Another warning sign is the recent fall off in retail IPOs. There had been a steady flow of retail names listing in 2013 and early 2014 however sentiment changed and one transaction, Fat Face, even had to be pulled at the last minute in May.
The situation is more nuanced than these things may suggest however with good opportunities to be found by managers who look beyond the negative headlines of recent weeks.
Sainsbury’s quarterly sales fell 1.1% like-for-like it said yesterday, the second consecutive drop it has suffered. Its outgoing CEO Justin King has bemoaned the ‘very challenging times for the grocery industry.’
Tesco and Morrisons, Sainsburys’ principal rivals, have also suffered over recent times. Tesco reported a 3.8% drop in UK like-for-like sales last quarter while Morrisons posted a calamitous 7.1% fall in sales for the quarter.
It is clear that the combination of stagnant wages and increased competitive pressure from continental retailers like German chains Aldi and Lidl aggressively building their presence in the UK has put an unprecedented squeeze on the profitability of supermarkets.
“With the downward price pressure coming from the budget supermarkets like Aldi, in the near term food retailers are going to have a rough ride,” said Sarah Emly, manager of the JPMorgan Claverhouse Investment Trust.
This is despite the stream of good news on the UK economy which keeps flowing. Yesterday it was announced that average unemployment rate fell from 6.8% to 6.6% against expectations of 6.7%. The 345,000 more people in jobs figure was the largest rise since 1992.
The bullish UK economic outlook also has a dark side for retailers however. Each piece of good news on the economy creates more pressure on the Bank of England’s monetary policy committee to raise interest rates to stop things overheating. There does appear to be some room for the Bank to move, however, as wage growth is so far not correlating with growth in the economy and improving employment levels.
This cannot continue indefinitely though as rising confidence and falling unemployment inevitably feeds through to wages and creates inflationary pressure at some point. Predictions for the first rate change since 2009 are being brought forward accordingly, and this appears to be weighing on retail stocks.
How to play it
Given all this, how should long-only investors approach the UK retail space? A key starting point is to recognise the increased divergence between food-focused and general retailers.
“There are winners in the retail sector out there,” Emly said. “[Clothing retailer] Next is an example which we have invested in as it consistently beats its competition,” she added. Other examples of retail gems to take a look at Emly pointed to include Halfords, the cycling and motoring retailer and generalist WH Smith.
Emly explained that rather than shunning the sector, now is the time for good fund managers to earn their money and take advantage of the opportunities that those who walk away from the sector as a whole will miss. Strategy and a company’s performance relative to its close competitors will be key.
“Wage increases are going to coming through so among retailers with good leadership and the right strategy there will be successes,” Emly noted. “Managers need to be very selective in the sector at the moment but there are opportunities to be found,” she concluded.
