Downgrades a sign sector is struggling

It may not be a merry Christmas for Australia's retail sector, as JB Hi-Fi and Billabong are put to the sword on the back of successive profit downgrades.

JB Hi-Fi fired the first shot after market on Thursday when it forecast a 5 per cent decline in first-half operating earnings.

The 5 per cent decline in earnings was mild compared to the market's brutal reaction to the news that saw JB Hi-Fi tumble from $15 a share pre-announcement to close at $11.80 on Monday.

The 21 per cent fall in two days caught some fund managers off guard, and the commentary through the broking world was scathing because there was no indication that profits were under significant pressure at JB Hi-Fi's annual general meeting (AGM) in October.

But the wipe-out of the week went to surf wear company Billabong, which dropped a staggering 44 per cent on Monday following a bleak trading update.

Billabong reported it expected first-half sales revenue to be up by about 5 per cent on year in constant currency terms, which was well below the 24 per cent rise reported for the first quarter at the AGM in October.

Billabong was planning a further operational review to cut overheads and a review of its capital structure - which has sent investors scrambling for the door.

At this stage, Billabong said an equity raising was not the preferred option, but investors who had recently been stung by the BlueScope Steel capital restructure, and with nervousness still surrounding Europe, were not hanging around to find out.

Where there is smoke there is fire, and the above two examples should be clear warning signals that the retail sector is struggling, especially in the December quarter - despite a 0.5 per cent cut in interest rates - and further earnings downgrades in the sector may not be too far away.

Without singling any stocks out in particular, investors should be keeping a close eye of the likes of Myer, David Jones, Harvey Norman and Pacific Brands Group.

It's also pertinent to remember that some of the weaker retail business models, such as Colorado, Border's and Fletcher Jones, have already collapsed, signalling the retailing sector is undergoing a structural change.

I think in the future we'll see a much stronger online presence from the major retailers - as flagged recently by Myer - and physical stores will be managed much more ruthlessly than we have seen in the past.

The question of which companies survive and which companies thrive will depend on how quickly each company can adapt.

Whatever the outcome, have no doubt that as a consumer in the next five years, walking into a retail outlet will be a new and refreshing experience.

Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time.