While households up and down the country are recovering from the excesses of the Christmas break, retailers will be poring over their sales figures in the hope that the festive season has brought with it some glimmer of good news. Any contrarians betting on bumper trading from the UK's high street are likely to be disappointed, but the news won't all be bad and good stockpicking should continue to reward investors.
Following a phenomenal run in 2012 that saw the FTSE All-Share general retail sector deliver a total return of 39.2 per cent - a performance that was only bettered by the single-stock forestry and paper sector and on a par with the life insurers - the big question is whether the momentum can continue.
Broker Peel Hunt points out that the average share price in the retail sector was up by more than 50 per cent last year. While the economy remains fragile, the broker believes profit conditions are the best they’ve been for several years, with a likelihood of more upgrades than downgrades.
However, dig a little deeper and the picture is not so rosy. That's because the sector's apparent outperformance last year was fuelled by weak trading in previous years and consequently low ratings. Like-for-like sales were mostly in negative territory throughout 2011, according to figures from the British Retail Consortium. What's more, the pick-up in trading last year was not that strong.
In November this year, the BRC/KPMG sales monitor reported like-for-like sales growth of 0.7 per cent. David McCorquodale, head of retail for KPMG, urged caution, saying the figures were "only just" positive against a weak comparative period. Retailers, he warned, entered December "in a state of nervousness due to weak top-line growth and pressure on margins".
Sanjay Vidyarthi, an analyst for Espirito Santo, warns that if earnings upgrades don't come through at some point this year, it will be hard to justify further upside and even the current level of some valuations. "Unless we see a catalyst, it will be another tough year and you may see retrenchment in share prices," he says.
Verdict's forecasts reinforce some of these concerns. It expects retail spending volumes over Christmas (excluding food) to have contracted 0.2 per cent. Growth forecasts this year are under the 2 per cent mark, meaning 2013, like 2012, will be all about how companies cope with the tough conditions.
"The UK general retail sector outperformed [in 2012] because earnings forecasts were broadly stable and there was consequently a dramatic re-rating of the sector," says Matthew Taylor, an analyst for Numis Securities. "Following the re-rating of discretionary stocks, the premium being asked for the quality and safe end of the sector is now more modest. We would tilt weightings towards this segment as opportunities arise."
Back the winners
For the best retailers the weakened economy has brought with it the advantage of market consolidation as high-profile rivals have gone bust. For the strongest in the sector, this means they can, and are, picking up business from the casualties while improving what they offer shoppers, and that's good news for their shareholders.
Maureen Hinton, director of research for Verdict, expects another year of weakened earnings, revenue and margins for the industry as a whole. But she believes companies such as
Aviva Investors' director and head of UK institutional equities, Trevor Green, believes the economics of supply and demand also suggest high-street survivors should have an easier time ahead. He points out that while queues were forming at Comet when the retailer went into administration, shares in Dixons shot up by 25 per cent in anticipation of a key competitor exiting the market.
However, Mr Green also warns that the environment is very competitive and that the online threat is intensifying. "Shares in HMV rallied in February 2009, as it was perceived to be a beneficiary of the demise of Zavvi and Woolworths," he says. "However, online retailers proved the real winners. The lesson is that supply coming out of the marketplace can be good news provided you have backed the beneficiary."
While group like-for-like sales were down 0.1 per cent in the first half of its financial year,
*Based on Seymour Pierce estimates
It may feel as though there is not a lot to be bullish about for general retailers. Indeed, it has been widely accepted that disposable incomes will remain flat or negative in 2013, keeping a tight lid on sales growth. However, companies with distinctive offerings who keep their websites up to scratch will ride out this storm. Online is becoming an increasingly popular way of shopping, with consumers demanding more choice, such as click and collect, rather than home delivery. Retailers who cater to this will do well. And those that capture global market share, particularly in the Far East, will be able to offset losses in a recession-weary West. This year will be tough for the high street, but for those left standing at the end, there is a lot of potential.
By Kate Calvert, analyst at Seymour Pierce
Christmas 2012 was certainly a technology Christmas, helped by a strong aspirational product pipeline. Stock clearance by Comet's administrators may have hit margins in the short term, but we view Comet's demise as a major positive for electrical retailers' profitability this year. Continued consolidation will remain a theme across retail in 2013 and will give the strong the opportunity to take further market share.
Multi-channel or omni-channel is a big focus for all retailers and 2013 will see material investment in this area. Consumers' changing shopping habits continues to lead the industry and mobile is accelerating this development. This will put pressure on costs over the medium term as the industry works out how to offer the consumer a seamless service in the most cost-effective way. Meanwhile, many retailers have too much floorspace, particularly DIY retailers, and will need to downsize their portfolios, while pure-play online retailers need to consider delivery options and whether to have a physical presence.
With consumer budgets set to remain under pressure as food inflation picks up and with higher utility bills coming through, value and necessity will continue to drive shoppers' decision making. No bounceback in demand is expected, so those retailers that give the consumer what they want will continue to thrive. Generally, we expect 2013 to be another difficult year for the industry, but with subdued consumer spending now the new norm retailers will need to make their own fortune.
Retail has been one of the best performing sectors in the stock market in 2012 and has been re-rated, despite weak fundamentals and consensus downgrades of 11 per cent. With the sector, excluding Asos, now trading on 13 times expected 2013 EPS and consensus expectations already for 10 per cent earnings growth, it is not as attractive as it was last year and we believe stockpicking will remain key to outperformance.