Carnage on the shop floor

The pressure on the retail sector has been a consistent staple for investors since the end of the financial crisis, partly as a result of changing shopping habits but also down to rising costs and outdated business models. This has been no better illustrated by the way UK consumers behaved over the so called  ‘Black Friday’ and ‘Cyber Monday’ weekend which saw some rather mixed messages from what is slowly becoming a regular event for UK consumers.

Spending in the lead up to Christmas also now appears to take place over a longer period of time, not altogether surprising when companies like Amazon start their pre-Christmas and Black Friday sales promotions from the middle of November. This tends to stretch the overall spend over a longer period of time thus creating a smoothing effect for retail sales growth which this year has been much better than it was over 12 months ago.

It also has to be remembered the problems last year, which saw retail sales growth plunge were largely self-inflicted by the Bank of England’s reckless rate cut in the wake of the 2016 Brexit referendum vote which sent inflation soaring and squeezed consumer spending.

Since the end of last year, as can be seen from the retail sales chart below, consumer activity has improved, mostly in line with the slow decline in CPI inflation from peaks of 3.1%, while wages growth has slowly improved over time from 1.7% in mid-2017 to 3.3% now.

For most of the summer annual retail sales growth averaged in excess of 3.5%, and while it has slipped back as we headed towards the end of the year, the numbers look much better than they were this time last year

That isn’t to say that 2018 hasn’t been a hard year for retailers, it most definitely has, given we’ve seen Maplins go under, while companies like Carpetright, Debenhams, Dunelm, House of Fraser and Mothercare have all issued warnings about profits, while the tough environment has even dragged in major bellwethers like John Lewis, which reported a 99% fall in profits in its last set of numbers, calling into question in some quarters its motto of “never knowingly undersold”. It hasn’t all been bad news for retailers, there have also been some success stories, this may have something to do with the fact that wages growth has now overtaken price inflation, and as long as that continues the outlook for 2019 should be encouraging assuming our esteemed politicians don’t find a way to throw a wrench in the economic gears.

John Lewis reinforced those hopes of a decent year end by reporting that store sales and web sales smashed records as consumers snapped up a wide range of goods over the course of the Black Friday weekend, with sales up 7.7% over the same week last year.

For the sector as a whole it’s been a year of two halves  with a fairly flat performance in H1 despite the problems from the “Beast from the East”, however the second half has seen a steady decline in the sector with the FTSE350 General Retailers index, sliding over 25% since its July peaks, to its lowest levels since late 2012.

The reasons for the struggle are not too hard to find given that the top three companies in the index are Next, Kingfisher and Marks and Spencer and make up almost 50% of the sector.

Conclusion

UK retail has had a difficult year despite the improved climate around retail sales growth. This growth in headline numbers from a disappointing 2017, appears to have been encouraged by heavy discounting as well as erosion of retailer margins, which has claimed a number of high profile victims, and could claim a whole lot more in 2019 if Sports Direct CEO Mike Ashley is correct in his recent assessment of the sector, when he said that the current environment was smashing retailers to pieces.

His recent activities in the sector with respect of Debenhams and House of Fraser has seen the Sports Direct share price hit heavily, and for all the criticism he has faced from various politicians about his company’s industrial relations, if it weren’t for him the carnage on the High Street this year could well have been much worse.

Whatever you think of the boss of Sports Direct at least we have a CEO who isn’t afraid to tell it like it is, in the hope that our economically illiterate politicians will look at new ways to try and deal with a problem that is decimating the high street.

The increase in business rates, along with higher staffing costs as a result of the living wage have also shrunk margins, so even without Brexit the challenges would have been just as significant, and don’t believe any company that says Brexit is their primary concern. Brexit is an excuse for a retail environment which is struggling to adopt to the growth in online and click and collect, as well as changing retail shopping habits.

The retail sector is likely to remain vulnerable to further shocks in the weeks and months ahead, irrespective of the upcoming Brexit denouement, however a benign outcome is likely to be preferable if only for the sake of consumer confidence, which has now started to impact margins in the online space, something most investors didn’t consider a possibility at the beginning of this year.  

Michael Hewson is the chief market analyst at CMC Markets UK