Inflationary pressures and interest rate hikes have put the UK consumer in a tough spot as the cost-of-living crisis continues to weigh on household budgets. Despite this, retail sales have proven resilient. Spending by value has risen steadily since February 2022, although volumes fell considerably last year as consumers receive less for their money. Against this backdrop, is there any potential in UK consumer stocks?
In May, retail sales continued to tick up. The ONS revealed the value of retail sales (excluding auto fuel) grew 0.8% on the previous month, while volumes also continued to inch up 0.3% after growing half a percentage point in April.
Charlie Huggins, manager of the Quality Shares Portfolio at Wealth Club, says: “Consumer spending remains robust in the face of inflationary pressures and results from retailers themselves back this up. Earlier this week, Next upgraded its profit expectations on the back of much stronger than expected trading. The big question, is how much longer this can persist?
“Mortgage rates have increased significantly in recent weeks and inflation is at risk of becoming entrenched. This doesn’t bode particularly well for consumer confidence in the back half of the year. At that point retailers may really start to feel the pinch. But for now, the UK consumer continues to defy the doom mongers.”
% change volume and value retail sales, seasonally adjusted, May 2023
| Retail sales | Most recent month on a year earlier | Most recent 3 months on a year earlier | Most recent month on previous month | Most recent 3 months on previous 3 months | May 2023 compared with February 2020 |
|---|---|---|---|---|---|
| Value | 4.8 | 4.1 | 0.6 | 1.1 | 17.0 |
| Volume | -2.1 | -3.3 | 0.3 | 0.3 | -0.8 |
| Value (exc. auto fuel) | 7.7 | 6.3 | 0.8 | 2.2 | 18.5 |
| Volume (exc. auto fuel) | -1.7 | -3.1 | 0.1 | 0.5 | 0.2 |
David Kneale, head of UK equities at Mirabaud Asset Management, says: “It is a surprise to nobody that UK households are going through a tough period. However, many came into this period with higher levels of savings – or lower levels of credit card usage – and significant pent-up demand to get on with life. The net effect, to quote a recent conversation with the CFO of a large housebuilder: ‘How bad is it?’; ‘Not as bad as it might have been.’
“That last comment is the crucial one: it is not as bad as it might have been, nor as bad as just about everyone expected.
“For investors, this raises the crucial question: ‘What is in the price?’ It is understandable to be nervous about current trading; but just how bad must it be for the valuation to be sensible? OnTheBeach is perhaps the most extreme example. The enterprise value of OTB’s franchise is priced today at just £70m (well below the Covid nadir). From 2017 to 2019, this business made post tax income of more than £20m per year. For OTB’s valuation to be correct, the business needs to make just £8m per year and never grow again. OTB should make roughly double that amount this year despite the cost-of-living crisis.
He adds: “A second source of opportunity is ‘mistaken identity’. UK markets are being heavily influenced by asset allocators, passive funds and thematic baskets. Generally, these decision makers are not considering the specifics of individual assets, rather they are taking a view about a section of the market. St James’ Place is treated as a domestic UK business, yet the vast majority of the shareholder value resides in the ~£150bn global, multi-asset investment portfolio – which contains 3x more US equities than UK equities.
“It is hard to know when investor sentiment will turn and market pricing reflect the money to be made over the next few years – rather than fearing the news headline to be read tomorrow – but when it does upside abounds.”
Company ratings ‘dislocated from reality’
Speaking before last week’s interest rate rise, Tellworth Investments UK income fund manager Mark Barnett said he expects the gap between volumes and values to begin to narrow as inflation recedes.
Despite the squeeze on household budgets, he says the UK consumer is “fundamentally in decent shape” due to strong cash balances, high employment levels and low levels of debt.
“Last year, the stock market was taking the view on a very straightforward correlation: high inflation and high interest rates are bad for the economy and bad for consumer spending. So, you saw a really sharp decline in share prices and valuations of consumer-focused companies,” Barnett says.
“The key focus of attention were the retail and leisure-type stocks which offered an opportunity because it looked like there was a lot of value on offer in those sectors, particularly if you took the view that profits were going to hold up better than the market was expecting.
“We found that the ratings on these companies were dislocated from the reality – that’s why I wanted to buy into businesses which are exposed to the UK consumer – such as Whitbread, Next, JD Sports, and Jet2. With many of those companies, we have started to see a re-rating, but if you read the trading updates from those businesses, and others in the retail sector, they are reporting resilient trading. So, the evidence is that the UK consumer is spending and many of the companies on the stock market that are exposed to consumer spending are actually reporting resilient trading.”
Compelling opportunities
Going against the current economic outlook for the UK, Ken Wotton, managing director for public equity at Gresham House, is optimistic about the investment opportunities in specific areas of the UK consumer market.
He says: “We are starting to see compelling investment opportunities in certain areas of the UK consumer sector. Concerns about the UK economy and understandable worries about the outlook for consumer discretionary spending in the face of inflation and increasing interest rates have driven consumer stocks to almost unprecedented lows. The de-rating has been widespread across consumer stocks without seeming to differentiate sufficiently between cyclical and more resilient businesses.”
Wotton singles out three leisure and e-commerce stocks as especially good value. Those companies are:
“Ten Entertainment Group – The ten-pin bowling operator continues to see very strong trading; Angling Direct – The UK’s leading fishing tackle and equipment retailer which benefits from a loyal hobbyist customer base; and Moonpig – The business enjoys high gross margins, a structural channel shift to online cards and gifting and a strong repeat revenue dynamic with existing customers driving the majority of revenue growth.
“All three businesses can continue to grow despite the wider economic headwinds yet trade on discounted valuations offering exceptional value.”
