Investor Spotlight: Counting on the consumer

This issue of Investor Spotlight is brought to you by IG, with Kyle Rodda, Market Analyst and ausbiz presenter.

The back backbone of any developed economy is the consumer. In Australia, more than 50 percent of GDP comes from household spending, while in the US it’s roughly 70 percent. With the cost of living pressures and higher interest rates a headwind to demand, the outlook for the US and Australian economies and their share markets will be heavily influenced by what happens to consumption going forward. In this piece, we deep dive into what’s driving consumption at the moment, review what the major US retailers revealed during the US reporting period and look ahead to some key earnings from ASX-listed consumer stocks.

Assessing the strength of Australian and US households

The global consumer is coming off a period of almost unprecedented strength. The actions of fiscal and monetary authorities in response to the onset of the pandemic cut interest rates to effectively 0%, while trillions of dollars of the stimulus were handed directly to households. This drove a huge increase in incomes and also pushed joblessness towards multi-decade lows in many parts of the world. Savings rates also climbed markedly. In Australia, the household savings ratio surged to as high as 23.8%, which has also bolstered consumption as the domestic unemployment rate plunged to a 48-year low. The profits of retail companies skyrocketed.

Of course, the boom in consumer spending is now facing a potential bust. As we discussed here last week, very strong consumer demand has exacerbated supply shocks to push inflation to 40-year highs in the United States and 20-year highs in Australia. That’s forced central banks to hike interest rates in a very aggressive fashion, with the Federal Funds Rate rising to 2.50% and the RBA’s cash rate rising to 1.85% - with market pricing suggesting that further interest hikes are still to come over the next six months. Retailers' profits have also contracted as companies struggle to maintain the unsustainable earnings growth of 2020 and 2021. Fears are for a major slowdown in consumption now, as policymakers look to cool economic activity.

What did US retail companies report in Q2?

There weren’t the highest expectations for US retailers going into the Q2 reporting period. Owing to softening growth and the treachery of base effects, analysts had forecast earnings growth of -9.4 percent and -2.5 percent for the consumer discretionary and consumer staples sectors, respectively, according to data compiled by FactSet.

As of the 5th of August, 2022, the Fact Set figures reveal consumer discretionary stocks have underwhelmed expectations of aggregate, posting an earnings contraction of 18.2 percent, while the consumer staples sector exceeded estimates, but still posted an earnings contraction of -0.9 percent.

Of greatest concern might be the downgrades the sector delivered throughout the period. Estimates for Q3 earnings from consumer discretionary stocks dropped from 27.2 percent to 19.5 percent; while for the consumer staples sector, estimates for Q3 dropped from 1.5 percent to -3.2 percent.

The dynamic led to a mixed set of numbers from Wall Street’s retail heavy weights. As you can see below, the large-cap retail firms beat estimates more often than not. However, in the case of giant Walmart, that came after two successive profit warnings in the lead-up to the actual earnings report.

What’s the outlook for ASX-listed consumer stocks?

A deluge of consumer companies will report full-year results this week, with the numbers expected to confirm weaker growth for the sector. Of most interest will be the guidance given by management, with investors concerned that the recent rate rises, cost of living pressures and very pessimistic sentiment will see consumer spending and corporate profit growth slow.

Two of the most-watched company reports this week will be Wesfarmers and Woolworths. Here we break down what to expect from the results, how analysts view the companies, and how the charts look for both stocks.

• Wesfarmers

Wesfarmers (WES) will hand down its full-year earnings on Friday the 26th of August. According to data compiled by Reuters, the business is expected to report a more than eight percent drop in profits for the year $2.2 billion - in large part as rising costs eat into margins. Based on the same source, Wesfarmers is estimated to pay out a final dividend of $0.845 per share.

The analyst community is mixed towards Wesfarmers’ stock. Of 15 brokers, the consensus rating is for a hold. But five have a buy, four have a hold, four have a sell, one has a strong sell, and one has a strong buy. The consensus price target is $US48.16 - marginally below where the stock closed trade on the 19th of August.

The technicals show a primary downtrend for Wesfarmers shares. In a short-term time frame, the stock is counter-trending, with price pushing above the 20- and 50-week moving averages. Price is also trading within a trend channel but is approaching its upper bound. Wesfarmers shares sit just below technical resistance around $49.00, which if broken, may see buyers push the stock back above $50.

• Woolworths

Woolworths reports its FY22 results on Thursday the 25th of August. Reuters data suggests the company ought to report full year profits of $1.5 billion, which will be down more than 23% on the year due to both a drop in sales and a squeeze on profit margins. The company is tipped to pay a dividend of $0.494 per share.

Broker analysts have a consensus buy rating on Woolworths stock, despite the $38.59 average price target being below the current share price. Out of 15 analysts, three have a strong buy, five have a buy, another five have a hold and two have a sell rating.

The charts for Woolworths stock show’s price approaching a key level of technical resistance at around $39.60 per share. Momentum has turned to the upside on the weeklies, with the RSI above 50 and price above all major moving averages. The next major level of resistance above $39.60 is around $41.16 per share; major support is around $38.10.