FTSE 350 general retailers: General retailers feeling the pinch

Despite the strong share performances, the tough trading conditions continued to take their toll on the sector. According to figures from accountancy firm Deloitte, 194 retailers fell into administration last year, a 6 per cent rise on 2011. But in an industry which has always tended towards survival of the fittest, there were inevitable winners from this market contraction, not least Sports Direct International (SPD) and Dixons (DXNS). Both retailers saw their share prices rise as they snapped up customers when rivals JJB Sports and Comet crumbled.

But these beneficiaries can also take some credit for their continued success – both Dixons and Sports Direct have improved their operations and should continue to prosper, albeit slowly, despite the ongoing economic gloom. In Sports Direct's case, it has improved its product offering, acquiring new sports and fashion brands to broaden its demographic appeal into wealthier customer segments – and invested heavily in international and online operations. Online, in particular, has become a major catalyst for growth, with sales from this segment up 54 per cent in the first half, boosted by a revamped website with new language and currency options. "Other stores are doing fantastically well online, but their like-for-like sales in store are suffering: that's not happening to us," said chief executive Dave Forsey.

His point is that it's no longer enough for companies just to offer internet shopping. They must find a way for their high street chains and websites to work in tandem – only those which do will deliver growth, with the development of click and collect services proving an important differentiator. Marks and Spencer (MKS), for example, launched a free next day collection service during the year, but once again the high street bellwether appears to be behind the curve of an industry is rapidly moving to same-day click and collect.

Whether this explains M&S's disappointing Christmas sales isn't clear, but it certainly has plenty of catching up to do in improving its multi-channel offer. A new e-commerce distribution hub will open this year, but a much needed makeover of its website will not happen until Spring 2014. If that means further trading weakness, pressure could mount on chief executive Marc Bolland – according to broker Seymour Pierce, he has been given a year to turn things around. Should share price weakness follow, M&S is also vulnerable to a bid. Private equity group CVC Capital Partners is said to have explored a buyout of M&S, while Philip Green sold a 25% stake in Topshop in December, fuelling speculation that Arcadia Group might move for M&S.

Overall, internet shopping has accounted for a major share of UK retail sales, with purchases through mobile phones growing at an astounding rate. Added to this, areas that were once considered sacrosanct for store-based transactions, such as clothing, are no longer safe, according to Dr Jonathan Reynolds, of Oxford university's Saïd Business School. "Consumers are deconstructing the buying process and deciding which channels work for them at which stage," he added. "The multi-channel approach retailers will win. It's survival of the most adaptable."

Many of last year's success stories such as N Brown (BWNG), Next (NXT) and Debenhams (DEB) are reaping the benefits of having a so-called multi-channel business in place, allowing shoppers to use the web to reserve, collect in store or arrange home delivery, with Next demonstrating that consumers are just as willing to buy clothes online as they are books. Next's Directory business is growing much faster than its retail operation, and the company now expects group profits to be roughly £618m for the full year to January 2013, implying earnings growth of between 14 and 17 per cent. However, Next warns that rising price inflation ahead of wages means the consumer environment will remain subdued – although the group has a tendency to play down expectations and subsequently beat them.

N Brown spent last year exploiting previous investment in its online systems, which drove solid revenue growth in its first half. Sales in the US increased, where the country's obesity problem is likely to boost business in the company's core range for plus-sized people. WH Smith (SMWH) is also making progress by tapping into international markets, particularly through its travel business where it plans to open more such units in the UK and abroad, and has also continued to squeeze out cost savings from its more mature high street estate. That's translating into steady profit growth, strong cash flows and chunky returns to shareholders, although the surprise resignation of highly regarded chief executive Kate Swann last October has made us cautious on the shares.

Weakened consumer spending should have been disastrous for homeware retailer Dunelm (DNLM), but the company's broad appeal and ability to swiftly change product ranges is driving sales. Buoyed by a cash-rich balance sheet, Dunelm plans to open new stores and is likely to steal market share from rival, Home Retail Group (HOME). It also has the advantage of having too few stores rather than too many, and therefore doesn't have to undertake the expensive and painful pruning process seen at its more established rival. Although caution is needed – the shares have risen over 65 per cent since mid-June and now trade on a precarious rating. Debenhams is in a similar position – it reckons it can add another 80 stores in the UK without cannibalising existing stores.

Of course, constrained household budgets and structural challenges mean further distress for the sector in 2013 and probably more insolvencies – Jessops and HMV have already become the first major high street casualties of 2013. Despite this, we remain buyers of those retailers that have credible multi-channel strategies and expansion opportunities both at home and overseas.