 35 fund managers. 

The survey highlights a reversal of the hitherto negative posture held by investors towards retailers, and Barrenjoey believes there’s more room for share price gains because many managers have yet to revisit their outlooks for the retail sector. The implication is that more managers will be positively surprised when they take a closer look. 

The broker believes the easy gains from the revision have been made and the ‘low-hanging fruit’ picked. But the emphasis is on the 21 per cent of managers who remain ‘underweight’ in the retail sector, and only 41 per cent are ‘overweight’. 

Of special note is the contrarian nature of fund manager positioning. Relative positioning by managers in the consumer discretionary sector matters because the sector has an approximately 17 per cent weight in the ASX Small Ordinaries and a circa seven per cent weight in S&P/ASX 300 Index. 

Broadly, fund managers currently believe consensus earnings forecasts are broadly ‘fair’ or reasonable, while a growing number of managers surveyed believe downside earnings risk has fallen meaningfully.  

And finally, and perhaps obviously, Barrenjoey made the observation that valuations will become more important for those managers that are underweight as they may believe they have ‘missed’ the rally/recovery. Encouragingly perhaps, on balance, the fund managers surveyed still don’t think valuations are at extreme levels. 

For investors interested in consumer discretionary retailers, the results of these surveys should not ever change the main focus, which should be on identifying quality, and estimating growth and value. 

For ideas about how to undertake this work, we wrote about ARB Corporations (ASX:ARB) and Nick Scali last year, offering intrinsic value estimates for Nick Scali. We will do that again soon, so stay tuned. 

The Montgomery Small Companies Fund owns shares in ARB Corporations. This blog was prepared 15 March 2024 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade ARB Corporations, you should seek financial advice 


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