Retail braced for a battering

After a strong post-recession recovery in 2009, the retail sector struggled to make further progress in 2010, reflecting investors' fears that waning consumer confidence would put a dent in sales.

Ironically, consumer spending didn't collapse in 2010, despite the uncertainty surrounding an election and weather disruption top and tailing the year. According to the Office of National Statistics, the volume and value of non-food retail sales grew in every month last year bar January, culminating in a 3.7 per cent sales increase in November. And retailers' efforts to streamline their businesses in the wake of 2008's recession has meant many have continued to deliver steady increases in profit and cashflow.

Whether these initiatives will be enough to sustain momentum throughout 2011 is less certain, though. The high street bloodbath that many expected in 2010 may not have appeared, but there is little doubt that conditions are likely to get genuinely tougher in the coming months, as VAT rises and the Coalition government's planned spending cuts result in more job losses. According to the British Retail Consortium, a majority of retailers expect sales to fall this year, while the Centre for Retail Research says the tax change alone will result in £2.2bn of lost sales in the first quarter, a 0.5 per cent drop in like-for-like sales. There is also evidence that shoppers have been bringing forward purchases of large-ticket items to beat the tax increases, which means that retailers selling electricals and home furnishings may see sales soften in the coming months. We remain particularly wary on Carpetright, which is highly dependent on the fragile housing market.

Keeping profits ticking up in a stagnant sales environment won't be easy this year, either. Much of the low-hanging operational improvement has been completed already, so scope for further cost savings is now more limited. And rising input cost inflation - through higher cotton prices, increased wages in the Asian manufacturing regions and a rise in shipping costs - could prove problematic as consumers resist attempts by retailers to pass them on.

That's not to say they won't try - research from KPMG says that nearly 60 per cent of retailers are planning price increases over and above the 2.5 per cent VAT increase, but the accounting firm warned that they will need to be careful that any increases don't hit sales volumes. "Downturn discounting has re-set the baseline for consumers, who are now unwilling to pay more for goods and services", said the accountancy firm.

Next has already said that it expects the 8 per cent price hikes it's planning to hit underlying growth, as shoppers hunt around for bargains or turn to discounters like Associated British Foods' Primark or supermarket groups, which continue to chip away at established retailers with relentless non-food expansion. Companies in the electrical space look particularly exposed to this trend, particularly Argos and Homebase owner Home Retail, which doesn't have the recovery potential of Dixons or the overseas exposure of Kesa, which could well split its struggling UK business Comet from its high flying French counterpart Darty this year.

Given the likely struggles ahead for the UK high street this year - which could be further exacerbated by persistently high inflation and the consequent spectre of interest rate increases - companies with overseas exposure look better positioned to prosper in the coming year. Mothercare may have started the year with a profit warning after snow kept shoppers away from its out-of-town sites, but the importance of the UK operation will continue to diminish over the longer term - international sales from 53 countries already outstrips the UK, and the group plans to open around 150 new outlets a year for the foreseeable future.

That also explains why Inchcape remains the only remaining motor dealer in the FTSE 350 – it's the only one that operates outside the UK, so is poised to benefit from rising car ownership in emerging markets and insulated from the stagnant UK market.

BROWN (N) GROUP30184311.73.814.1
DIXONS RETAIL2383119.20.0-37.8
DUNELM GROUP510102718.81.633.2
HALFORDS GROUP43892710.95.05.4
HOME RETAIL GROUP20216548.47.3-28.7
JD SPORTS FASHION8664218.52.157.4
KESA ELECTRICALS16386215.93.77.8
MARKS & SPENCER GROUP388614811.83.62.9
SPORTS DIRECT INTL.16595115.50.062.6
WH SMITH477703104.1-3.8

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