Retail Stocks - Industry Faces Tough Year As UK's Working Households Feel The Squeeze

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• February's ONS retail sales figures predicted to rise on Friday
• Marks and Spencer Group Plc (LON:MKS) joint venture with Ocado Group PLC (LON:OCDO) could be a headwind to growth this year
• Market apprehension ahead of NEXT plc (LON:NXT)'s results on Thursday
• Cost pressures affecting Frasers Group PLC (LON:FRAS), J Sainsbury plc (LON:SBRY) and Tesco PLC (LON:TSCO)

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Q4 2021 hedge fund letters, conferences and more

• 1. How The Retail Sector Is Faring
• 2. Ocado's Declining Sales
• 3. Frasers' Challenges

Ahead of the ONS Retail Sales figures for February being published on Friday, Steve Clayton, HL Select Fund Manager, gives his verdict on how parts of the retail sector are faring:

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“Last month's retail sales figures showed growth of 1.9% and February is a hard month to call. Last year, sales volumes in the UK were down on a year ago, making for an easy comparison. But with inflation chipping away at workers' spending power and rising utility bills hitting the headlines last month, confidence could well have taken a knock. Then of course, Russia invaded Ukraine toward the end of the month. Sales are likely to have crept forwards, but momentum will be harder to maintain from here, given the accelerating pace of price inflation.

If the pandemic was tough for retailers, the reopened economy could be worse. Stores are open, and consumers spending freely for now, but there is a storm coming. Petrol prices of over 170p per litre mean filling the family car can cost well over £100. Soon the energy price cap will jump to £1,900 p.a. for a typical household's dual fuel bill. Meanwhile, National Insurance jumps by 1.25% in the new tax year, an unwelcome double-whammy for working households. Household budgets will be squeezed hard so retailers will struggle. The pandemic accelerated the shift toward online shopping, so the playing field had already tilted against the High Street.

But retailers are impacted by the same costs as consumers. They must heat and light their stores and they have to pick up the extra costs of moving goods. They need to raise their prices to protect their margins, but their workforces will be seeking higher wages too.

Then there is the hangover from the pandemic; just getting hold of the right stock can be a challenge, especially at a price that makes sense. These supply issues might have been expected to ease over time. Firms find ways around obstacles year in year out. But supply challenges bundled with rampant cost pressures is an exceptionally challenging retail environment.

The outlook is for a sharp squeeze on earnings for any retailer unable to control their costs. Each will have their own issues. Stalwart M&S saw its joint venture with Ocado providing growth during lockdown, but Ocado faces tough comparisons against lockdown trading, so the Ocado tie-up could be a headwind to growth this year. Ocado Retail's most recent update showed sales declining 5.7%.

The core of M&S is still the stores and joint CEO's Stuart Machin and Katie Bickerstaffe face a baptism of fire as they take on the challenge of building on predecessor Steve Rowe's turnaround programme, just as consumers tighten their belts.

Over at NEXT plc , long-time CEO Lord Wolfson has already sketched out a view of the year ahead. In January, NEXT forecast sales growing by 7% this financial year. Selling prices were predicted to be rising at a 6% clip by year end. Wages are rising almost as fast, highlighting the pressure on margins. Inflation forecasts have jumped up sharply since NEXT guided in early January, and the market is nervous that NEXT could change their relatively benign view when they report on 24 Mar.

Frasers Group , formerly known as Sports Direct, has built a portfolio of retail brands in recent years and now sits on a vast portfolio of real estate and brands. Frasers has a huge supply chain bringing in goods from far and wide. So far the group has managed its margins well, lifting them 0.7% at the interim stage. Back then in December they sounded confident, but flagged that cost pressures were developing. Oil prices have surged since so the challenges facing the group are clear.

The invasion of Ukraine has sent the prices of grains soaring, because of the importance of Ukraine as a growing region. The UK's food retailers were warning of inflationary pressures long before Ukraine hit the radar and this can only intensify. Food retailers will face upward pressure from living wage increases, and pressure to accept price increases from suppliers.

What is unique about the current situation for the grocers is that it seems as if the price of everything is going up at once. Food producers face higher feed costs for meat rearing, higher fertiliser costs for crop production. Food manufacturers face rising wage pressures, higher energy bills, higher input costs and distribution costs pushed upward by fuel costs. Everyone the food retailer talks to is asking for more. Whilst on the one hand, people still have to eat, so food retailers can raise their selling prices, they know that if they do, the discounters will take market share. So they may feel they have to accept a squeeze on margins to protect their long term position. But with post-tax margins for Sainsbury and Tesco already wafer thin, there isn't a lot of wriggle room.”

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Updated on Mar 24, 2022, 12:17 pm

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