Anyone holding Australian retailers in their portfolio will be aware that the sector is currently under pressure. Consumer confidence and spending are down as housing affordability, low to no wage growth and our fragile, commodity driven economy weigh on the minds of consumers. Making matters worse, there is a vague and ominous shadow being cast across the Pacific Ocean from our neighbours in the USA, by the name of Amazon. The global ecommerce (and data) giant has formally announced its intentions to expand its operations to Australia over the medium-term. We expect it will secure its first major distribution centres (DC’s) within the next 12 months, most likely beginning with Sydney and Melbourne.
One thing the market hates more than almost anything else is uncertainty. The impact and timing of Amazon at this stage is difficult to quantify so investors have gravitated towards worst case scenarios. In some ways this is justified, as many listed companies will likely experience a material drop in margins, volumes or both. However, if we look at Amazon’s home market (USA) for guidance, outcomes for retailers are anything but uniform. Foot traffic to malls declined 50% from 2010-2013, the years Amazon established its dominance. Not surprisingly, many retailers have struggled, and some have gone out of business. Yet others still have seen little change or have actually benefitted. Combing through these case studies, some clear trends emerge about what it takes to survive in a post-Amazon market, and possibly how to thrive.

Figure 1. US quarterly sales of department stores vs. e-commerce
Source: US Census, St. Louis Fed
The first and most obvious point is price. The scale and scope of Amazon’s distribution network and its extremely low margin model, make it very difficult for traditional local businesses to match its prices. For evidence of just how large the scale imbalance is, consider that Amazon’s market value is greater than all the listed retailers in Australia put together. We estimate it will take Amazon around five years post-entry to reach critical mass, whereby it can sustainably operate under the pricing it is so famous for. To compete on price, retailers will need a strong, global supply chain with access to low manufacturing and distributions costs. Businesses with high labour and raw materials costs, excessive warehousing footprints or uncompetitive freight/logistics models will all struggle and face a Darwinist challenge to adapt or die.
That being said, there are retailers which can bypass the need to price match. These are the retailers with ownership or long-term exclusive access to leading brands. If there is a brand consumers want enough, price becomes less relevant. Brands such as A2 Milk, Smiggle, Lululemon and Breville are not low cost operators and do not have access to the strongest or cheapest supply chains. Yet they have thrived both domestically and internationally because they own well-known, popular brands that competitors such as Amazon cannot readily substitute. Generally speaking, we prefer businesses which own these brands outright, but those with exclusive rights to them also have an advantage.
Finally, there are those retailers that are naturally resistant to disruption from online. Products that are very large or heavy like whitegoods, vehicles, hardware, and furniture, cannot be cheaply shipped and delivered, eroding Amazon’s pricing power. Products where fit and feel are important, such as jewellery and shoes, also have some defensive qualities but are not immune from disruption. We also believe groceries and other FMCG will be more resistant, given lower consumer engagement with Amazon Fresh in the US and the natural difficulties of competing on range, convenience or freshness. Lastly, products where expertise and staff engagement are required, jewellery and hardware again, as well as healthcare and some electronics, will be naturally more resistant to the Amazon threat.
Advanced Super Workshop
With the above features in mind, we conclude with a high-level overview of ten listed players on the ASX, with illustrative scores for their supply chain, brand power, defensiveness of products and customer engagement. Scores range from 1 to 3 with low scores indicating a lack of defensiveness or competitiveness respectively.

Company (Code)

Category

Cost competitiveness

Brand power

Defensiveness of product

Customer engagement

JB Hi-fi (JBH)

Electronics, whitegoods

2

1

1

2

RCG Corp (RCG)

Shoes

1

3

2

2

Myer (MYR)

Department stores

1

2

1

1

Harvey Norman (HVN)

Electronics, homewares

1

2

2

2

Nick Scali (NCK)

Furniture

1

2

3

3

Woolworths (WOW)

Food and liquor, apparel

3

3

3

2

Wesfarmers (WES)

Food and liquor, apparel

3

3

3

2

Premier Investments (PMV)

Apparel, stationary

1

2*

2

2

Super Retail (SUL)

Sportswear, auto parts

1

2

2**

2

Breville (BRG)

Kitchen appliances

1

3

2

2

Michael Hill (MHJ)

Jewellery

1

2

3

3

Figure 2. Listed retailers competitiveness with Amazon
Source: Clime
*Smiggle’s brand power likely warrants a score of 3, but Just Jeans, Jay Jays and the like are not nearly as strong.
**Super Cheap Auto warrants a score of 3, but large exposures to sportswear category brings overall score down.
In the US, department stores and electronics retailers were the worst hit. In Australia, it may prove to be a similar story. Only time will tell but investors looking to buy retailers at heavy discounts to value should seek supply chain competitiveness, brand power, product defensiveness and/or customer engagement.

Figure 3. US announced store closures for 2017, by company
Source: company reports, Zero Hedge