Is there opportunity in the retail squeeze?

Business after business has hit the profit alarm from US mega-store Target to UK high street stalwart Marks & Spencer.

The announcement that every household is to receive £400 off their energy bills in the autumn, coupled with a comprehensive package of support for pensioners and those on benefits, immediately resonated with investors and shares in retailers shot up. But the resurgence was short-lived – the consensus being there are just too many head winds battering the sector, and consumers on both sides of the Atlantic are simply too constrained by budgetary pressures. The latest Opinions and Lifestyle survey* conducted for the Office for National Statistics found that 56% of people were spending less on non-essential purchases.

Business after business has hit the profit alarm from US mega-store Target to UK high street stalwart Marks & Spencer. Sales have been robust, even rosy, through the first part of the year as pandemic restrictions finally fell away, but inflation has sent jitters through boardrooms. Next, Primark owner Associated British Foods, and online behemoth Boohoo have all warned prices will have to rise – a particular anathema to businesses chasing value-driven shoppers.

Brands that had already been struggling like Ted Baker and Misguided have either had to hoist the for-sale sign or appoint administrators, though the latter has now been snapped up by the Frasers Group. And with a number of high-profile bosses heading out various doors – from B&M Retail to Pets at Home – it adds an extra frisson of uncertainty.

A tale of two customers

But not all retailers are the same and, in this case, investors might want to consider the customer rather than business model.

Whilst decades-high inflation is forcing most consumers to cut back, those with higher incomes are, at least for the moment, proving more resilient.

Earnings growth for different categories of UK and US retailers

Source: Stockopedia **current financial year

Upbeat profit forecasts from luxury retailers have highlighted the disparity between more and less affluent consumers. The deep pockets of the customer base shared by London-listed Burberry and its US compatriots Nordstrom and Ralph Lauren deliver a designer cushion against price pressures. Whilst decades-high inflation is forcing most consumers to cut back, those with higher incomes are, at least for the moment, proving more resilient. All have commented that so far, they’ve been able to hike prices without seeing any kind of major push-back from customers. That pricing power is enabling high-end brands to avoid the discounting spiral that other retailers have fallen headlong into as they try and clear out stock gathering dust on backroom shelves.

If high-end retail is expected to cruise through the inflationary storm, and value to be buffeted by both head and tail winds, what of those middle-of-the road…?

Up until now lockdowns in the lucrative Chinese market may have given investors pause, but as restrictions are lifted it seems many are taking a long look at the distinctions between retailers. However, even in the case of high-end US department store Nordstrom, which has rallied considerably over the last month, its valuation is still subdued compared to pre-pandemic levels. Retailers, particularly bricks and mortar stores, have had it tough over the last couple of years, something that makes the predicament faced by more mainstream businesses even more difficult to deal with.

There may have been some expectation that value names like Target and B&M Bargains might also have benefited from the inflationary environment as customers looked to trade down in search of cheaper deals. Certainly, that’s the way its going in the UK’s competitive supermarket sector with discounters pulling market share from middle-of-the road stores, in particular Morrisons. But when margins are wafer-thin and supply chains are still sluggish, profits become harder and harder to generate, and there’s no doubt core customers are laser-focused on value.

This inflationary spike is unprecedented, and the shifting sands of geopolitical instability make it harder than ever for investors to get a grip on what’s coming down the tracks. If high-end retail is expected to cruise through the inflationary storm, and value to be buffeted by both head and tail winds, what of those middle-of-the-road, multi-channel operators like Next? Often seen as a bell-weather retailer it was one of the first to sound a cautionary note. Will it end up adrift or will its mix of products, brands and prices, coupled with its credit option, make a difference and provide a way through increasingly choppy waters?

Latest figures from the Bank of England suggest shoppers have been hammering their credit and store cards, and retail sales figures last month saw a surprising uptick in clothing purchases as people prepared for a summer of delayed celebrations and sunshine holidays. But every month seems to bring another bill hike and by the time Christmas comes around the worst of those energy bill increases will take hold.

What’s true in the first six months of the year is unlikely to change significantly over the next six months. Those for whom money isn’t really an issue will continue to spend and the retailers that enjoy their patronage will continue to boom.

*Public opinions and social trends, Great Britain - Office for National Statistics