1. Sector landscape and outlook

UK retail industry is very crucial to the economy and contributes approximately 5% to the GDP and is one of the largest employers, with approximately three million workers. Also, one-third of the consumer’s spending in Britain go through the retail industry. According to ONS data, In 2019, the UK retail sector reported a growth rate of 3.4%, on a YoY basis, whereas average annual growth rate witnessed in the online retail sales stood at 10%, significantly above the overall growth in the industry. Also, according to the ONS data, online retail sales in the UK has recorded a growth rate of approximately 324% over the past ten years.

Around 60 retailers-based out in the UK are listed and traded on the London Stock Exchange, with Tesco Plc is the UK’s largest retailer with a market capitalization of £21.38 billion, followed by Ocado Group PLC, Next PLC, JD Sports Fashion PLC and so on.

COVID-19 Impact

A number of UK retailers are reducing the size of their bricks-and-mortar portfolios and seeking to renegotiate terms of leases with landlords (including, in many instances, retailers seeking a move from fixed to turnover-based rental payments) in response to the COVID-19 pandemic. Prominent UK High Street retailers, including John Lewis & Partners, TM Lewin, and Zara, have all announced the closure of a significant number of their bricks-and-mortar stores. A number of UK retailers have entered into company voluntary arrangements (CVAs) with their creditors to reduce their liabilities, including recently well-known UK High Street retailers AllSaints and Hotter Shoes.

While the UK government permitted all nonessential UK retailers to reopen their bricks-and-mortar stores on June 15, 2020, after the lockdown; the British Retail Consortium has reported that UK retailers continue to enhance their online offerings and seek ways to mitigate the depressed revenue in the early part of 2020 caused by the COVID-19 pandemic. UK retail returned to growth in June 2020 as UK retail sales increased 3.4% year on year. This was driven by online sales, which were three times the yearly average and increased 48.2% year on year.

What is the stimulus available for retailers impacted by COVID-19?

The UK government has made available a number of stimulus funding measures, in which UK retailers have been able to participate. These include the following:

• COVID-19 Corporate Financing Facility (CCFF): The CCFF is designed to support liquidity among larger companies, helping them to bridge disruption to their cash flow caused by the COVID-19 pandemic through the purchase of short-term debt in the form of commercial paper.
• Coronavirus Business Interruption Loan Scheme (CBILS): The CBILS is a scheme designed to provide financial support to smaller businesses affected by the COVID-19 pandemic. Under the CBLIS, the UK government guarantees 80% of the amount of loans made to small and medium-sized enterprises, up to a maximum value of £5 million (approximately $5.9 million) per loan.
• Coronavirus Large Business Interruption Loan Scheme (CLBILS): The CLBILS is a loan guarantee scheme to support the financing of large businesses with a turnover in excess of £45 million ($56.5 million) that are experiencing lost or deferred revenues, leading to disruptions to their cash flows, due to COVID-19.

UK Retail Sales Recovered Back to Pre Covid-19 level in July

According to the data reported by ONS, retail sales in July 2020 witnessed continued growth in volumes, increasing by 3.6% on a month-on-month basis and recovering from the steep falls during the lockdown. More importantly, retail sales volumes were 3.0% higher in July when compared with February 2020.

Further, it is worth mentioning that total retail sales have recovered in July, while the wider economy entered a technical recession in Quarter 2 (April to June) 2020. In the second quarter of 2020, the economy shrank by a further 20.4% from the fall of 2.2% in the first quarter of 2020 (January to March).

Fig 1: Retail Sales data: July 2020, Seasonally adjusted, percentage change

Source: ONS

Food and Non-store retailing leading in the league

Food and Non-store retailing were at higher levels than before the pandemic, while non-food and fuel still remained lower than February 2020.

Fig 2: Retail Sales Volume, seasonally adjusted, July 2018 to July 2020.

Source: ONS

The monthly growth rates seen in July 2020 for non-food at 10.0% and fuel at 26.2% have shown some recovery; however, these strong monthly growths are from exceptionally low levels. In July, volume sales within non-food stores were still 6.6% lower than February 2020, and for fuel, it was 11.7% lower than February. Recent analysis shows that in July, car road traffic was around 17 percentage points lower compared with the first week in February, according to data from the Department for Transport.

Despite a fall of 3.1% in July for food stores, volume sales were still 2.4% higher than February 2020. The monthly fall in food store sales could be explained by the re-opening of restaurants and bars from 4 July as consumers’ retail food bills reduced as they began to eat out.

For non-store retailing, there was some contraction in June and July 2020 from the sharp growth in March, April and May 2020, possibly an impact of an increasing number of retail stores re-opening. The monthly decline in July of 2.1% in non-store still results in volume sales being 49.2% higher than pre-pandemic levels in February.

Fig 3: Retail Sales Trend: February 2020 to July 2020 (Indexed to 100)

Source: ONS

Regardless of a monthly decline in online retail sales in July 2020, sales are still higher than February’s pre-pandemic levels. Online retail sales fell by 7.0% in July when compared with June, but the strong growth experienced over the pandemic has meant that sales are still 50.4% higher than February’s pre-pandemic levels. As total retail sales bounced back in July, a higher proportion of online spending continued.

Fig 4: Online Retail Sales Trend

Source: ONS

UK Inflation rate jumped 1% in July 2020

UK annual inflation has jumped to 1% in July of 2020 from 0.6% in the previous month and surpassed the consensus estimate of 0.6%. It is the highest reading since March, as the restrictions caused by the coronavirus pandemic have been eased. The largest contributions came from clothing (-0.1% vs -2.2%), rising prices at the petrol pump (transportation prices were -0.7% vs -1.6% in June), and furniture and household goods (0.8% vs -0.5%). In contrast, food inflation slowed (0.8% vs 1.1%), mainly due to fruit, vegetables (including potatoes and tubers), fish, meat, and milk, cheese and eggs. On a monthly basis, consumer prices went up 0.4%, after a 0.1% rise and beating forecasts of a 0.1% fall.

Fig 5: Inflation

Source: Trading Economics 

The risk associated with the Sector

Heightened online penetration may lead to increase price competition among the retailers, and it would have an impact on the retailer’s margin in long-run. Further, in the wake of increased unemployment and falling purchasing power could lead to lower demand, especially for the non-essential products. Further, the next wave of COVID-19 outbreak could again drag down demand for non-essentials. Also, it can disrupt the supply chain of retailers as well. The availability of credit could also be a potential risk for the retailers, as it is widely expected that the British government will not announce any further stimulus measures at this time. As the lockdown measures continue to ease and societies and economies begin to reopen after months of closure, the markets are watching lenders’ credit activities and risk appetites with keen interest.

Outlook

Great Britain’s retail sector is likely to grow by at least +1.0% in 2020, regardless of a weaker food sale, according to the latest consensus estimates. The General Election result, following over 36 months of political volatility, brings with it a perception of clarity regarding Brexit and perceived certainty in the UK political landscape is likely to increase consumer confidence and kick start spending. UK retailers continue to enhance their online footprint and seek ways to mitigate the depressed revenue in the early part of 2020 caused by the COVID-19 pandemic. Also, UK retail returned to growth in June 2020 as UK retail sales increased 3.4% year on year. This was driven by online sales, which were three times the yearly average and increased 48.2% year on year, and the momentum is expected to continue.

2. Investment theme and stocks under discussion (SMWH, INCH, FRAS and HFD)

After understanding the recent trends in the sector, let’s now look at the four players from the industry those are listed on the London Stock Exchange. To assess the same, companies’ stocks are evaluated based on Discounted Cash Flow (DCF).

1. LSE: SMWH (WH SMITH PLC)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: GBP 1.64 Billion)

WH Smith PLC is a United Kingdom-based retailer in convenience, books and news for travelling customers. The Company operates through two segments: High Street and Travel.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~19% over the closing price of GBX 1,188 on 8 September 2020.

2. LSE: INCH (INCHCAPE PLC)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: GBP 1.87 Billion)

Inchcape PLC is an automotive distributor and retailer company based in London, UK. The group is involved in body shop repairs, logistics & marketing, and sale & distribution of automotive parts in Asia, New Zealand, Australia, and European markets.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~21% over the closing price of GBX 470.2 on 8 September 2020.

3. LSE: FRAS (Frasers Group PLC)

(Recommendation: Hold, Potential Upside: High Single Digit, Mcap: GBP 1.88 Billion)

Frasers Group plc is a UK based retail group that deals in sports-goods. The group has lilywhites, flannels, USC & house of Fraser retail brands under its belt.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~9% over the closing price of GBX 359.4 on 8 September 2020.

4. LSE: HFD (HALFORDS GROUP PLC)

(Recommendation: Watch, Potential Upside: Low Single Digit, Mcap: GBP 366.4 Million)

Halfords Group plc is a retail group that is engaged in sales of car parts, car enhancement, tools, camping and touring equipment and bicycles based in Ireland & UK.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ~3% over the closing price of GBX 178.4 on 8 September 2020.

Note: All the recommendations and the calculations are based on the closing price on 8 September 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

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