Why don’t we have more investments in the Australian e-commerce industry?
Given our investment philosophy is centred on buying high quality and growing companies this is a fair question.
Structural Growth
In line with global trends Australian e-commerce is a structurally growing category. And it will keep growing for many years to come The shift to online retail has also clearly been accelerated by COVID-19. Online sales figures for omni-channel (bricks & mortar) and online pure-play retailers have posted regular monthly all time-records through the year. Assisted by robust consumer spending, this growth has boosted share returns in the year from JB Hi-Fi (+34% year to date) to online pure-play Kogan which has risen a whopping +180% (this is not a typo!). Strong investor appetite for e-commerce has also supported the recent listing of online beauty products retailer Adore Beauty. It wouldn’t surprise us to see more companies like this list on the stock exchange.
We have researched and continue to learn about the online retail landscape. However, our direct e-commerce investment for Australian portfolios is limited to a shareholding in Woolworths which has a small, burgeoning online retail presence.
We are primarily invested in Woolworths because of its scale advantages rather than because of its online growth strategy (important as that is). It is the #1 supermarket operator by a mile in Australia. It also operates in a stable competitive environment. Supermarket retailing is largely a duopoly in Woolworths’ Australian and NZ markets.
Choosing the leader
In other core investments in our Australian portfolios we’re typically invested in clear leaders in their fields. REA Group and Carsales are both the dominant #1 players in their classified advertising markets. Resmed is a global leading player in sleep disordered breathing. Brambles dominates the pooled pallet market globally. CSL is the global leader in plasma based therapies.
In each of these industries, it is clear who the leaders and winners are amongst the competition.
In contrast, the e-commerce landscape in Australian retail is crowded. Traditional retailers like electronics retailer JB Hi-Fi, Super Retail, or footwear retailer Accent have built substantial online businesses. They are growing their online sales approximately as fast as the pure-play retailers such as Kogan or Catch Group.
Global behemoth, Amazon also poses a longer term threat to the online aspirations of domestic companies. Amazon has arguably disappointed market expectations to date following its launch to much fanfare in Australia a few years ago. But with an eye on the long term prize, Amazon is investing substantially in its Australian e-commerce capability. This includes the construction of a large fully automated distribution centre which will be commissioned in late 2021 in Sydney. Its competitive threat to domestic competitors is rising. It is not going away any time soon.
We do think it is possible for competitors to thrive in an Amazon world as evidenced by the +32% and +22% per annum share price returns over the last five years for US retailers Best Buy and Wal Mart respectively. But competitors will need to be on their toes to succeed. Because while these two have flourished, many other retailers have withered.
Commensurate with sales trends, valuations of online retailers in Australia have also risen materially this year. Some degree of strong future sales growth seems to already be expected by the market. We note that online furniture/homewares retailer Temple & Webster’s share price fell -30% from its highs in October despite a strong trading update. Adore Beauty likewise has fallen -15% since listing in October.
These may be temporary setbacks. But it does highlight the risks inherent in blindly chasing the online theme. Guaranteed growth in a category does not guarantee positive investment returns from buying shares in companies in that category.
There are elements of the online retailers that we do like. With its entrepreneurial culture, Kogan has done an outstanding job building a profitable platform with a strong brand presence that could prove to be durable. Adore Beauty founder Kate Morris has similarly done a superb job over decades locking in exclusive agreements with beauty products brands.
The future
So we will continue learning about and researching the e-commerce sector in Australia in line with our investment process. If we have conviction in the strength and durability of a company’s business model (i.e. we are confident it will be a leader in the category). If its track record and earnings history are sound. If we have confidence in its people. And if these factors line up with a reasonable valuation, then we may increase our investments in Australian e-commerce companies.
