Join our community of smart investors

FTSE 350: Clothing retail a stockpicker's market

This part of the retail market might have its own 'squeezed middle' in 2017
January 26, 2017

The ‘squeezed middle’ was a term that best applied to Britain’s supermarkets during the last recession, as high-end and discount players fared better than the mid-market. In the event of a decline in consumer sentiment this year, we think this term will apply much more widely to all of Britain’s retailers, especially those in the clothing sector.

The ones we see at particular risk will have a significant high-street presence, an embryonic online business and a mass-market – and ultimately fickle – customer base. The more robust retailers will be found at either end of this scale, in either fast-fashion online pure-plays or towards the more premium, and even luxury, end of the market.

Most of the online pure-plays have yet to enter the FTSE 350, meaning our scope for investment here is narrowed further. But this doesn’t just mean gravitating towards the likes of Burberry (BRBY) and Jimmy Choo (CHOO). Instead, we’re keeping the faith in recent Tip of the Year Ted Baker (TED) and high-street chain SuperGroup (SGP), in light of bumper Christmas trading figures from both groups, and recent in-line half-year figures from the latter.

The biggest challenge clothing retailers face this year is higher costs as a result of the national living wage and weaker sterling. Most of the clothing we buy in the UK is manufactured in Asia and sourced in US dollars. Price rises and cutting other production costs are the obvious way in which retailers can offset costlier imports, but a dismal Christmas trading update from high-street bellwether Next (NXT) suggested this won’t be enough.

To be successful, a product will have to remain as high quality as possible relative to its price point; it has to draw functional and fashionable shoppers alike, while the brand name has to be alluring enough to encourage people to spend money at a time when wages aren’t expected to keep pace with prices.

That said, the recent sterling slump could actually work in favour of groups such as Burberry. The luxury fashion house has already revealed a currency tailwind for the current financial year in translational terms, but sales were boosted thanks to an increase in tourist shopping in the UK as visitors took advantage of their travel money going a little further.

CompanyPrice (p) Market value (£m)PE (x)Yield (%)1-year change (%)Last IC view
Brown (N)2035769.47.0-29.2Sell, 211p, 19 Jan 2017
Burberry1,6507,25323.62.347.2Buy, 1,453p, 10 Nov 2016
JD Sports3533,437116.80.163.8Buy, 333p, 29 Nov 2016
Next3,9905,86894.0-40.0Hold, 4,299p, 4 Jan 2017
Sports Direct Int'l2931,72913.20.0-24.8Sell, 290p, 8 Dec 2016
SuperGroup1,6071,307221.57.1Buy, 1,753p, 12 Jan 2017
Ted Baker2,9661,30727.51.712.5Buy, 2,774p, 5 Jan 2017
 

Favourites: This part of the retail sector is a true stockpicker’s market. In our view, it’s wise to aim for what we call the premium lifestyle retailers – namely Ted Baker and SuperGroup – rather than their middle-market rivals. The luxury end of the market is trickier. We prefer the look of Burberry's recovery potential to Jimmy Choo's heavy dependence on Asian sales in 2017.

Outsiders: This year, we’ve already seen Next fall at the first hurdle, but it’s unlikely to be alone. We’re also not enthused about N Brown's (BWNG) ability to reignite sales growth as its over-50s customer demographic continues to shift. Margins are also slipping there, which won’t be helped by the current environment for costs.