UK shoppers have gone on a spending spree this summer, driven perhaps by a combination of factors: the warm weather, Murray's Wimbledon victory, the Ashes success and the birth of the country's future king. Figures from the Office for National Statistics confirm that the value of retail sales grew a mighty 5.1 per cent in July, compared with 2.9 per cent growth a year ago and 3.9 per cent in June. This corresponds with data from the British Retail Consortium, whose director-general, Helen Dickinson, says the results are further evidence of a tentative recovery. "UK retailers still face significant challenges, but the outlook is gradually improving," she says. But is it?
The real question is whether this uplift will gain momentum, or if it's just a temporary blip. Arguably, stable or rising property prices are giving households confidence to spend more. Inflation as measured by the consumer prices index is also expected to fall to 2 per cent by Christmas from a high of 2.9 per cent in June, according to a report from researchers at Capital Economics (CE), which should ease the squeeze on household budgets.
Meanwhile, GDP forecasts have been revised up and unemployment is improving, albeit slowly. Real household spending has risen for the past six quarters, too, and is driving the overall recovery - spending in 2013 is on track to equal the 1.2 per cent rise achieved last year, according to CE. All of this paints a pretty perky picture for UK retail and that's good news for the government, whose hopes are pinned on a spending-led recovery, fuelled by monetary and fiscal policy designed to keep interest rates artificially low and house prices buoyant.
But despite these tailwinds, the likelihood is that consumer spending and sentiment will, in fact, remain subdued for some time. Even if the housing recovery were to support increased consumer spending, there's a real risk of reinflating a house price bubble that could burst further down the road, particularly as interest rates begin to rise, warns CE. And with property prices overvalued by historical standards, millions of people are stuck paying sky-high rents, which erodes what they can spend at the tills. Housing aside, real earnings are still falling and this will probably keep any near-term consumer revival muted - in the first quarter real earnings fell 1.7 per cent, the biggest quarterly fall since 1987. As a result, retailers' pricing power will remain constrained.
"In the near term, there's a real risk that the consumer recovery will stall," say the report's authors. "Robust growth in consumer spending seems unlikely for some time. Households still have a bit more to do in reducing their indebtedness. Meanwhile, the economic recovery seems likely to be 'jobless' given that firms have scope to boost output from their existing underutilised workers.
"But, as inflation falls, renewed rises in real pay should underpin a modest spending recovery." Accordingly, CE expects an increase in real consumer spending of between 1 per cent and 1.5 per cent a year for the next two to three years.
Jon Copestake, a retail analyst at The Economist Intelligence Unit, takes a similar view. He expects volume growth in the retail sector of just 1 per cent in the next year or two. "Overall, the market is set to remain challenging," he says. "Consumers are bearish. We had a good summer and sales in July were up, but I don't think it will last. The same thing happened last year with the Jubilee, and the Olympics. Everyone spent money, then there was talk about recovery, but then winter came.”
Mr Copestake also highlights slow wage growth and unemployment as factors limiting spending, and points out that the so-called housing boom is very much a London phenomenon. "The situation in the wider country isn't as bullish, especially in housing, and I can't see this housing boom will have the effect of boosting retail sales. I think the opposite might be true," he adds. The reason being that prices are still rising, access to credit is low and prospective first-time buyers are more likely to be belt-tightening as higher rental prices hit disposable incomes.
"Something has to give," says Mr Copestake. "CPI inflation is around 2 to 3 per cent, while wage inflation is 1 per cent. General retail sales will suffer as a result. Confidence will return, but at this stage, consumers are still focused on value."
Add to that growing pressure caused by e-commerce, where bargain-hungry consumers can read reviews and compare prices at the touch of a button, while demanding ever-shorter delivery times, and you can see why the UK retail outlook is bearish. Big internet hitters Amazon and Ebay are also moving into bricks and mortar, while cheaper clothing labels from the supermarkets are no doubt stealing market share from old hands such as Marks and Spencer (MKS) and Debenhams (DEB).
IC VIEW
Despite all the gloom, there is, at least, some growth, and provided well-run companies can continue to hit their earnings targets and invest in their businesses, their share prices should continue to outperform the wider market. Indeed, after a great 2012, the general retail sector had a wobbly start to the year, but has since rallied strongly - up nearly 33 per cent so far this year, outperforming the FTSE All-Share index by more than 20 per cent.
Many UK retailers, Supergroup (SGP), Next (NXT) Sports Direct (SPD) and N Brown (BWNG) have exposure to faster-growing overseas markets, too, helping counter slower domestic growth. A recovery in the housing market, however shortlived, could also drive demand for DIY goods, so companies that have been struggling these past few years, like B&Q owner Kingfisher (KGF) and Home Retail Group (HOME), which runs Homebase and Argos, might benefit.
Also, while some shops are struggling with e-commerce, others, such as Next, Sports Direct and Dunelm (DNLM), are winning out, while a handful are relatively internet-proof. Topps Tiles (TPT), for instance, uses its website primarily to showcase its products rather than transact sales, as customers prefer visiting stores to buy. N Brown has only ever been catalogue and web-based, and Majestic (MJW) has always operated a delivery model, so the internet didn't increase costs. And Argos' well-established distribution network means it could prosper if its revamp lures customers.
| Company | Price (£) | Market Cap (£) | Dividend Yield | Forward P/E ratio | FY Net Debt (Cash) | Return on Capital | OperatingMargin |
|---|---|---|---|---|---|---|---|
| ASOS (ASC) | 48.81 | 4,005 | - | 88 | (27.9) | - | 7.3% |
| Carpetright (CPR) | 6.71 | 453 | 0.0% | 43 | 10.2 | 7.8% | 2.5% |
| Darty (DRTY) | 0.82 | 434 | 3.6% | 21 | 129 | 61% | 0.8% |
| Debenhams (DEB) | 1.09 | 1,347 | 3.0% | 11 | 377 | 9.7% | 7.4% |
| Dignity (DTY) | 14.7 | 842 | 0.0% | 19 | 279 | 11% | 30% |
| Dixons Retail (DXNS) | 0.43 | 1,558 | - | 21 | (42.1) | 32% | 4.1% |
| Dunelm Group (DNLM) | 9.33 | 1,892 | 1.6% | 22 | (65.2) | 37% | 16% |
| French Connection (FCCN) | 0.32 | 30.9 | 0.0% | NM | (28.5) | (7.0%) | (4.0%) |
| Halfords Group (HFD) | 3.77 | 733 | 4.5% | 16 | 111 | 11% | 9.0% |
| Home Retail Group (HOME) | 1.5 | 1,202 | 2.0% | 18.6 | (396) | 2.5% | 2.0% |
| JD Sports Fashion (JD.) | 9.33 | 454 | 2.8% | 9 | (45.6) | 15% | 4.9% |
| Kingfisher (KGF) | 3.87 | 9,112 | 2.4% | 16.4 | 33.0 | 6.7% | 6.6% |
| Laura Ashley Holdings (ALY) | 0.27 | 196 | 7.4% | 12.6 | (34.6) | 19% | 6.3% |
| Majestic Wine (MJW) | 5.05 | 329 | 3.1% | 17 | (2.90) | 18% | 8.7% |
| Marks & Spencer (MKS) | 4.59 | 7,384 | 3.7% | 13.8 | 2,072 | 10% | 8.2% |
| Moss Bros (MOSB) | 0.63 | 60.2 | 1.4% | 28 | (25.7) | 6.5% | 3.4% |
| Mothercare (MTC) | 4.43 | 392 | 0.0% | 26 | 32.4 | 8.9% | 1.7% |
| N Brown (BWNG) | 5.72 | 1,588 | 2.4% | 19.4 | 189 | 9.5% | 13% |
| Next (NXT) | 48.6 | 7,329 | 2.2% | 15.0 | 516 | 45% | 19% |
| Sports Direct International (SPD) | 6.5 | 4,000 | - | 21.0 | 154 | 16% | 9.7% |
| Super Group (SPG) | 1.39 | 402 | - | 10.1 | (26.6) | 13% | 9.7% |
| Stanley Gibbons (SGI) | 2.98 | 85.5 | 2.0% | 17.0 | (6.60) | 11% | 14% |
| Topps Tiles (TPT) | 0.83 | 160 | 1.2% | 16.9 | 51.2 | 18% | 8.5% |
| WH Smith (SMWH) | 8.5 | 1,048 | 3.3% | 11.6 | (36.0) | 41% | 8.8% |
| Summary Statistics | |||||||
| Mean | 7.39 | 1,736 | 2.2% | 27.7 | 123 | 18% | 8.7% |
| Median | 3.82 | 593 | 2.2% | 17.3 | (1.10) | 11% | 7.8% |
| Source: S&P Capital IQ | |||||||
FAVOURITES
Mothercare (MTC), a recent buy tip, is undergoing an overhaul, and if it can continue to meet targets and lure shoppers back through the doors, the shares should enjoy further upside. Supergroup should, too. It's had an astonishing run in the past year and, with more shops set to open overseas, a much improved womenswear range and hefty cash pile to fund growth, there should be more to come. N Brown is an extremely well-run, cash-rich business, catering to a niche market with good exposure to the US.
OUTSIDERS
M&S faces significant headwinds. Its womenswear is becoming less appealing to shoppers and the store estate is clunky, drab and bloated. Halfords (HFD) recently slashed its dividend and has suffered a fall in profit as it attempts to invest in the business against a backdrop of falling sales and stiff online competition. Poor old Carpetright (CPR) is struggling, with particularly poor sales in Europe. It's also being investigated by the Office of Fair Trading for allegedly misleading consumers.
