The Retail Sector: In focus

Capital International Group
 on 
July 27, 2018
Investment

Parts of the UK retail sector have faced significant struggles this year. The first casualties were Maplin and Toys “R” Us, both of which went into administration. More recently, Marks & Spencer announced it would be closing one hundred stores as profits dropped, and Mothercare took the decision to close down fifty of their stores in final bid for survival. Debenhams is the latest high street name to face speculation of operating difficulties, with its share price having dropped 65% this year alone.

In addition to closing stores, some companies have resorted to a form of administration termed a ‘company voluntary arrangement’ (CVA) whereby they are able to reduce/ break undesirable leases, making store closures easier. However, this arrangement has put many retailers and their landlords at loggerheads, with landlords accusing companies of abusing these measures which were originally designed to help companies stave off bankruptcy. House of Fraser is currently facing legal action from a group of creditors that have accused the company of treating them unfairly.

Several of these struggling businesses have blamed the snow for their difficulties this year, as the ‘Beast from the East’ played a role in depressing activity within the first quarter. The Office for National Statistics estimated that retail sales in the three months leading up to April increased by a mere 0.1%, with the adverse weather deterring consumers from the high street. However, the UK retail sales slowdown was already in evidence prior to the arrival of the snowstorms that effected the country and additionally, longer-term trends are still contributing factors. Consumer spending, which accounts for 60% of GDP, was hit hard by higher inflation last year, with inflation rising above 3% as the Brexit-related drop in Sterling was passed through. Moreover, wage growth stalled, putting a squeeze on household expenditure. The continued shift from the high street to online shopping also continues to have a notable impact on the market.

Although price and product range continue to be disruptive aspects of e-commerce, consumers are increasingly drawn to the convenience of shopping online, and advances in technology and logistics are accelerating this trend. The latest data shows that internet sales as a share of total sales are approximately 17%, while fifteen years ago, it was nothing! The increase in online shopping has undoubtedly hurt many high street shops, particularly department stores and would have been a factor in the demise of the likes of Maplin and Toys “R” Us.

Some traditional ‘bricks and mortar’ retailers trying to address rapid structural changes with increased investment have found that e-commerce sales are failing to compensate for lost offline sales, which is eventually leading to operational deleverage as can be seen in the retail margin of Next. Their online sales come with additional fulfilment costs that are rarely recovered through incremental charges. Such trends appear to be established in the near-term, and without a short-term rebound in consumer spending are likely to result in ongoing margin pressures for traditional retailers. Many companies have under-invested in their online offering and are subsequently lagging behind. Marks & Spencer, for example, has admitted that its website is still too slow. Internet-focused retailers such as Boohoo, Just Eat and Asos are meanwhile looking well placed to benefit from investment that unlocks new pools of profitable consumer demand.

The impact of e-commerce, and the winners and losers that have arisen from it, has been particularly hard felt in the UK as UK consumers have embraced ‘online’ more readily than other European consumers have. The UK is the third largest e-commerce market in the world, and has the highest online shopping penetration rate in Europe by a considerable margin. Amazon has captured a significant proportion of this business; perhaps highlighting the lack of innovation from certain retail sectors.

The growth of the ‘discounters’ provides yet another challenge! The two ‘big’ German players, Aldi and Lidl, now account for 12% of UK market share and are still growing rapidly. They still, however, may have a long way to go- in Poland and Germany, these discounters account for nearly 50% of the market.

Recent data has indicated that retailers suffered the sharpest drop in business in over two decades as earlier bad weather, the squeeze on household budgets and the timing of Easter led to a large fall in consumer spending. The British Retail Consortium and KPMG found that sales were down by 3.1% in April, which is the biggest drop since the survey was launched in 1995. Non-food items were the hardest hit, and retailers are anticipating tough trading conditions to continue for the rest of 2018, even though wages have now started to rise at a quicker pace than prices.

However, the story across the Atlantic is very different. The US economy is booming! Retail sales in June grew by 6.6% compared to last year, which is the strongest rate of growth in over six years. The strong labour market and lower taxes in the US has resulted in high consumer confidence, feeding a rise in spending. Consumption in the US accounts for around 70% of GDP, and real growth of close to 4% annualised is anticipated for the second quarter of this year. Although the American consumer has already begun to benefit recently from tax cuts, GDP growth should also be boosted next year because of continued support from fiscal stimulus.

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