“Unbelievably bad”
Christmas is a critical time for retailers. For many, it’s when the majority of the profits for the year are made (or not). Sports Direct CEO Mike Ashley’s comment that “November’s trading was unbelievably bad” is a stark warning that there may be bad news to come for retailer figures in the new year.

Is this anything new?
Retail has always been competitive and the rise and fall of well know names is nothing new – Woolworths, Comet, and BHS are just three examples from a very long list. For a time we feel nostalgic, express shock and outrage… then quickly, we forget and shop somewhere else. Retailers that stop giving customers what they value rightly disappear, replaced by others that do.

What is different this time?
Pressure in the industry has been heating up for years– take Debenhams as a case in point. The issue isn’t really sales, they’re actually 30% higher now than they were in 2011. So the problem? Profits. The margin of operating profits during the same period has nosedived from 12.5p per pound of sales to just 1.5p. Factor in interest and taxes and that 1.5p profit is next to nothing. Debenhams aren’t alone here; high street favourites, Marks and Spencer and Next are impacted too- their only saving grace being their higher profit margins.

What have been the causes?
Demand isn’t the issue. The UK population continues to grow, employment is high and interest rates low. It’s about rising costs and competition. The national minimum wage raises staffing costs, and upward-only rent reviews keeps rental costs high. Until recently, retailers have been actively adding space, often on long-term leases in larger, out-of-town stores. Adding costs is easy, taking costs out is more difficult, especially if the savings affect service levels or stock availability.

Growing competition is another burden. Supermarkets no longer just stock groceries, they also offer clothing, and homewares. Discount retailers like Primark and B&M began offering attractive products at material savings. And then to top it off, in to this already challenging environment comes… the internet. A consumer’s heaven; limitless choice, more convenience, and low prices. In 2006 this was a marginal percentage of overall sales at less than 3%. Now however, to say it’s caught on would be an understatement. Online shopping accounts for 18% of sales and that continues to rise with improvements to the ease of the technology.

How have retailers adapted?
At considerable cost, store-based retailers have built online businesses with the systems and the warehousing to service them. They are adapting. Marks & Spencer now has over 20% of its clothing and home sales on-line. While getting online sales adds costs, the store costs don’t disappear though. More pressure on profits.

So the space driven strategies that made sense before the internet now look wrong and companies are stuck in long, expensive-to-exit leases. It is interesting that pressure on the retailers is finally being pushed back to the landlords. Faced with tenants going bust, or changing the terms of their agreements, they are often doing the latter and it is increasingly common to hear of landlords agreeing to 25% rent reductions to keep good tenants. A rare ray of sunshine.

What about the weather?
The mention of sunlight introduces that favourite British topic of the weather. Retailers, particularly clothing retailers, change their product ranges with the seasons, and must order stock weeks, or months ahead. 2018 has been particularly challenging, wet when the retailer wants dry, warm when it should be cold and vice versa. Footfall and high street sales have been poor. Unsold stock may be moved to online but excess stock sees retailers discount: great for shoppers, dreadful for profits.

Year end
So Mike Ashley’s comments look well founded, although what we are seeing is actually a culmination of pressures that have been building for many years. Some well-known High Street retailers will survive, perhaps as smaller businesses and the process of adjustment will continue to be painful. Others will disappear.

Even retailers born in the internet age are not immune. The recent profit warning from ASOS, a very successful retailer operating wholly online, is a reminder just how competitive the market is, and how weather and other factors can hit profits.

And we haven’t even mentioned Brexit yet.

Opinions and views from the Equities team at Kames Capital are not an investment recommendation, research or advice and should not be considered as such. Content discussing investment strategies and stocks is derived from and solely relates to the investment management activities of Kames Capital.

About the author

Iain Wells is an investment manager in the UK Equities team with responsibility for managing several equity income funds. In addition, Iain has analysis duties for the insurance, general retail, engineering, utilities and paper & packaging sectors. He joined us in 1996 from Edinburgh Fund Managers where he was an investment manager and, prior to that, worked for Dunedin Fund Managers on the Asian equities desk. Iain studied Business Studies and Accounting at the University of Edinburgh and has an MBA. He has 31 years’ industry experience*.

*As at 30 November 2018

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