Retailers to suffer as Amazon set to thrive in Australia: Morgan Stanley

ELI GREENBLAT
Retailers are being warned not to feel complacent about Amazon’s recent low-key launch in Australia and the global giant’s minimal impact to date on the nation’s $300 billion consumer sector, with Amazon’s new Prime service tipped to act as a battering ram that will grab market share and customers from leading domestic chains such as Bunnings, Kmart, Target, Big W and Harvey Norman.
And helping to fuel the rapid acceleration in Australia of Prime, Amazon’s flagship subscription service that offers a suite of services such as music, e-books, movie and TV streaming as well as discounts on Amazon orders, will be highly conducive demographic and income factors such as high population densities in key capital cities, cheaper courier costs and a relatively flat income distribution.
Amazon Prime landed in Australia last month, costing $6.99 for a monthly subscription or $59 a year. The service has more than 100 million users worldwide.
Morgan Stanley analyst Thomas Kierath warns in his latest report to clients that the Amazon impact is most underappreciated at Wesfarmers (WES), which is Australia’s largest non-food retailer and that the market has underestimated how damaging Amazon could be to the profitability of its retail chains.
Casting an eye over the upcoming reporting season, Mr Kierath added that “exposed” retailers earnings will progressively disappoint as they increase their spend on digital initiatives driving operating deleveraging, with companies like Woolworths and JB Hi-Fi already showing some strains to their like-for-like store sales and earnings in the December half.
Morgan Stanley thinks Australian department stores are the most exposed, and that a soft start to Amazon in Australia shouldn’t fool anyone into thinking the pain to earnings will be minor.
“Despite much anticipation, we think Amazon’s impact on Australian retail is largely confined to forcing retailers to increase spend on their internet platforms and delivery terms, rather than via a loss of revenue in the near term,’’ Mr Kierath warned.
“But the long term Amazon impact could be significant. We think Australia is well suited for Amazon, given relatively low delivery costs relative to other developed countries, the high concentration of the population, the relatively flat income distribution, relatively high incomes and an Amazon Prime offer that is priced to succeed.
“We continue to believe that Amazon will be successful in Australia longer term, which will at a minimum depress retailers’ P/E multiples relative to their history.’’
Mr Kierath said Amazon’s impact on Australian retail to date has been minimal, but he expects it to accelerate quickly post the Prime launch and likely product expansion.
“The Australian Prime offering looks particularly good value given the required purchases needed compared with the Prime cost vs. global offerings and is likely to resonate with Australian consumers, in our view.’’
Smoothing the path for Amazon and Prime in Australia will be a range of population, demographic and income factors.
“On a per parcel basis we estimate Amazon’s delivery costs are only slightly higher in Australia vs. the US, but lower than Canada. The relatively high population concentration within the top 3 cities helps: 40 per cent in Australia compared to 12 per cent in the US and 30 per cent in Canada.
“Strong Australian courier competition drives down delivery costs, in our view, which partially offsets low major city population density in Australia and high minimum wage costs. We think Prime will be compelling for Australians as delivery costs aren’t prohibitively high.
“Australia has attractive population demographics for Amazon too: Analysis compiled by our US internet team on Amazon Prime penetration by income bracket shows Amazon’s success in the ‘upper-middle’ income bracket.
“Since Australia has flatter income distribution vs. the US, we think it supports Prime penetration.’’
Mr Kierath said Amazon impact is most underappreciated at Wesfarmers.
“Australia’s largest non-food retailer generates $2.2bn in operating profit across Bunnings, Kmart, Target and Officeworks. We think the market underappreciates how impacted it will be given; high existing operating margins (FY18E); Bunnings 11.7 per cent, Kmart 9 per cent and Officeworks 7.3 per cent; online percentage of sales (ex-Officeworks with 20 per cent online) is very low (less than 2 per cent) or non-existent; and a high proportion of stores (more than 95 per cent) are leased.
“Retailers that we think are particularly exposed to Amazon across our coverage are Kmart/Target (Wesfarmers) — relatively weak online platforms with exposed department store category, Big W (Woolworths) — exposed category, Bunnings (Wesfarmers) — no online store, despite attractive category, Rebel Sport (Super Retail Group) — exposed category and Harvey Norman — relatively weak online platform, exposed category.”