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Defending the un-defendable

The AFR reported Coles’ claim that it intends to expand its private label range because “customers are demanding” this.  It’s easy to see how it works: Coles removes branded stock from the shelf and its sales drop to zero.  The customers then have no choice but to buy the only ‘brand’ available, i.e. Coles, which is then definitely in higher demand.  The real reason behind the rush to cheap home brand stems from Coles’ inability to reduce its operating costs.  So, the only option left to keep the business profitable is to buy cheaper stock and sell it for less, but with a higher margin.  The bad news: even this won’t make Coles competitive when compared to Aldi.  In the meantime, Coles must have started to realise that some of the local suppliers have disappeared because they now intend to look for branded merchandise overseas.

UK retail solid growth

US retail is not alone in experiencing boom times.  Reuters reported that UK sales in May went up 3.9% year on year.  We were again disappointed by Reuters – we had to dig deep into their article to find this data.  Most of it was focused on the analysis of meaningless month-on-month sales rate change (1.3%, which means literally NOTHING).  The May results could be a sign of recovery in the UK, but it is worth remembering that the UK economy is still suffering from the uncertainty caused by the approaching Brexit and the re-alignments in international trade driven by the US.

Mission impossible at Godfreys?

In the infancy of a business takeover and restructure by Godfrey’s co-founder John Johnson, the situation has gone from bad to worse with sales slipping by 15% in June compared to the corresponding period last year – triggering a significant profit downgrade. The business had warned earlier this month of a serious cash flow squeeze looming in July and the need for emergency finance. The retailer has failed to adapt to structural shifts in the market and fierce competition from both traditional and pureplay rivals. Saving the business is starting to look a lot like mission impossible.

Coles’ long-term strategic blinkers

The AFR reported further details about Coles’ plan to increase private label brands to 40% of sales within five years. Outgoing Coles MD John Durkan said the grocer wants to be an “own brand powerhouse” by 2023. This just reinforces our prior comments that Coles is operating with long-term strategic blinkers. The initiative may push revenue up in the short-term, but over time it will punish local suppliers (destroying many), increase the business’s cost of operations, and progressively degrade the brand – all without materially enhancing the customer offer or making the business more competitive on price.

Tech tail wagging the dog

Multiple media outlets, including Reuters, reported that Microsoft is working on technology that “would eliminate cashiers and checkout lines from stores”.  This is apparently in a nascent challenge to Amazon's automated grocery shop. Microsoft is working on systems that will track what shoppers add to their carts.  The systems will rely on a combination of customers’ phones, cameras, and sensors.  A claim was made that this will work well for grocers.  Our view has not changed: simply because something is technologically possible (and expensive) doesn’t mean that it makes practical sense.  What about people who don’t have smartphones (still about 10% in Australia), what about shrinkage, or someone throwing an item into somebody else’s cart?  What about the correct handling of fresh meat, produce and other items that are somewhat less precisely defined as SKUs in comparison to a simple can of baked beans?  What about this complex electronic ecosystem experiencing issue? Finally, what about genuine customer service? A good history lesson can be learned from the Great Eastern experience.  Complexity results in clumsy solutions.

Retail sales surge in the US

Reuters reported that retail sales in the US went up 5.9% in May compared to the year before.  This reflects US economic revival, a pipe dream for Australian retailers, plodding along in a sluggish economic environment, which no Australian politician has the guts to reform. The level of unemployed in the US is at a 44 year low and the jobless rate is expected to drop to 3.6% by the end of the year.

Australian retail forecast

Inside Retail reported on Access Economics’ forecast for 2018/19, which expects a mild increase in the rate of retail sales growth, from 2.4% this year to 2.6% the next year.  What interested us more was the comment that “pureplay competition is heating up quickly”.  We have predicted earlier that Amazon’s arrival in Australia would have a significant impact, but predominantly in the e-commerce space. This was based on the assessment that the actual sales drift from brick and mortar to online had mostly already happened prior to Amazon’s arrival.  Given Amazon’s fierce competitiveness in e-commerce and its bottomless coffers, we expect them to make an even bigger dent in the pureplay space in the future.

US interest rates

Reuters commented that the US economy is as close to ideal as it could have been dreamed of a decade ago. It is growing at a pace topping 4 percent, unemployment is as low as it has been this century, and inflation has safely edged up toward an official target.  On Wednesday, the Fed increased its benchmark overnight lending rate from 1.75 to 2.00%.  The rate hike was the seventh in this cycle and marked a shift to a neutral stance in which the policy rate matches inflation. Fed Chairman said that “the economy is doing very well”.

The problem of doing too well

The Wall Street Journal commented that the US Federal Reserve is concerned with the US unemployment rate being too low.  Only twice in the past half-century has unemployment fallen to its current rate of 3.8% - for a few years in the late 1960s and for one month in 2000. The ’60s episode helped spur years of soaring inflation that took a decade for policymakers to corral. The latter coincided with a technology bubble that, when it burst, caused the 2001 recession. The WSJ expects that on Wednesday the Fed will raise short-term interest rates, trying to put some brakes on the economy.

Poundworld enters administration

Inside Retail reported that UK-based discount retailer, Poundworld has officially entered administration after twice failing to secure a buyer to purchase the struggling business. The fate of the retailer’s 5,000 employees will remain up in the air until a buyer is found. As reported in late May, Poundworld’s problems stem from a mix of high rent, product cost inflation, decreasing footfall, weaker consumer confidence in the UK and stiffer competition. It’s a perfect storm for discounters, with insurers also withdrawing credit from The Original Factory Shop this month after the business reported falling profits. Based on all the contributing factors, we think the vertical will remain under pressure for the foreseeable future.

The Fall of the House of Fraser

The BBC reported that the House of Fraser plans to close 31 of its 59 stores by the end of the year, including its flagship Oxford Street store.  House of Fraser needs approval from at least 75% of its creditors to go ahead with its rescue plan.  Established in 1849, House of Fraser became a national chain after World War II, through multiple acquisitions.  In 1948 the company was publically listed, but in 2006 it was acquired by a private consortium of investors.  In 2014 the chain was sold to a Chinese department store chain, and it now needs to handle voluntary administration.  Multiple other attempts were made along the way to acquire the business.  We have always held a view that multiple ownership changes will eventually destroy any business.

The Bitcoin saga continues

We have commented on a few occasions about the Bitcoin bubble (and we are not alone – Warren Buffet recently characterised it as “rat poison squared”). Reuters reported that today Bitcoin traded at US$6,763, down 65% from its December 2017 peak.  This is also an 11% drop since Friday, after the South Korean Coinrail Bitcoin exchange was hacked and apparently lost about 30% of its accounts.  If you ask us, we think that US$6,763 is still a stiff price for something that is virtually worthless.  Warren Buffet said that “buyers of bitcoin thrive on the hope they’ll find other people who will pay more for it.”  We couldn’t agree more.  Like all other bubbles, this too will come to an end when the majority of people will no longer be willing to pay more for it.