Share price ratings in the general retail sector started 2014 on fairly punchy multiples. It was no surprise, then, that a six-month IPO frenzy followed as companies rushed to cash in while the going was good. Accordingly, there has been a number of new entrants into the FTSE 350 general retail sector this year: Pets at Home (PETS), Poundland (PLND), Game Digital (GMD), Card Factory (CARD), Just Eat (JUST.), AO World (AO.) and Saga (SAGA) - the la ter arguably more of an insurer though. That makes this year's round-up a very different beast to that of 2013. Interestingly, however, shares in just two of those new listings - Card Factory and Just Eat - trade above their admission prices.
Such lacklustre share price performance reflected weakening sentiment during 2014 on the back of a few profit warnings and lower-than-expected sales growth from a number of companies. There were exceptions and one of those was Dixons. The electricals retailer not only had a great year of growth, but it culminated in the biggest merger the sector has seen in years as it teamed up with Carphone Warehouse to create digital technology giant Dixons Carphone (DC.). The pair are a good fit and the combined group is well placed to benefit as the boundary between mobile connectivity and electronic devices becomes increasingly blurred.
Halfords (HAL) had a reasonably good year as its turnaround programme continued, although the shares remained volatile. It's benefiting from the UK's love of cycling and improved sales in its autocentres. News that chief executive Matt Davies is to step down to join Tesco was, however, a blow, given that he was the architect of the recovery strategy. Meanwhile, homewares retailer Dunelm (DNLM) delivered a credible performance, but a slow start to the year and news that investment in growth would eat into profit this year and next led to earnings downgrades. That investment should bode well in the longer term, however, given Dunelm's low penetration in the UK and its ability to roll out new stores. It has started tapping the potential of the internet, too, while increased direct sourcing is leading to gross margin gains.
Eurozone weakness was a thorn in DIY retailer Kingfisher's (KGF) side, however, which has a huge exposure to the French market, where consumer spending remains weak. But rival Home Retail (HOME) seemed to thrive, despite a management change mid-year. Argos stores were revamped into more digital-friendly outlets and unprofitable locations closed. The efficient 'hub and spoke' distribution model was implemented across the estate, too. Sister company Homebase seemed to benefit from a combination of weak comparatives and a buoyant housing market, although Christmas wasn't as profitable as management had hoped.
As for the newbies to the sector, we're positive on Card Factory, Poundland and Pets at Home. New merchandising, improved product quality and ranges, together with market share gains from maturing stores, supported strong like-for-like growth at Card Factory last year. Its business model is vertically integrated, so almost everything it sells is designed in house - meaning it has some of the best operating margins in the sector. It also plans to pay a decent dividend and push ahead with a big store rollout programme. Poundland, meanwhile, has been hugely successful at broadening its consumer base. That mirrors the way supermarkets Aldi and Lidl are attracting more affluent shoppers with good quality products at low prices. Poundland is capitalising on a perfect storm of cost-conscious consumers, an improving economic backdrop and cheap commercial property to expand its footprint. Admittedly, Pets' shares haven't performed well, but trading was bang in line last year and the company is growing fast as the pet sector expands.
Looking ahead, the new year has started on a high. Significantly, consumers should start to feel richer as the UK's economy continues to recover and as inflation remains subdued: consumer price inflation dropped to just 0.5 per cent in December, its lowest level since May 2000. That partly reflects the falling oil price, but also the vicious supermarket price war which - combined with rising real wages - should bolster consumers' spending power. Things appear to be picking up already: retail stocks rose in the final months of 2014, while the key Christmas trading period was better than expected. So stocks that lost ground in 2014 could yet recover in 2015.
That said, uncertainties as the general election approaches - as well as the eventual rise in interest rates - aren't good for consumer stocks. On that basis, 2015 looks set to be a year in which to tread cautiously when it comes to retail stockpicking.
| Company name | Share price (p) | Market value (£m) | PE ratio | Dividend yield (%) | 1-year performance (%) | Last IC view |
| Home Retail Group | 202 | 1,645 | 31.6 | 1.6 | 0.2 | Buy, 193p, 26 Nov 2014 |
| Dunelm | 864 | 1,748 | 19.6 | 2.3 | -7.9 | Buy, 821p, 6 Oct 2014 |
| Kingfisher | 339 | 7,969 | 14.9 | 2.6 | -12.0 | Hold, 318p, 10 Sep 2014 |
| Dignity | 1,818 | 894 | 22.3 | 1.1 | 23.5 | Hold, 1,468p, 18 Sep 2014 |
| Just Eat | 346 | 1,967 | 96.2 | 0.0 | NA | Hold, 241p, 12 Aug 2014 |
| Saga | 167 | 1,854 | 22.4 | 0.0 | NA | Hold, 173p, 30 Sep 2014 |
| AO World | 271 | 1,139 | 132.0 | 0.0 | NA | Sell, 211p, 26 Nov 2014 |
| Card Factory | 276 | 939 | 23.4 | 0.0 | NA | Buy, 215p, 19 Sep 2014 |
| Dixons Carphone | 440 | 5,063 | 19.7 | 1.4 | 56.2 | Buy, 444p, 1 Jan 2015 |
| Game Digital | 250 | 425 | 14.0 | 0.0 | NA | Sell, 250p, 16 Jan 2015 |
| Halfords Group | 443 | 882 | 14.2 | 3.3 | -8.3 | Buy, 489p, 10 Nov 2014 |
| Inchcape | 705 | 3,156 | 14.8 | 2.6 | 9.1 | Hold, 692p, 28 Aug 2014 |
| Pets at Home Group | 210 | 1,050 | 21.0 | 0.9 | NA | Buy, 203p, 5 Dec 2014 |
| Poundland Group | 350 | 875 | 29.1 | 0.5 | NA | Buy, 318p, 27 Nov 2014 |
| WH Smith | 1,354 | 1,597 | 17.1 | 2.6 | 33.3 | Hold, 1,032p, 17 Oct 2014 |
Favourites
Given 2015's uncertainties, it's perhaps unsurprising that reliable and defensive stocks appear to be popular - as witnessed by the recent share price gains at funeral services provider Dignity (DTY) and newsagent WH Smith (SMWH). Our other favourites include Dixons Carphone, which we think will continue to benefit from the so-called 'internet of things' effect. Dunelm's long-term growth plans look solid, boosted by the housing recovery, while Poundland's strategy to widen its customer base will pay off. Pets at Home hasn't been a star performer, but the market is huge and the veterinary industry is highly fragmented, with Pets at Home acting as a major consolidator.
Outsiders
Kingfisher will struggle due to the weak French economy and its inability to shrink its bloated UK store base. AO World's shares, meanwhile, are trading on an eye-watering rating for a company that effectively flogs white goods - its expansion into Germany carries risk, too. And Game Digital's shock profit warning over Christmas suggests to us that, apart from the name change, it's substantially the same company that went into administration a few years back.
