Australia’s retail market is undergoing significant structural change against a backdrop of struggling household budgets, but the latest reporting season reveals some retailers are experiencing improved sales – and profits. With household budgets remaining under pressure from weak wage growth and moderating wealth gains, subdued demand from consumers at a time when competition is rapidly increasing makes for difficult operating conditions in the retail market. However, despite the economic headwinds, many large retailers have reported good profits over the past year, with retail sector revenue rising 4.8% over the year to the March quarter 2018. Constrained household budgets keeping a lid on retail spending When you are leading the world in debt levels relative to income (as Australian consumers are), something has to give. After a boost to wealth (and debt levels) through sharply rising property prices over recent years, households are now left with a debt hangover just as property price growth has started to moderate, and wage growth remains anaemic. That’s the bad news. The good news is that retailers are still seeing good sales growth, despite the debt overhang. Retail spending growth held up relatively well over the 2017-18 financial year with retail volumes expanding 2.6%. There were two reasons for the solid performance – households are drawing on savings to supplement weaker income growth, and retail prices are growing more slowly, supporting sales volumes. The household savings ratio fell to a decade-low 2.1% in March 2018, less than half the 4.7% ratio in March 2017. With income growth stagnating and some non-discretionary prices rising strongly, many households turned to their savings to support spending. The decline in the household savings ratio since 2015 (see chart) has helped retailers, but it’s not a sustainable support. Stronger income growth will be needed going forward (and Deloitte Access Economics expects to see some improvement in wage growth). Household saving ratio – share of household disposable income Source: ABS 5206.0 Households have benefitted from increased retail competition, which has kept a lid on retail prices and supported stronger sales volume growth. Online retailers and the expansion of international fashion houses in Australia have delivered more choice for consumers than ever before. Retail prices rose by exactly zero last year, led by price deflation in apparel and household goods – and delivering a boost to consumer spending power. Retailers still making profits In spite of the economic challenges, many retailers started 2018 on a strong footing. Retail gross operating profits picked up in the opening quarter of the year, rising 11.1% over the 12-month period. This has supported a rise in the ratio of gross operating profits to sales to 4.8%, from 4.6% in the opening quarter of 2017. Ratio of gross operating profits to sales, retail sector Source: ABS 5676.0 Some retailers are still seeing higher revenues without accompanying profit improvement. In 2016-17, over 70% of publicly listed retailers reported improved revenue streams, but only half of the market reported an increase in profit margins. Based on recent announcements, discount department stores have seen some success at the price conscious end, with Wesfarmers’-owned Kmart a stand out in the sector. Many household and electronic goods retailers have also performed strongly, with JB Hi-Fi reporting a 35% jump in net profit. However, apparel remains a difficult segment of the market, with major retailers such as Esprit, Specialty Fashion Group brands including Katies, Millers and Rivers, and Gap announcing store closures over the past 12 months.