Retailers gear up for a not-so-festive season

Confidence levels dived by 13 index points during the fourth quarter of 2007, but despite the sharp fall, 71% of respondents in the retail sector still rated ‘prevailing business conditions' as satisfactory. (Confidence is calculated as the gross percentage of respondents that rated prevailing business conditions as satisfactory.) However, the latest results are some way from the record 91% of respondents that were satisfied with conditions in the same period during 2006.

These are the findings of an annual festive season sales survey conducted by Stellenbosch University's Bureau for Economic Research on behalf of global audit and business advisory firm Ernst & Young. The results are in line with the official data on retail sales, which also pointed to a consumer demand slowdown in recent months. According to Statistics South Africa, real retail sales volumes (compared with the same month in 2006) slowed to 2.0% in September, the weakest performance since early 2003. Sales volumes grew by 7.2% during the first nine months of 2007 against 9.6% for 2006 as a whole.

Economic impacts

The survey results as well as the official data should be seen against a macroeconomic backdrop where inflation has breached the SA Reserve Bank's (SARB) 6% upper target for six consecutive months, interest rates have been raised by a cumulative 3.5 percentage points since June 2006 and consumers are facing tougher credit standards since the introduction of the National Credit Act on 1 June 2007.

Furthermore, the festive season may start on a sour note amid indications that the petrol price could rise sharply in December, while recent hawkish interest rate comments from SARB Governor Tito Mboweni have raised the risk that consumer finances may be further stretched following the SARB's December interest rate meeting.

“Only 23% of the respondents to the survey indicated that they expected higher sales compared with last year during the 2007 festive season,” says Derek Engelbrecht, Retail and Consumer Products Director at Ernst & Young. “The combination of slower sales growth and high input costs have seen retailer profitability decline to levels last seen in 2003. Easing demand conditions are also reflected in retailers (mainly in the clothing and footwear sector) reporting rising inventory levels in relation to expected demand.”

Engelbrecht concurs that retailers will have to adopt some innovative thinking in order to shift units which are inherently linked to their profits. Discounting products, he says, is likely to be the best option so as to avoid being stuck with festive season goods in the new year.

An analysis of the results per retail sales category shows that (contrary to the trend witnessed in recent quarters) the growth in sales of food, beverages and general groceries slowed sharply over this festive season, while sales of durable goods such as furniture, household appliances and electronic equipment are set to increase compared with the third quarter.

Higher prices may hurt the demand for non-durable goods

Although confidence levels in the non-durable goods sector (mainly food and beverages) declined during the fourth quarter, almost 80% of respondents still remained satisfied with current conditions. The more startling result was the sharp slowdown expected for sales volumes.

“To date a sustained rise in the real disposable income of households (mainly as a result of increased employment, the rapid rise in social grants paid by government and above inflation wage increases) has shielded consumers against higher food and petrol prices. The result was that non-durable consumption remained robust,” he says.

However, non-durable goods consumption already started to slow in the second quarter of 2007 to an annualised rate of 3.3% from 7% during the first quarter. In its September 2007 Quarterly Bulletin, the SARB mentioned that the slowdown was mainly as a result of higher food, beverages, tobacco and petroleum product prices. Food prices have subsequently increased further, rising by 12% on an annual basis in September.

The latest survey results indicate that the slowdown in non-durable consumption is set to continue over the festive season and beyond.

Semi-durable confidence the hardest hit

“Another surprising result (not so much the direction of the trend, but the severe nature of it) was the very sharp decline in confidence amongst clothing and footwear retailers to the lowest level since 2000,” he says.

The large fall was despite respondents in this retail category actually being somewhat more optimistic about sales volumes during the fourth quarter compared with the previous quarter.

Engelbrecht says the lack of confidence may be a result of significant margin pressure, which is weighing on profitability. He suggests that in an effort to ensure adequate demand for their goods from the more cash strapped consumer (along with increased competition), semi-durable retailers seem to be absorbing most of their input costs instead of passing it on to the consumer.

The survey also indicates that retailers in this sales category are concerned about demand in 2008, which also explains the large fall in confidence. Historically semi-durable confidence has been known to periodically show a large fall/increase so it is not inconceivable that confidence levels could bounce back somewhat in the first quarter.

Stronger durable sales over festive season, outlook not as rosy

As was the case during the 2006 festive season, the survey indicates that durable goods sales (which are the most interest rate sensitive) are again set to defy the challenging macroeconomic environment.

Official data indicate that sales of furniture and household appliances have been negative on an annual basis since June, but the latest results hint that retailers in this sector may receive (temporary) respite over the Christmas period. Importantly, the expectations for sales in the first quarter of 2008 are negative, indicating that the good times are unlikely to last.

“As it becomes expensive to take out debt and as the quantity of debt has been restricted by legislation such as the National Credit Act, we might see a savvy consumer who prefers to spend his last few cents on goods that will last longer,” he adds.

Retail environment to remain tough for next 12 months

Regarding the outlook for overall consumer demand, the lagged impact of the interest rate hikes already seen is expected to become more pronounced during 2008 with especially durable consumption set to feel the pinch.

Engelbrecht concludes: “The festive season survey results clearly indicate that demand is responding to the higher interest rates and provides some justification to the view that rates should not be raised further in December. Also on a more positive note, inflationary pressures are forecasted to ease during the second half of 2008, which may provide some leeway to the South African Reserve Bank for a moderate interest rate cut towards the end of the year. For at least the next 12 months the retail environment is set to be tough, but from 2009 a recovery is likely to set in.”

About the Ernst & Young Festive Season Retail Trends Survey
The Bureau of Economic Research's business surveys are conducted quarterly. The BER's panel for the retail sector consists of 611 retailers and is broadly representative of the formal retail sector, taking into account the response rate and the results from a comparison between the composition of the survey panel and census and other official data. The fourth quarter survey took place between 22 October and 19 November 2007.