Anyone following developments across the UK grocery sector will be familiar with the rise of the discounters. The arrival of German brands Aldi and Lidl in the UK has caused nothing short of chaos for Britain's largest supermarkets. Once-loyal customers have deserted the big brands as loyalty schemes, multi-buy promotions and money-off vouchers all fall prey to the lure of permanently low prices. This trend has been extremely disruptive for the grocery sector and has arguably caused a structural change in the market. However, less attention is paid to value-based retailers outside of food retail. Discount retailers elsewhere in the industry simply aren't faring as well as their produce-focused cousins, which makes for an interesting comparison.
The arrival of value chain Poundland (PLND) on the London Stock Exchange in 2014 was met with serious fanfare. It wasn't long before the share price gathered real momentum and rumours of a high-profile takeover of close rival 99p Stores started to swirl. A series of blue-blooded media outlets also gave the product range the thumbs up, proving the brand had started to gain a following among Britain's middle classes. The trend also demonstrated how the UK consumer had started to demand value for money over other variables when hitting the high street.
Not all it's cracked up to be
However, it wasn't long after the competition authorities gave Poundland the green light for the 99p takeover deal that cracks in the foundations of value retail started to show. Poundland bosses started blaming loom bands - a children's fad in 2014 - and the timing of Easter for why it couldn't keep up with initial, phenomenal growth rates. At the time of full-year results last June, the group saw sales top more than £1bn, which on a constant currency (CC) basis represented growth of nearly 12 per cent. But that growth rate has actually decelerated since the year-end. In the first 11 weeks of the 2016 financial year, CC sales grew 4.1 per cent. That represents a significant fallback from last year, when sales were tracking 18 per cent ahead during the first quarter.
Suddenly, concerns mounted that demand for pound shops was waning, particularly as supermarkets wage ongoing price wars in an attempt to win back market share. Although popular at first, the group's recent £55m acquisition of rival 99p Stores is also proving especially costly - particularly in terms of rebranding and making sure stores are sufficiently stocked. In fact, the costs of that deal, coupled with weak trading across the existing business, are expected to lead to a painful second-half hit. A disappointing trading update at the start of the year has done little to help, and management has warned that even adjusted full-year pre-tax profits (which exclude losses from the 99p deal) will come in at the lower end of expectations.
Poundland’s not alone
B&M European Value Retail (BME) sells multiple household items from electricals to DIY to food and drink. The difference is that it sells big brands at small prices. But it seems the group's extensive store rollout is actually hurting its organic growth. At the time of interim results in November, the discounter reported like-for-like sales growth of 1.2 per cent, but the growth rate would have been double that, according to management, had some of its new stores not cannibalised the sales of existing outlets. In the UK, the company opened 47 net new stores in the period to bring the total to 472 - a record pace of expansion.
The launch of two new distribution centres, one in June and the other in September, also caused some operational hiccups. Management service levels to stores fell "below normal" in the run-up to Christmas, while mild temperatures resulted in a "slow start for cold weather and seasonal ranges". Third-quarter results showed similar trends. Sales for the 13 weeks to 26 December grew 24 per cent to £615m, but like-for-like sales contracted by 0.7 per cent.
Although not a traditional discounter, convenience chain McColl's (MCLS) share price has gone a similar way to Poundland and B&M over the past year. Interim results from convenience showed a 1.9 per cent fall in like-for-like sales following significant price deflation on categories such as newspapers and tobacco. The second quarter was particularly challenging, with like-for-like sales down 2.5 per cent. Interestingly, that's a sharp contrast to the group's premium food and wine stores, which kept comparable quarterly sales flat compared with a 4.7 per cent decline across the group's value-orientated newsagents.
What does the future hold?
The outlook for general discount retailing differs markedly to that of grocery retailing, although changing dynamics across the sector are common to both. For instance, the introduction of the new national living wage (NLW) this year will affect retailers of all shapes and sizes. But companies like Poundland and B&M now have vast store estates - thus huge numbers of employees - and therefore face the possibility of far higher unit costs. Some high-street retailers, like clothes horse Next (NXT), have planned to offset rising costs with price increases. But this becomes more difficult for retailers that pride themselves on a value offering. Increasing prices alienates customers and goes against brand.
Grocery retailers may have to increase prices to offset wage inflation too, but so will their big-brand competitors. This has the effect of levelling the playing field, leaving the discount chains looking like the cheapest option available. As long as the oil price stays depressed, they may also be able to offset higher wages by savings on distribution costs.
IC view:
Discount retailing in the grocery sector grabs most of the headlines as the ongoing supermarket price wars touch customers and investors alike, every day. But discount retailing beyond this part of the industry is a different game, one that’s underperforming. The two sides should not be confused by investors interested in fast-growing discount retailers.
