Which Stores Will E-commerce Hit the Hardest?

Research by UBS shows that online purchases in the US will grow to around 20 per cent of all purchases by 2022. This upward trend should also occur in Australia. But the pain won’t be equally felt by all brick & mortar stores. Some might be hit particularly hard.

Today, it’s impossible to put the retail sector into one basket, from pet food to clothing to cars, there are almost as many sub-categories as there are consumers. But no matter whether they’re selling Lego or lingerie, one thing every retailer is trying is e-commerce. I cannot remember the last time I couldn’t find something I was looking for online.

The question for investors however is not whether an item will be available online, the really important questions are 1) how much of the retail dollar will migrate online for each category, and therefore 2) how much disruption will be experienced by brick & mortar operators in those categories?

I don’t believe the online juggernaut will kill store-based retailing, but I do believe retail strips and malls will, in a decade, look nothing like they do today. I suspect the change might be painful too, which we can speculate might explain why the Lowy family chose to exit retail real estate when they did.

But some categories are succeeding with a traditional store concept. The Australian fast fashion jewelry chain Lovisa, with its affordable prices, small basket size and the instant gratification that spur-of-the-moment purchasing provides, has given Lovisa success, which it is rolling out globally.

According to a fascinating piece of research by UBS, who examined e-commerce migration and how penetration rates might evolve in each category, predicts ‘online’ will grow from about 13 per cent of US retail sales today to circa 20 per cent by 2022. This represents growth significantly faster than the expected one per cent aggregate growth of brick & mortar stores.

So, there will be some terrific opportunities, especially if the market falls in the mean- time.

Adopters of E-commerce

E-commerce has been most widely embraced by the younger generation. If we remember that younger people usually don’t have the money to make big ticket purchases, e-commerce is dominated, currently at least, by categories where the price point is relatively low.

The categories experiencing the highest online penetration, and therefore the most disruption for traditional retailers, has been books and music. More than 50 per cent of US retail sales in these categories is conducted online. Other categories witnessing between 30 and 50 per cent online penetration include, sporting goods, electronics, power tools, appliances, clothing, toys and shoes. Bath and bedding is currently just under 30 per cent and groceries around 10 per cent.

But according to UBS, bath & bedding (think towels and pillow cases) is a category in which brick & mortar stores face great risk. And that puts businesses like ASX-listed Adair’s, which must also contend with the slump in residential activity and house prices, in the firing line.

Adair’s reported a strong FY2018 result. On the back of a 19 per cent jump in sales, the company reported a 45 per cent increase in earnings per share and a 69 per cent rise in dividends per share. But the outlook for 2019 - 2020 is perhaps not as optimistic.

If the Australian economy slows, not only will that impact the revenue line, but a weaker Australian dollar could also materially increase the cost of its imported items. Meanwhile, declining confidence among consumers – related to the weakening housing cycle – and the fact that the company is cycling very strong numbers last year suggest it may have a tough time maintaining the growth rates of prior years.

While the Adair’s’ share price has already fallen considerably from its October 2018 highs, the risk of further downgrades and the longer-term risk of growing online penetration in the category suggests investors should become more alert.

Roger Montgomery, Chief Investment Officer, Montgomery Investment Management