The general retail sector remains a fairly disparate one. Retailers of all shapes and sizes will have to tackle similar issues this year – inflation, rising costs, a possible squeeze on household incomes – but each company will face individual operational challenges, too.
If there’s any company in the sector most at the whim of macroeconomic forces it’s Dixons Carphone (DC.). The business has a track record of outperforming expectations, but if we see a consumer slowdown, small electricals is a market often badly affected. This could also hurt companies such as AO World (AO.), which has already disappointed the market with a third-quarter update that fell short of expectations.
Others could benefit. Take homewares retailer Dunelm (DNLM), which navigated the last consumer dip by taking market share from higher-end rivals such as John Lewis. The discount end of the market typically performs well against a subdued consumer backdrop, as the recent turnaround in fortunes for B&M European Value Retail (BME) demonstrates.
Marks sparks general merchandise sales
The most prominent story for 2017 might be found at retail behemoth Marks and Spencer (MKS) as it seeks to make good on years of disappointing trading updates. Partly, it’s the same old story: the food business continues to be remarkably resilient, but its clothing and home business has been in dire need of a makeover. There’s reason to hope this could happen: chief executive Steve Rowe has already managed to propel general merchandise sales back into the black over Christmas.
He’s been credited with steering the food business through the last recession with initiatives such as the ‘Dine in for two for £10’ promotion, so there are reasons to remain hopeful about its resilience. A similar case could be seen over at Debenhams (DEB). The group’s chief executive, Sergio Bucher, only took over in October 2016, but investors were pleased to see the group keep Christmas sales momentum going year on year – particularly online, due to the popularity of the click-and-collect option.
Other, more specific, recovery stories could play out for the likes of Halfords (HFD) and Pets at Home (PETS). Both companies’ shares suffered clear deratings last year. The former is showing signs of improved trading, particularly over the third quarter, but the latter is still trying to iron out wrinkles in its business as more shoppers turn to Amazon for their pet needs.
Looking for growth
At this point it’s worth asking if there are any viable growth stories left in general retail this year. One of the best performers last year was online takeaway service provider Just Eat (JE.), and with its recent acquisition of rival Hungry House in December it still looks set to take market share in 2017. Having listened to a great deal of management’s rhetoric last year, the plan is to be the number one player in all markets – hence the decision last summer to exit Benelux, where it was consistently the second-largest operator.
Ultimately, we need to be cautious on the consumer-facing stocks this year as economists and analysts try to predict exactly where we are in the consumer credit cycle. Borrowing is at historically high levels, so positive Christmas trading updates should be understood in that light, not to mention that customers would have been well aware of imminent price increases and brought their spending forward.
But tighter credit conditions will undoubtedly affect a number of middle-market retailers. Wider trends aside, there are a couple of companies we expect to tread water this year. WH Smith (SMWH) has been a game of fifty-fifty for some time now. Its travel business is growing nicely, but its high-street stores struggle to attract the same level of customer interest. It’s one of the best cost-cutters in the business, though, so margins might just hold up.
Similarly, motor retailers are in for a tough year, especially once Article 50 is triggered. But bigger, globally diverse businesses such as Inchcape (INCH) – a distributor as well as a retailer – can probably withstand the pressure.
| Company | Price (p) | Market value (£m) | PE (x) | Yield (%) | 1-year change (%) | Last IC view |
| AO World | 160 | 674 | NA | 0.0 | 8.8 | Sell, 170p, 12 Jan 2017 |
| B&M European Value | 302 | 3,018 | 21.7 | 1.7 | 10.6 | Buy, 305p, 12 Jan 2017 |
| Card Factory | 249 | 848 | 12.7 | 3.5 | -24.3 | Buy, 247p, 24 Nov 2016 |
| Debenhams | 55 | 675 | 7.9 | 6.2 | -28.2 | Buy, 55p, 27 Oct 2016 |
| Dignity | 2,460 | 1,224 | 22.6 | 0.9 | 9.0 | Hold, 2,683p, 29 Jul 2016 |
| Dixons Carphone | 351 | 4,044 | 10.7 | 2.9 | -20.6 | Buy, 349p, 14 Dec 2016 |
| Dunelm | 677 | 1,364 | 13.4 | 3.7 | -21.4 | Buy, 823p, 6 Oct 2016 |
| Halfords | 353 | 703 | 12.1 | 4.9 | 7.4 | Hold, 320p, 14 Nov 2016 |
| Inchcape | 720 | 3,031 | 13.8 | 2.9 | 1.8 | Hold, 698p, 29 Jul 2016 |
| Just Eat | 536 | 3,637 | 58.9 | 0.0 | 27.0 | Buy, 534p, 2 Aug 2016 |
| Kingfisher | 347 | 7,772 | 14.9 | 2.9 | 6.0 | Hold, 384p, 20 Sep 2016 |
| Marks & Spencer | 345 | 5,599 | 10.6 | 5.4 | -17.4 | Buy, 346p, 19 Jan 2017 |
| Pets At Home | 238 | 1,191 | 16.1 | 3.4 | 3.0 | Hold, 222p, 28 Nov 2016 |
| WH Smith | 1,540 | 1,724 | 16 | 2.9 | -1.6 | Hold, 1,583p, 13 Oct 2016 |
Favourites: We’re leaning towards those retailers that have hit a sweet spot in their respective growth cycles. These include fast-growing groups such as B&M and Just Eat, as well as others such as Dunelm, which have proved themselves to be well-run companies of late. None of these stocks come particularly cheap, but that’s likely to be a characteristic of quality retail picks this year.
Outsiders: Outsiders for us are companies that have substantial ground to make up in 2017, but aren’t likely to be helped by a more frugal customer and shrinking consumer confidence. These include Pets at Home and Halfords, both of which have suffered their own internal problems as well as macroeconomic pressures. For now, we prefer to wait to see if management can reignite sales momentum and keep margins intact before turning bullish.
