Christmas is a critical time of the year for Britain’s shopkeepers. The last two months of the year can account for up to 50% of the year’s overall takings in some cases.
Unfortunately it seems there’s been very little to celebrate this festive season. Yesterday, fashion retailer Next reported on its holiday season trading. It wasn’t glad tidings for the high street – or for the firm’s shareholders.
And things look set to get even worse. Most of the same problems that afflicted the UK in 2011 will continue into 2012. Anyone relying on a strong recovery this year to keep them afloat is unlikely to make it.
But everything has a price: even battered retailers. And one stock in particular is starting to look cheap.
2011 was tough for retailers – but 2012 will be tougher
Clothes seller Next is one of Britain’s retail industry bellwethers. So it always pays to listen to what the company says about its sales. On the plus side, Next had “a good final week before Christmas” while its “end of season sale has gone well”. What’s more, Next Directory – the group’s online operation – grew sales by 17% between 1 August and 24 December.
But that’s about as good as it gets. Overall turnover levels in November and December were “disappointing” compared with 2010. Bearing in mind that half the country was buried in a snow drift back then, that shows just how bad 2011 has been. From August to December, turnover shrank by 2.7%. Next shares dropped 4% on the statement.
And bad as things already are, they could get worse still. The outlook for high street spending is getting grimmer. Next uses the usual buzzwords like “uncertainty” and “difficult consumer environment”. But the bottom line is that UK shoppers are going to remain squeezed this year.
Pay packets are growing more slowly than the cost of living. Average earnings are rising at 2%. That compares with inflation of around 5%. So there’s less spare cash to spend on non-essentials.
Yes, fuel prices may have stopped climbing for now. But if you travel by train, you won’t need reminding how much pricier your journey has become. And while inflation may drop in the near future, that will give companies the excuse to offer even lower wage deals.
On top of that, borrowing money to plug gaps in household budgets remains tough. The latest loan figures from the Bank of England show that consumer credit (spending on credit cards and personal loans) is growing at only 2% a year. That’s adding little to consumers’ firepower.
With Britain’s economy likely to slow even further amid the crisis in the eurozone, there will be fewer jobs and longer dole queues too. So all in all, that means even less money around to spend in the shops.
How carnage on the high street could spread
So what does it mean for retail stocks – and your portfolio? More retailers will report their year-end trading over the next few weeks. Chances are they’ll say similar things to Next. That’ll be bad news for the sector’s share prices.
Now if you’re a regular Money Morning reader, this won’t come as a great surprise. We’ve been wary about the general retail sector for ages. If you’ve followed our advice, you won’t own many shares in high street stores.
But the risks run deeper. As sales drop, many of Britain’s retailers will become ever more desperate to generate cash flow to pay their bills. That could lead to knock-on trouble for plenty of other businesses.
Retailers will try cutting prices to sell more stuff. This may provide a short-term cash-flow boost by shifting goods from shelves faster. But that stock will need to be replaced at some stage. So storeowners will have just one way out – they’ll have to put an even bigger squeeze on their own suppliers.
The process has already started. As the Telegraph notes, last year “the majority of retailers markedly increased the number of days it took to repay creditors”. This “highlights the growing pressures on smaller companies supplying Britain’s biggest retailers”. In other words, retailers’ cash flow problems are being handed down the supply line.
This can’t go on forever. In the end, many retailers will run out of money and go bust. No wonder restructuring consultancy RCapital forecasts a year of “carnage” for the sector, with the number of insolvencies expected to exceed even a horrendous year like 2008.
In turn, this could cause big cash flow problems in the future for retailers’ suppliers. So if you hold shares in firms who sell to the retail sector, it’s a good idea to find out who their major customers are, and just how dependent they are on individual chains.
Retail failures would hit landlords and banks too, because they’ll have to take big losses on their balance sheets. Steering clear of both these sectors looks a sensible bet.
However, there will be some survivors on the high street. Major player Marks & Spencer (LSE: MKS) is likely to be one of them. The stock now trades on a p/e ratio below ten and offers a 5.5% dividend yield. That’s getting close to being a bargain basement valuation for such a quality company.
It may get dragged down further amid the adverse sentiment towards the sector, so you might want to wait for a few more gloomy Christmas trading updates before buying in. But at these levels, Marks & Sparks is a buy.
Category: Market updates