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UK retail sector: how is it performing and what’s the trading opportunity

The retail sector has had a tough start to 2018, and the outlook for the UK’s high street remains bleak, mounting more pressure on an industry already dealing with the likes of Brexit, the move to online shopping and customers tightening their purse strings. But is it all doom and gloom for UK retailers?

CFDs are a leveraged product and can result in losses that exceed deposits. Trading CFDs may not be suitable for everyone, so please ensure you fully understand the risks and take care to manage your exposure.
Sports Direct
Source: Bloomberg

‘Retail is now totally propelled by consumers and their needs. People can buy what they want in any way that they want it. That trend started a long time ago, and it has really changed everything,’ – venture capitalist Kirsten Green, founder of Forerunner Ventures.

UK retailers have had everything thrown at them over the last couple of years and the drastic change occurring in the industry has killed off some of the country’s most beloved stores. The list of victims has continued to grow since the failure of Woolworths in 2015, which was the biggest casualty on the UK high street this side of the financial crisis. BHS collapsed last year and 2018 has already seen some big names fall victim to the changing landscape including Toys ‘R’ Us and Maplin. Even Joe Bloggs went bust.

Times have been particularly tough for retailers since the UK’s EU referendum vote to kick-start what is proving to be a lengthy Brexit process, the outcome of which remains uncertain to this day. The consequential knock to sterling made it more expensive for retailers to import goods at a time when people were feeling less optimistic about their financial future and wages were being squeezed.

While the industry is having to cope with an array of short-term pressures, they have had considerably longer to react to the biggest shift occurring in the industry, one that has been happening for a while. Online shopping continues to thrive at the expense of the high street, and many of those who have fallen victim were those who were slow to respond to the threat of Internet shopping and the likes of Amazon.

Read more about the potential economic impact of Brexit

Competition has become fierce, and the entire sector looks to be refreshing their strategies and changing their models to bring the retail industry into a new era. So how is the landscape changing, how are retailers responding, and what trading opportunities are there in the UK retail sector?

How have UK retailers and their share prices performed?

The FTSE General Retailers Index has lost 6% in the past 12 months. But the 4.4% drop since the start of 2018 accentuates the tough trading environment this year.

Find out more about what indices you can trade with IG

UK retail sales hit by colder weather

The latest figures from the Office for National Statistics (ONS) shows UK retail sales in March were 1.2% lower than February as colder weather, including the ‘Beast from the East’, encouraged people to stay at home. With fewer people hitting the shops, they used less fuel, which was the main driver behind the fall. The month-on-month decline in UK retail sales was 0.5% excluding fuel.

The colder weather is likely to have aided online sales as people turned to their tablets. This further propelled the move to online shopping, which accounted for 17.4% of all sales in March compared to 15.9% a year earlier.

Shoppers have had less to spend after prices started rising faster than incomes in February 2017, forcing many to tighten their purse strings over the past year. However, the squeeze on wages could be coming to an end after income grew at faster pace than prices in March for the first time in a year.

In addition, sentiment among UK consumers rose in March. GfK’s consumer confidence index rose by three points last month to minus seven, but is still in negative territory.

UK wages begin growing faster than prices after year-long squeeze

Consumer price inflation dropped to 2.5% in March (its lowest level in a year) from 2.7% in February. This was primarily because the price of women’s clothing and footwear rose at a slower pace. Meanwhile, average wages climbed 2.8% in March, which is being supported by continued high levels of employment placing pressure on companies to up their game to both entice and retain staff.

The latest quarterly figures show the more people than ever are in work, standing at 32.2 million, while the UK unemployment rate of 4.2% is at its lowest level since 1975, with just over 1.4 million people seeking work.

Will the Bank of England still raise interest rates?

There is widespread expectation that the Bank of England (BoE) will raise interest rates to 0.75% in May, from the current rate of 0.5%. Although the fact price inflation is falling and wages are picking up means a rate hike now looks at odds, Governor Mark Carney and the rest of the Monetary Policy Committee are still expected to raise rates to provide the wiggle room they need to cut interest rates when the next downturn arrives.

Learn more about how to trade interest rates

Whether or not the latest economic data points to the start of a brighter outlook or simply a blip is not yet known, but if the picture does improve then the BoE, after May, could look to implement their monetary policy at a slower pace. Having said that, inflation is still running way ahead of the BoE’s target of 2%, but it does mean inflation could fall below that threshold sooner than expected.

Sterling takes a knock after flirting with post-Brexit highs

Sterling has proven to offer plenty of opportunity of late. The pound had managed to climb to its highest level since the Brexit vote, before being derailed by the latest economic data and uncertainty over when interest rates will be lifted.

Learn more about forex trading

Having traded around $1.50 prior to the referendum (circled in red), the pound plunged to a low of $1.20 after the results but recently recovered to $1.43 before heading lower.

UK retailers refresh their strategy

While there are plenty of ecommerce companies enjoying the shift to online shopping, it has stolen footfall from the high streets and left the older, more traditional retailers competing harder for the customers left on the streets.

This means the amount of promotional activity on the high street is intensifying and in order to draw people in, retailers are having to upgrade stores and bring them into the digital age by allowing customers to order using installed tablets or introducing virtual dressing rooms. It all comes down to the customer experience – people need more of a reason than ever to go out and browse for items.

Retailers are therefore finding new and unique ways to make their stores more useful for customers and to attract a crowd. With the power of online, big brands require a smaller amount of physical stores than they used to but they must ensure they are in the right locations. Many have been left with long leases or oversized property portfolios for the digital age. Yes, many businesses do continue to open stores in the UK, but many of these are being relocated and in reality thousands of businesses have shut-up shops to leave some high streets looking bare. The level of attention being paid to location is demonstrated by the regional impacts on high streets.

One way some retailers are looking to utilise any excess retail space is by allowing other companies to use it. Supermarkets have done this for a while, allowing a dry-cleaners or a locksmith to open up in the corner of the store. Who could resist buying at least a pint of milk as you walk past it to pick up your dry cleaning? This played a part inSainsbury's decision to buy Argos, widening the product range and making better use of its space. Next has said it is considering introducing restaurants, coffee shops and other concessions as a way of boosting footfall and sourcing new sources of revenue.

Retailers have pushed some of the pressure onto their supply chains, bartering harder on prices and demanding an ever quicker service, particularly in areas like clothing which demands a quick turnaround as fashion trends change. Much of the success of Spanish firm Zara has been down to its ability to spot a trend, design a garment, produce it and then get it into stores as quickly as possible. However, changing the supply chain can cause havoc for any business (think of Yum! Brands and the KFC chicken crisis). Moss Bros, who sells and leases suits, ran into trouble last year after trying to consolidate its suppliers, resulting in stock shortages which are still affecting the company now.

Is online shopping harming the UK retail market?

In short, yes. Firms that only operate online like fashion firm ASOS have been thriving compared to those languishing on the high street, but the rise of digital shopping is not solely to blame for the gradual demise of the high street. In addition to the cost of leases, companies are being asked to stump up more and more money for the upkeep of the local area and regional promotional activity through the likes of Business Improvement Districts as council budgets continue to be slashed, and business rates have been rising at an alarming rate over recent years.

The evidence is clear. High street sales have dwindled over the years and margins have come under pressure thanks to rising costs. Meanwhile, online sales have consistently grown, and margins are much healthier as the costs involved of an online operation are considerably less than a store’s.

There will always be a role for bricks and mortar retailers, there are some products people prefer not to buy online and at the very least the hospitality industry will always have a place. Companies no longer have a choice over whether to open an online shop, it is a must. But does it have to be one or the other? And does that mean the end to our much loved high streets?

The UK high street isn’t dead: bricks and mortar have a role to play

The high street is not going down without a fight, and many of the UK’s biggest brands have made it clear they have no intention of abandoning their stores to sell purely online. Next, JD Sports, Debenhams and Sports Direct are just some that have (while recognising the importance of their online strategy) committed to their high street presence and argue bricks and mortar still have a very important role to play.

While people shop online, many are still choosing to use services like ‘click and collect’, and more recently ‘click and return’. The returns process for ecommerce retailers, particularly in fashion, has been a problem for online retailers. Without the ability to try clothes on, many customers wanted to return clothes and the sector is only starting to address problems like the cost and speed of doing this. However, these ‘click’ services not only provide a solution but also gives people a reason to go in-store, where companies hope they will spend even more. People may not want to shop in the store but they do want somewhere close they can pick up their item relatively quickly, it seems.

At Next, about 50% of all online orders are delivered through stores rather than to people’s homes. Debenhams states about one-third of all online sales ‘include a store as part of the journey’. Moss Bros believes the ‘click’ services are the foundations on which to reshape its high street offering, and at car maintenance and cyclist specialist Halfords a staggering 80% of online orders are collected in-store. 

There has also been claims that some retailers are using their bricks and mortar to subsidy online sales, as companies focus on where future growth is coming from, whilst leveraging what they have got on the high street.

The cost of setting up (and optimising) an online platform, refreshing brands, revitalising stores, undertaking more aggressive promotion and higher costs including the likes of the National Living Wage culminate into a costly change for retailers, but one that they cannot avoid.

Hammerson and Intu: merger collapses amid tougher retail conditions

Hammerson launched a £3.4 billion takeover for Intu Properties late last year in a deal that would have combined the UK’s biggest shopping centres, which obviously need the high street to survive. Hammerson was originally looking to take advantage of the huge discount on Intu’s shares, which were trading at less than half its net asset value before Hammerson pounced. Hammerson was also looking to scale-up the business so it could borrow money at a cheaper rate to refinance its debt and gain more bargaining power with tenants.

Hammerson has now pulled the plug on the deal, much to Intu’s annoyance. Despite both companies reporting growth in footfall and occupancy levels in the early part of this year, Hammerson is convinced that the deteriorating perception of the UK retail market means there is a disconnect between its share price and actual value, and therefore generating returns from the Intu deal would take longer to reap. Intu argues Hammerson’s reasoning is unfair, particularly as Hammerson reaffirmed its support for the deal only last month.

Adding further catalysts to the mix was European shopping centre group Klepierre, which made two informal bids for Hammerson in an attempt to derail the deal with Intu. Both were turned down. 

Interestingly, Hammerson shareholders could still vote on the Intu deal, albeit without the board’s recommendation. Intu shares were benefiting from the deal while Hammerson’s share price was heading lower, but those trends have both reversed since the deal was scrapped, with Hammerson heading higher and Intu sinking back down.

The trading opportunity: which retailers should you keep an eye on?

There are a swathe of UK retailers listed in London, all offering something slightly different to investors. Here are some companies and developments to watch:

ASOS: exponential growth setting high expectations

The online-only fashion retailer is geared toward the younger generation and the firm has delivered impressive growth in recent years. ASOS recently released interim results that showed UK retail sales climbed 22% from the previous year to £414.5 million. The website is the engine of the company and ASOS grew its UK customer base by 10% to 5.5 million, representing about one-third of its total customer base which also lies in Europe and the US.

Whilst revenue and profit has continued to grow, ASOS saw its share price plunge after hiking its budget by unveiling plans to invest up to £250 million on logistics and distribution in the UK and Europe over the next two years. It seems ASOS is confident in doubling-down, but investors are cautious about whether or not it can pull it off in the current environment.

Next: licking its self-inflicted wounds

Next shares are on the verge of breaking higher after finding traction following what was a tough 2017. The clothing retailer described 2017 as ‘the most challenging year we have faced for twenty-five years’, partly caused by its own errors and shortcomings with its product range. High street sales have suffered heavily, but Next is delivering progress with its move online. The firm generates about 63% of its total profit from online despite generating more revenue from its high street stores.

Next shares are heading toward their highest level since early October last year, and if they continue it could signal a break higher. Shares have found support despite the problems last year, but there is still plenty of drivers that could emerge to push it lower.

JD Sports vs Sports Direct

These two sportswear giants cater for very different markets, but both are committed to their high street presence. The solid performance delivered by ‘athleisure’ firm JD Sports Fashion becomes even more impressive when compared to Sports Direct.

JD is growing the number of overall sites it has but is also closing or relocating those not up to scratch and is refreshing its stores. UK revenue jumped 24% in its recently-ended financial year and growth in international markets was also substantial, all feeding into a 24% rise in pre-tax profit to £294.5 million.

Meanwhile, Sports Direct released its interim results in December revealing a 1.4% decline in UK retail sales as well as tighter margins. UK sports retail, accounting for over 65% of all revenue, fell 1%. Overall revenue did grow thanks to the addition of its US operations, but overall pre-tax profit plunged from £140.2 million to just £45.8 million after the firm sold off its shares held in JD Sports in the previous year for a large profit, while also booking a loss from the devaluation of sterling.

Sports Direct: investments in Debenhams and others

Debenhams released its interim results earlier this week showing an 84% drop in pre-tax profit, as sales dropped amid the colder weather, with positive momentum maintained online with digital sales growing 9.7%, faster than the average pace of growth in the market. The company also lost its chief financial officer, who is heading to Selfridges. While the company is redesigning its stores on leaning on better faring products like beauty and food, shares plunged.

Importantly, Sports Direct holds a notable stake in Debenhams and, after increasing it in early March, stands at 29.7% - just below the 30% threshold which could require a takeover to be launched.

Liam Rowley, the head of strategic investments at Sports Direct said: ‘We see huge value for both companies in a strategic partnership between Debenhams and Sports Direct. There are obvious synergies that can be achieved through the integration of our respective web operations. We also see opportunities to work together internationally. Importantly, there is scope for greater collaboration in the UK in order to roll out an elevated offering to consumers. We believe Sports Direct can complement Debenhams very well across the spectrum’.

Sports Direct is often willing to invest in the retail sector when the rest of the market is in retreat, having invested in the likes of French Connection and GAME Digital.

Other UK retailers worth watching

Two other companies that are worth following are N Brown Group and WH Smith.

N Brown is an online fashion retailer that owns brands like JD Williams, Simply Be, and Jacamo. Revenue has been rising, thanks to increased online penetration, and the firm is one of a few delivering growth across different product ranges. It is having to promote aggressively at the expense of its margin, but its online operation means margins have the power to stay robust.

WH Smith is focused on setting up shop in high-footfall areas, like airports, train stations and hospitals, all of which delivered 6% to 9% growth in revenue in its recently-ended first half. The company has partnered with the likes of Marks & Spencer's and coffee shops to bolster its offering, and it is looking to grow the number of sites in these prime locations.

While its high street arm is not performing nearly as well, profit fell from a record high in the first half as revenue declined, but notably its margin improved thanks to better buying and sourcing. Books and stationary are proving particularly good sellers for the firm. The firm has big growth plans and seems to be targeting the right areas, while the deterioration in its high street performance has been much milder than the wider retail market.

This information has been prepared by IG, a trading name of IG Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication.  Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. 

CFDs are a leveraged products. CFD trading may not be suitable for everyone and can result in losses that exceed your initial deposit, so please ensure that you fully understand the risks involved.

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