RETAIL

SPEND TREND

3SPEND TREND

TABLE OF CONTENTS

Introduction 4

Household spending versus Australian retail turnover 5

Online retailing 6

Key considerations for Australian retailers 9

Review of financial indicators for ASX speciality retailers 10

Wesfarmers and Woolworths 11

Key findings 12

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INTRODUCTION

BDO is pleased to present “Spend Trend”, which examines trends within the Australian retail industry and their impact on retailers.

We have partnered with BIS Shrapnel, Australia’s leading provider of industry research, analysis and forecasting services, to provide a review of household spending versus Australian retail turnover, based on ABS data, as well as BIS Shrapnel survey results.

In addition, BDO’s Retail team has undertaken analysis of financial indicators for 18 listed specialty retailers. Finally, we compared the specialty retailers’ results to the results when Wesfarmers and Woolworths were included in the analysis to investigate to what extent the industry trends are impacting the specialty retailers compared to the larger and more diversified retail operators.

BDO Retail teamWe have a dedicated national Retail team that harnesses the combined knowledge and experience of all our staff and partners to provide audit, tax and advisory services to clients across Australia.

In Australia, we host regular retail seminars and forums that allow our retail clients to network and discuss industry issues throughout the year with industry experts and their peers.

Our retail experts provide specialist audit, tax and advisory services to a broad range of large and small retail clients across a range of sub-sectors including:• Fast moving consumer goods• Fashion and footwear• Grocery• Technology• Homeware and textiles• Hardware• Pharmacies and healthcare• Restaurants and cafés.

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HOUSEHOLD SPENDING VERSUS AUSTRALIAN RETAIL TURNOVER

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Perc

enta

ge c

hang

e (c

onst

ant

$ 20

09-1

0) Retail turnover

Household spending

10

8

6

4

2

0

Chart I: Household spending and retail turnover

Year ended June Source: BIS Shrapnel, ABS

There has been much discussion over the challenges facing Australian retailers over the last couple of years. Chart I illustrates the slump in retail turnover growth post Global Financial Crisis (GFC), with the exception of a temporary rebound associated with the government’s fiscal stimulus package.

Growth slumped to a 20 year low in the year to September 2011. Since then, there has been a sharp bounce-back in the pace of retail turnover growth. Even so, it remains modest in comparison with historical growth rates.

The chart also shows that a substantial gap opened up in 2010 and 2011 between the pace of growth in total household spending and retail turnover. This was an unusual period as historically, the gap was more typically the other way around ie retail turnover was growing at a faster pace than household spending.

The gap has now more or less closed, but it is useful to dissect what caused the gap as it had a marked impact on the performance of Australian retailers, as discussed in the Review of financial indicators for ASX speciality retailers to follow.

There are two main reasons for the divergence between growth in household spending and retail turnover.

The first is the increased spending by Australians overseas rather than at home. Over the last two years, the high Australian dollar encouraged overseas trip by Australians; the number of Australian residents departing on short-term overseas trips increased by 16%. While overseas, Australian holiday-makers went shopping. This spending overseas detracted from spending at home.

Secondly, retail turnover was also hit by a decline in spending by visitors to Australia. Short-term overseas visitor arrivals were up slightly, by about 4% over the same two year period, but we estimate that there was a decline in the total spending by foreigners in Australia during that time.

We estimate that these factors reduced average annual household spending in Australia by 0.7 percentage points (“net tourist spending” in Chart II) ie while total household spending was 3.3% higher in real terms, on average over the two years to September 2012, after adjusting for net tourist spending it came down to 2.6%.

6 SPEND TREND

Year ended September 2012 Source: BIS Shrapnel, ABS

Household spending

Net tourist spending

Services and overseas

online spending

Retail turnover

1.3%

-1.3%

-0.7%3.3%

Chart II: Attribution of difference between household spending and retail turnover

As seen in Chart II, another factor that has been important in holding down growth in retail turnover is the increased use of the internet to purchase goods from overseas. In addition, Australians are spending more on certain non-retail goods and services, including travelling overseas. These factors detracted 1.3 percentage points from average annual household spending.

The critical point is that the weakness in retail turnover experienced by Australian retailers in recent times is not a true reflection of the state of consumer spending.

Australian households have been spending, but it has not all found its way to Australian stores.

Nonetheless, there has been a clear improvement in retail turnover growth since the depths of 2011. Year on year growth through 2012 has been steadily improving, albeit monthly data remains volatile.

Online retailingOnline retailing has become a force to be reckoned with, although estimates of the online market share in Australia vary substantially. At present it appears to be close to 5% of total retail turnover in Australia, which equates to approximately $13 billion, having grown from 1% or less a decade ago.

The current market penetration is probably not far behind that in the US but is well behind the UK and some other European countries.

It is clear that the vast majority of consumers now shop online, many of them regularly. Significant numbers are now doing a large part (and even the majority) of their shopping online.

The key factors driving shoppers online are:

• Price – The rise of the Australian dollar has made online shopping at overseas sites more popular, but price is also a consideration in shopping online domestically. There is a proliferation of comparison shopping, daily deals, flash sales and group buying sites to help consumers track down a bargain.

• Choice / uniqueness – There is far more product choice available online than in-store as shoppers can access internationally-based retailers not available through Australian stores. Moreover, by tapping into online-only retailers or overseas retailers, consumers can access items that others are unlikely to have.

• Convenience – There are multiple aspects to convenience, from 24/7 availability online to the avoidance of traffic and parking hassles. Comparison of products and prices is also more convenient online than traipsing from store to store. Social media and online forums are particularly used by younger shoppers to source product information. The increased ownership of smartphones and other mobile devices has also enhanced the convenience aspect of online shopping.

• Service and experience – It used to be said that physical stores offered a level of service that you cannot get online. This is no longer the case. Online sites have improved substantially and have the advantage of detailed knowledge of past buying patterns. Many shoppers report an excitement to buying online that matches the offline shopping experience.

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It appears that Australian consumers would prefer to shop at domestic sites given the choice with the majority of online sales currently to Australian sites, whether belonging to ‘pureplay’ (online only) retailers or ‘bricks and mortar’ retailers. There is, however, quite a discrepancy in estimates of the Australian share, ranging from just over 50% to as high as 80%.

Australian retailers have been caught on the back foot as regards online retailing, having been slow adapters when it comes to this channel. A few dabbled in the first ‘Dot Com’ boom over a decade ago, but many gave it up as a lost cause until recently.

Over the last year there has been a surge in online offerings by Australian retailers. After a decade of no improvement, the BIS Shrapnel survey of online retailer activity recorded a dramatic rise in the proportion of Top 20 Australian retailers with a comprehensive online offering in 2012 (Chart III). The proportion has now reached over 50%.

Australian retailers have suddenly recognised that consumers are embracing online shopping and they have to be a part of it. The large retailers are latterly giving the online platform more respect. Since the date of the survey, both Myer and David Jones have substantially broadened their online offerings in a bid to become ‘omni channel’ retailers and dramatically raise their online share of sales (from less than 1% at present).

As retailers get up to speed, the online market share is widely predicted to grow substantially, with certain categories of spending having particularly strong growth prospects, such as fashion and beauty products. Even food shopping, which is unlikely to ever suffer a very great online market penetration, could see substantial growth off its current low base. After all, UK supermarket chain Tesco reportedly has 4% of sales online, whereas Woolworths reports only around 1% online.

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Perc

ent o

ffer

ing

full

rang

e on

line

100

80

60

40

20

0

Chart III: Australian top 20 retailers, online offerings

Year ended June Source: BIS Shrapnel, ABS

8 SPEND TREND

Online shopping via mobile devices

A key factor driving the growth of online retailing is the proliferation of mobile devices, including phones and tablets. Consumers have demonstrated their enthusiasm for browsing and shopping at websites optimised for mobile devices (mobile sites) so it is now up to retailers to make them available.

In March 2012 BIS Shrapnel undertook a survey of 40 retailers which were heavily represented in Australian shopping centres, to investigate retailers’ response to the popularity of mobile devices ie how many retailers provide a mobile site, using two different smartphone brands, an iPhone and an android phone. Key advantages of a mobile site versus a traditional website are faster load times for pages and less strain on users’ data download limits.

Of the 40 retailers surveyed, only 12 (30%) had a mobile site. Provision of a mobile site is high among fashion retailers. Within this category, nine out of 21 retailers had a mobile site (43%), compared to just three out of 19 (16%) among the other categories. This is consistent with the more pro-active approach to online retailing by small to medium sized fashion retailers generally.

While 70% of the retailers surveyed did not have a mobile site, not having a mobile site is not necessarily a barrier to making purchases on mobile devices. Of the 28 retailers that did not have a mobile site, 75% of them offered online retailing through a traditional website and this was still accessible on the smartphones. This reflects the capability of web browsers on mobile devices to handle full websites without sacrificing functionality.

Chart IV: Australian retailers, proportion of mobile sites40 retailers

21 fashion retailers

30%

70%

43%

57%

Mobile site

No mobile site

Mobile site

No mobile site

9SPEND TREND

Conversely, having a mobile site does not guarantee an easy shopping experience. For some mobile sites surveyed there were issues with pages not loading properly or the wrong page loading. Also, mobile sites often require loading more pages before getting to the desired page which can take longer than on a traditional website.

Of those that had mobile sites, as at the survey date, the smaller retailers appeared to be leading the mobile marketplace race. In comparison to leading department stores, the smaller retailers’ mobile site offerings were superior.

The internet offers many opportunities. It is not about fighting off competition. It is about growing your brand, developing better relationships with your customers, with a more frequent dialogue thanks to social media, and utilising mobile commerce to generate increased sales at considerably better margins both in-store and online.

Key considerations for Australian retailersRetailers can take heart from the fact that household spending growth has recovered post-GFC and is running at reasonably healthy levels. The challenge is to ensure that the recovery in domestic retail turnover continues and that an increasing proportion of consumer spending is directed through Australian retailers.

Online retailing is predicted to continue to grow and expand its market share at the expense of in-store retailing. It is imperative that retailers are up to speed in the online arena, so that they do not lose out to other retailers who are.

10 SPEND TREND

The key financial ratios and indicators that were examined include: • Net profit margin• Gross profit margin• Operating revenue• Stock turnover• Creditor days• Gearing• Salary, rental and marketing costs as a percent of revenue• Earnings per share

BDO compared key financial ratios and indicators for 18 ASX listed specialty retailers for the three financial years 2010, 2011 and 2012. We examined whether the perceived and much talked about softening in the economy, especially the kick-on effect on the retail sector, has actually been reflected in the retailers’ published financial results.

Given that the retailers selected for review represent a diverse range of retailers in both size and products sold, the weighted average for each financial ratio and indicator was calculated.

Our review found that the downturn in the economy and its flow-on effects to the retail sector, have, in relative terms, over the last three financial years, resulted in retailers recording deteriorating financial results. The effect has been prevalent among specialty retailers.

While the selected retailers were able to keep margins relatively stable and experienced increases in gross revenues (upwards of 7% over the three year period), the impact of asset write-downs, rising salary costs, rental and marketing expenses eroded net profit margins. As such, the selected retailers experienced a 70% fall in net profit margin over the three year period.

It is also interesting and pertinent to note that marketing expenses relative to sales experienced the highest increase, indicating that companies, while looking to keep employee and rental costs under control, recognised that they needed to increase their marketing spend in order to maintain their market share1.

1 The figures in relation to salaries/wages, rent and marketing expenses as a % of revenue are based on published numbers and are therefore not available for all selected retailers as they are not disclosed by each of the selected companies.

Our review clearly indicates that the slowing of the economy, increased competition from overseas online retailers and other local economic factors, have caused a significant deterioration in shareholder returns for Australian listed specialty retailers. While retailers have been able to maintain margins and revenue levels, net profit margins have fallen by a weighted average 70%.

Overall, the effect has been far more severe on specialty listed retailers with spending patterns on the more discretionary items being the most affected and causing more volatile financial results for these retailers.

REVIEW OF FINANCIAL INDICATORS FOR ASX SPECIALTY RETAILERS

The decrease in net profit margin has had a flow-on effect on earnings per share (EPS), which for the specialty retailers also dropped significantly over the three year period.

While retailers have traditionally had low gearing, the last three years have seen the gearing of the selected retailers increase by 50%, although, with the weighted average ratio at 30%, it is still quite low when compared to other industry sectors.

Rather surprisingly, creditor days, which is the amount of time that a company takes to pay its trade creditors, has barely moved, meaning that the selected retailers have not materially changed the rate at which they pay their major creditors, despite the adverse financial effects they are experiencing.

A review of stock turnover ratios for the specialty retailers selected, revealed that during the three year period, stock turnover has slowed by over 12% or approximately seven days, adding further significance to the creditor days result.

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Wesfarmers and WoolworthsTo provide a clearer picture we also compared the key financial ratios and indicators for the three financial years 2010, 2011 and 2012, for the same 18 ASX listed specialty retailers and included both Wesfarmers and Woolworths.

Wesfarmers and Woolworths cumulatively represent almost 90% of the total revenue of this selected group of 20 retailers, so BDO calculated and compared the weighted average KPIs for all the selected retailers including Wesfarmers and Woolworths.

Not surprisingly, the effect has been more prevalent among the specialty retailers rather than Wesfarmers and Woolworths as the two biggest and most diversified retailers, with Wesfarmers and Woolworths being able to withstand the economic factors far better given their diversity and presence in commodity product areas, namely food, beverage and petrol.

12 SPEND TREND

Full Year Full Year Full Year 2010 2011 2012

140

120

100

80

60

40

20

0

Gro

ss re

venu

e ($

billi

ons)

Overall, sales revenue in the last three years has remained flat.

Sales revenue

• The specialty retailers’ total sales revenue increased by 7.4% or $1.1 billion over the 3 year period, however, the increase between FY 2011 and FY 2012 was only 2%.

• The industry average sales revenue has increased by 9% over the three year period or by approximately $10.8 billion.

Key findingsThe key findings below compare the weighted average results for the 18 listed specialty retailers (the specialty retailers) to the weighted average results for the entire selected group of 20 retailers including Wesfarmers and Woolworths (the industry average). This provides an insight into the impact of industry trends across the retail industry as a whole, including larger diversified retailers, versus the impact on smaller, specialty retailers.

Gro

ss m

argi

n (%

)

Full Year Half Year Full Year Half Year Full Year 2010 2010 2011 2011 2012

46%

44%

42%

40%

38%

36%

34%

32%

30%

Generally, retailers have been able to maintain their gross margin at fairly steady levels.

Gross profit margin

• The specialty retailer weighted average gross profit margin has increased by 1.4% over the three years.

• The industry average weighted average gross profit margin has decreased by a modest 0.13% over the three years.

Total industry

Total specialty retailers

Industry average Specialty retailers

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Industry average Specialty retailers

Wei

ghte

d av

erag

e ne

t pr

ofit

mar

gin

(%)

Full Year Half Year Full Year Half Year Full Year 2010 2010 2011 2011 2012

8.0%

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

The deterioration in net profit margin has been much more profound for the specialty retailers, especially from FY 2011 to FY 2012.

Net profit margin

• The specialty retailer weighted average net profit margin has fallen by 70% over the three year period.

• The industry average weighted average net profit margin has fallen by 16% over the three year period.

Ave

rage

tim

es p

er y

ear

Full Year Half Year Full Year Half Year Full Year 2010 2010 2011 2011 2012

14

12

10

8

6

4

2

As expected, stock turnover has slowed over the last three years, more so for the specialty retailers.

Stock turnover

• The specialty retailer stock turnover has slowed by 12.5% during the three year period (or deteriorated from nearly 46 days to 53 days).

• The industry average stock turnover has slowed by approximately 1.3% during the three year period (remaining steady at approximately 30 days).

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Industry average Specialty retailers

Day

s

Full Year Full Year Full Year 2010 2011 2012

70

60

50

40

30

20

10

0

Rather surprisingly, despite the adverse economic conditions and other deteriorating financial indicators, creditor days have remained constant.

Creditor days

• The specialty retailer creditor days also increased by less than 1%.• The industry average creditor days have decreased by less than 1%,

and remained fairly consistent.

Perc

enta

ge g

eari

ng

Full Year Half Year Full Year Half Year Full Year 2010 2010 2011 2011 2012

0.6

0.5

0.4

0.3

0.2

0.1

0

Overall, despite the increasing debt levels, the gearing for the retailer sector is quite reasonable at around 30% when compared to other industry sectors.

Gearing ratio

• The specialty retailer gearing ratio increased by more than 60% over the three year period although it increased by over 166% from FY 2010 to FY 2011.

• The industry average gearing ratio increased by 24% over the three year period.

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Industry average Specialty retailers

Perc

enta

ge o

f rev

enue

Full Year Full Year Full Year 2010 2011 2012

45

40

35

30

25

20

15

10

Salaries, rent and marketing expenses as a percentage of sales

• The specialty retailer aggregated salaries and wages, rent and marketing expenses as a percentage of sales increased from nearly 34% in FY 2010 to 41% in FY 2012. The major increase was as a result of marketing and selling expenses which when expressed as a percent of sales, increased by 70% over the three year period.

Salary, rental and marketing costs have continued to increase during the three years, significantly impacting retailers’ profits, given the flat revenue levels.

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