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DFS under pressure after warning

DFS under pressure after warning

With the shares down by a fifth in a single day’s trading, one City analyst has called the profit warning from sofa specialist DFS (DFS) a "watershed" moment in British retail. It’s true that Britain’s shopkeepers tended to strike a cautious tone throughout the latest reporting season, but DFS appears to be the first to crack under the pressure of declining footfall trends, a rising cost base and – seemingly – a dwindling level of consumer spending.

Since the UK voted to leave the European Union almost a year ago, several companies have blamed political and economic uncertainty for sluggish trading. But some investors have called such excuses into question, arguing that shoppers aren’t usually deterred from buying items they can readily afford, irrespective of wider political or economic turmoil. For some time, we’ve seen the significant depreciation in sterling against the US dollar take a bite out of company profits as costs rise and margins squeeze. But what DFS has alluded to is a drop-off in orders, and thus, a much bigger top-line issue. However, it's one that will ultimately still damage profits: DFS now expects to report lower full-year cash profits, in the region of £82m to £87m.

So why aren’t people buying sofas? If the latest data from the Office for National Statistics is any indication, British shoppers in May cut back on spending all together compared with the previous month. Year-on-year sales volumes grew just 0.9 per cent in May – the lowest rate of monthly growth since April 2013. This is compared with a 4 per cent year-on-year increase in sales volumes in April.

But there’s some debate. Brokerage Shore Capital has warned that certain parts of the retail sector will come under more pressure than others, while DFS claims the problems are "market-wide". In Shore Capital’s view, there is a "greater likelihood of more short-term warnings coming from the non-food bricks and mortar retailers in the UK in the near-term, particularly the bigger ticket discretionary players." It also suggests that grocery will continue to benefit from an inflationary environment, while premium and luxury retailers are also insulated by the cash-rich nature of their clientele.

That view certainly holds water when looking at other share price reactions in the wake of the DFS warning. On the day, other big fallers included white goods retailer AO World (AO.), homewares company Dunelm (DNLM) and electrical retailer Dixons Carphone (DC.). In fact, out of the general retail and clothing companies, only high street clothing chain Joules (JOUL) and catalogue business Findel (FDL) witnessed positive share price movements.

IC VIEW:

We see one dominant trend emerging from this, which is that value retailers stand to do well. Companies like B&M (BME) and discount grocers like Aldi and Lidl have all reported pretty buoyant trading this year, and analysts see consumers continuing to trade down as 2017 progresses. As for DFS, we’ve been neutral on the stock for some time, but don’t hold out much hope for the next update in August. Sell.

Last IC view: Hold, 251p, 31 Mar 2017

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By Harriet Russell,
15 June 2017

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