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Broadline retailers It was fun while it lasted but the retail party is over for now. The sector is struggling, although the charts highlight one or two isolated chances for bargains

by John Marshall

A fortnight ago, Arcadia boss Sir Philip Green, echoing the gloomy comments of arch rival Sir Stuart Rose on the economy, warned ‘people have started to realise that this is going to be a long slog’. In particular, says Green, the middle market where he competes with Next and Marks & Spencer is ‘very, very tough’.

Arcadia is not weighed down by being a quoted company and Green mischievously pointed out that we had not yet ‘seen a major profits warning’. His warning coincided with an apoplectic circular from Citigroup in which the brokerage slashed its 2008 and 2009 forecasts for the retail sector. Previously it was expecting earnings to grow by 5.6%. Now they are forecast to fall by 6.7%.

Of the 13 stocks covered in that review, Citigroup downgraded eight to a ‘sell’ recommendation, expecting the ‘peak of a brutal slowdown to be felt in 2009’. The broker does not anticipate any ‘recovery in consumption patterns until 2010 at the earliest’.

The reasons for Citigroup’s gloom are clear. The slowdown in the housing market is a major factor, as is the high level of private debt. In addition, the low level of personal savings may act as a constraint as confidence evaporates. That apart, consumers are facing much higher fixed costs for food, petrol, energy and mortgages. None of this is likely to ease in the short term. Indeed, the situation is likely to worsen substantially. The increased costs of essentials mean consumers have less residual income to spend on discretionary items.

Historically, such a situation would have been eased by tax cuts and lower interest rates, but Citigroup believes there is little room for either. The government’s ballooning deficit means there is virtually no scope for a fiscal stimulus. What’s more, inflation is well above its target level. Some commentators have suggested this could lead to three interest rate rises this year as the government seeks to control inflation. Certainly, interest rate cuts seem to be off the agenda.

After the party, the hangover

The strength of the housing market has been a major factor in boosting consumer spending over the past decade. Rising house prices created a climate in which consumers believed their wealth was rising. That in turn encouraged them to withdraw equity from their homes. However, mortgage approvals are now at their lowest level for two decades, and consumers are finding it much harder to withdraw equity from the housing market.

During the past decade the UK consumer has been feasting off cheap goods from the Far East, and any companies that do their business in dollars, as the value of the greenback against the pound has slumped from $1.40 (in 2001) to $ 2.10. But it would seem that the dollar is no longer falling, while Chinese costs have risen substantially. Export subsidies have been reduced and freight costs have rocketed.

In the clothing market there has been an increased emphasis on price, with discount retailers such as Primark, New Look and Peacocks all doing well. At the same time, some consumers have decided to go slightly up market, buying more expensive clothes less often. This may explain the recent success of Debenhams, which has seen stronger sales than many high-street rivals. The increased popularity of these two extremes has placed additional pressure on the middle ground – explaining why Philip Green has seen this market as being so challenging.

The fact that sales are disappointing will almost certainly mean margins suffer. Retailers will have great difficulty passing on cost inflation from China. Indeed, competitive prices will be a weapon that many resort to in an effort to regain sales and clear stock. The next few months should be good for consumers benefiting from these prices, but it will be bad for shareholders.

The widening net

Against this backcloth, the internet has grown in importance for retailers in recent years and is expected to become even more significant over the next five years. Total clothing and footwear sales on the internet reached £1,696 million last year – a figure that is expected to grow to £5,968 million by 2012.

The growth of the internet has been especially difficult for traditional clothing retailers. Although one attraction of the internet is price, the main clothing retailers have so far not used it to undercut their high-street stores. Their reluctance to do so has probably helped to fuel the growth in Asos, which has been based on offering fashionable clothing at attractive prices.

Groups such as Marks & Spencer are now revamping their websites, but Marks & Spencer’s online sales are a very small fraction of total sales. That could be a competitive disadvantage as the popularity of internet shopping continues to grow. It is significant that a number of medium-sized retailers such as French Connection are now selling their clothes on the Asos site.

Historically, the sector has benefited from takeovers and speculation fuelled by several strategic stakes, often held by the ubiquitous Baugur, which currently holds stakes in Moss Bros, Woolworths, French Connection and Debenhams. Baugur recently decided not to bid for Moss Bros. Although a merger between Debenhams and the House of Fraser, which it owns, would generate significant synergies, Baugur is almost certainly deterred by the huge borrowings of Debenhams.

Venture capitalists are also likely o give the sector a wide berth for some time as banks are reluctant to increase their exposure to retailing. HBOS, for example, withdrew its support for Lord (Phil) Harris’s bid for Carpetright at the last moment.

The outlook facing the sector is therefore gloomy: sales are poor, margins are likely to be eroded, high-street retailers will suffer from increased competition from the internet, takeovers will be much less frequent, even those stocks offering good yields could suffer as dividends will become much less secure.

It seems the gloom of Sir Philip Green and Citigroup is well founded. Investors should – at least for the foreseeable future – be underweight in this troubled sector.

Key indicators

The economics:

• Consumer confidence

• Disposable incomes

• Cost control

• Liquidity

• Housing market

• Growth in internet sales

• Problems of high street

TOP ANALYSTS

Nick Bubb – Pali International

Influential veteran

Nick Bubb has been following the retail scene since 1978, having joined the blue-blooded Rowe & Pitman straight from Oxford.

Bubb serves on the KPMG/SPSL retail think-tank, and is included in Retail Week’s Top 100 list of the most influential people in retailing. He even made the Evening Standard’s ‘1,000 Most Influential People In London’ list last October.

Having witnessed several retailing downturns he is quick to point out that this time there is an ‘unprecedented credit crunch’ with ‘rising food and fuel prices decimating consumer confidence’. He feels the situation will ‘get tougher’ in 2009 and will be ‘tough’ in 2010.

He is currently recommending only two shares – WH Smith (with a 475p price target) and Kesa (with a 225p target price). Smith’s airport shops, which Bubb describes as a ‘its principal licence to print money’, should eventually attract a predator.

Although Kesa is committed to big-ticket items, its French business dwarfs its UK operations (Comet). It therefore benefits from the strength of the euro. Also, the French housing market is ‘more stable’ than the UK’s.

Bubb is recommending clients to sell many other stocks. In the case of DSG International, he describes management as ‘running up the down escalator’. There is ‘huge pressure’ on both the market and also DSG’s market share and he thinks the promised 4.4p dividend is ‘not guaranteed’.

He is also a seller of Marks & Spencer, believing that Stuart Rose did not ‘see the downturn as well as [Next chief executive] Simon Wolfson’.

David Stoddart – Altium

Voice of experience

This retail guru has practical industry experience. He saw Ian McGregor’s cull at British Steel, and was on the financial planning team at BhS, being among those advising the board not to roll out the Harlow model, which perversely involved reducing the commitment to homeware – a BhS staple – to enter the menswear market, where Marks & Spencer was a major player. The result saw cash pour out and BhS lose its way. This has given Stoddart an ‘insight into when management is misleading analysts as well as sometimes itself’.

Stoddart’s top two picks are Asos and Ideal Shopping. He says Asos is possibly the ‘only retailer where sales forecasts for the next two years are too low’. It has no high street exposure and its associated structural problems.

Television shopping company Ideal should benefit as the transition to digital television is completed by 2012. Its websites should ensure its online business also thrives. With a largely fixed cost base, any sales increase should fall straight to the bottom line.

Although the company held abortive takeover talks earlier this year, Stoddart feels it would ‘not be a shock’ if a predator returned.

He is especially cautious about Carpetright in the short term, especially as the company is ‘more housing-related than most companies’. Although its number-one position in floor coverings will not be threatened, the market will be weak short term.

The writer holds shares in Ideal Shopping

Rob Brent – KBC Peel

Down from here

Rob Brent had a baptism of fire joining KBC Peel Hunt as a technology analyst in 2000 after ten years with the Royal Navy. By the time reality set in he had exchanged the vagaries of the technology sector for the retail sector.

Brent is very cautious about the immediate outlook for the whole of the retail sector, but has one trading buy – Game Group – as he believes that the trading update next month should be ‘strong’.

Brent believes that the ‘consumer does not have the resources to keep on spending’. For many, their disposable incomes will fall due to bigger utility bills, higher mortgage payments and increased food prices. He is very bearish about the sector, believing that 2009 will be tougher than this year. Although the sector is ‘cheap’ he believes that it ‘can get cheaper’.

Although he has no outright ‘buy’ recommendations, Brent is ‘more positive than negative’ towards Ted Baker. He says the younger fashion market – which is Ted Baker’s stronghold – will be ‘more resilient’ as people under 30 will be much less affected by the economic downturn, as they are not exposed to the housing market and are less affected by inflation. In addition, Ted Baker’s international ambitions will help to moderate the impact.

Brent is bearish about the major stocks such as Marks & Spencer and Next as well as Debenhams, as he says all of these will be affected by consumers’ need to economise. Debenhams is also heavily geared.

BEST BUYS

N Brown – Big business online

Although a clothing retailer, N Brown has succeeded in ‘bucking the trend’ of poor sales currently blighting the sector. This is due to the company’s dominance of a niche market – providing fashionable clothing for the overweight and obese. With 38% of women and 44% of men overweight or obese in the UK, it is serving a substantial market. Demographics are also on N Brown’s side – its core customer is aged over 45, a group that is due to grow by over 7% over the next five years.

The group was traditionally a catalogue retailer, but its commitment to the internet has become increasingly important. Its internet sales grew by 50% last year and, within three to four years, 50% of the company’s orders will be generated online. This situation has two benefits – there is a cost saving, which is being reinvested in additional marketing, and the average online order is some 25% higher than the average catalogue order .

Unlike Findel, N Brown has not suffered from significant bad debts – perhaps due to more sophisticated credit controls. Management also believes that the fact that its core customers are older is helpful as they are ‘more honourable’ and likely to pay outstanding balances than the younger customers who are Findel’s basic constituency.

The rating is an undemanding prospective PE of 9.4; the yield an attractive 4.9%. The immediate and medium-term prospects are superior to those facing many retailers.

The writer holds shares in this company

John David Group – Looking good pays off

Despite the traumas that have afflicted other quoted sports retailers John David Group has succeeded in producing impressive sales and profits. While others, such as JJB, have had to issue profit warnings, JD has instead enjoyed profit upgrades.

This is partly due to the company’s sales mix. JD has a much smaller commitment to replica shirts and was therefore unaffected by the English football team’s failure to reach the Euro 2008 finals. However, its success runs deeper than this. Analysts have described JD as the ‘best visual’ retailer in the sector. It has certainly eschewed the ‘Pile it high, sell it cheap’ philosophy of Mike Ashley’s Sports Direct.

As a result, the recent trading update was very encouraging. Over the first 17 weeks of this financial year, underlying sales are up by 4.5% despite the gloom that has enveloped so much of the market.

Retail analyst Matthew McEachran of Kauptrhing, Singer & Friedlander has a target price of 600p on the stock.

The writer holds shares in this company

Mothercare – A not-so-little treasure

Mothercare’s position as a niche retailer has enabled it to escape the wider gloom. The shares have outperformed the market during the past year – showing 8% relative strength.

The group has been transformed over the past four years, reflecting the changes introduced by Ben Gordon since he became chief executive. In the UK the brand has been revitalised. Overseas expansion has continued apace. The acquisition of the Early Learning Centre (ELC) last year has provided the scope for substantial synergies.

The international division generated only 21.4% of profits last year, but saw like-for-like growth of 12%, plans to open at least 100 franchised stores this year and expects rapid growth in India, Russia, Turkey and Saudi Arabia in the next two to three years.

Mothercare will also expedite the international expansion of ELC. The acquisition of ELC will generate substantial synergies – worth £6 million this year and at least £10 million next year. Matthew McEachran of Kaupthing Singer & Friedlander believes the value of these synergies could eventually total £20 million. Mothercare plans to have 80 ELC inserts in its stores by Christmas as it seeks to be the destination store for parents of young children.

The group is also rationalising its UK store portfolio as leases expire. The strategy is to reduce its space requirements by 11%. But sales are expected to contract by only 3%. The internet currently generates sales of £100 million. The range is growing rapidly and sales should continue to rise strongly.

McEachran, who has a price target of 525p, is forecasting earnings of 30.2p rising to 34.4p next year, placing the shares on a PE of 12.8, falling to 11.2 next year.

The writer holds shares in this company

STEER CLEAR

Moss Bros – Threadbare figures

Although Moss Bros was once a strong brand, the recent history of the group has been very disappointing. It has suffered from poor trading and disharmony among major shareholders.

Baugur, with its 28.7% stake, has made two attempts to buy the company – both of which have been rebuffed by the Moss and Gee families, whose valuation of the business seems to be guided by nostalgia rather than trading realities.

The company is suffering from a toxic mix. There are now three shareholder groups: Baugur, Laura Ashley – which now has just over 10% of the equity – and the family, whose stake has fallen to around 20%.

Although the company enjoyed modest underlying growth in the early weeks of its current financial year, the latest trading update was disappointing. Paul Deacon at house broker Landsbanki believes that underlying sales are now falling by 3%. He is assuming that the rate of decline will accelerate further to 4% across the year as a whole. He is forecasting a loss of £1 million for this year and believes the group will suffer a further but more modest loss next year.

Meanwhile, there are likely to be management changes. Keith Hamill, the long- suffering chairman, has just left. It is also believed that the chief executive Philip Mountford may seek to leave.

The company’s one saving grace is that it has a strong balance sheet, with £15.5 million of net cash. That should mean the 1.8p dividend is relatively secure – especially as the group has succeeded in squeezing its working capital.

The house broker says it feels ‘somewhat agnostic about the shares’, and admits that ‘further downside would not surprise in the short term’. Although the broker has placed a ‘hold’ recommendation on the stock, this ringing non-endorsement should warn others to sell.

Signet Group – Weak dollar tarnishes the outlook

Although Signet Group is the dominant jeweller in the UK, the bulk of its profits are generated in the US. It has therefore been a major victim of the recent dollar weakness. Despite marginally better than expected Q1 figures, brokers are still cautious about the company’s outlook for this year and 2009/10.

Margins suffered last year from higher gold prices. Although the price increases implemented after Valentine’s day more than offset commodity price inflation and greater promotional expenditure, management – which recognises that expenditure on jewellery is highly discretionary – has set a target for US price increases, which will merely allow for maintained gross margins.

House broker JP Morgan believes that underlying sales will fall by 2.6% in the US and 1% in the UK. This latter figure may be too optimistic.

The company will propose a primary US listing later this year. Brokers believe this will be followed by a cut in the dividend and lead to selling by income funds.

JP Morgan recommends clients to be ‘underweight’, which is a euphemism for ‘sell’. Citigroup has a 50p price target.

Marks & Spencer – Higher costs, lower sales

At the AGM on 9 July Marks & Spencer will issue a probably gloomy Q1 trading update. The two main divisions saw underlying sales fall in Q4 2007/08. Since then consumer confidence has declined further.

Expanding the Simply Food stores has cannibalised sales of other stores, and M&S is an upmarket food retailer when consumers are trading down. Two weekends ago the company slashed prices of all its prepared meals – a bad sign. Also Project Genesis – launched to review and rationalise its food and drink supply – has annoyed many of the suppliers.

A plan for branded foods to be sold between Sainsbury and Waitrose prices begs the question: why pay the extra?

With clothing, discounters are growing rapidly, as is internet shopping, where M&S has minimal exposure. Others are leaving the mid-market to buy fewer, dearer clothes.

Costly modernisation seems to have had little impact on sales, and M&S has sensibly slowed the programme.

Nick Bubb of Pali believes M&S is caught between poor sales and higher costs. He believes the shares could fall to 325p. Similarly, Freddie George of Seymour Pierce is recommending ‘sell’.

The writer holds shares in this company

RISING STAR – ASOS

As seen on a silver screen

Chief executive Nick Robertson, plans further success for the online fashion retailer

Nick Robertson, chief executive of online fashion specialists Asos, has developed the business in eight years from a company employing five people to one employing 500. Turnover has grown from £1 million to £81 million, similar to the total turnover of Miss Selfridge, as the company rode the internet wave. Now he plans to expand the business dramatically over the next few years.

Some 2,300 fashionwear websites serve UK consumers, but Asos has particular attractions: it is easy to use, constantly refreshed – with 500 new items each week – and its wide choice also dwarfs many high-street stores. At the time of writing the site offers 686 full-priced dresses, 164 women’s sunglasses and 682 styles of shoes.

Presentation is excellent and good service means goods ordered before 2.30pm leave the warehouse that day.

Another plus is frequent communication. The monthly women’s magazine goes to 400,000 customers, and 1.8 million registered users receive at least two e-mails a week.

The online clothing and footwear market grew by 38% last year, but the internet still has further to go, currently accounting for only 4.2% of the market – the net has 5.2% of the wider market. Retail think tank Verdict believes the online clothing and footwear market will grow from £1,696 million last year to £5,968 million in 2012. Sales should more than double by 2010. More immediately, online clothing sales grew by 4% last month – the only online sector to enjoy better sales.

Robertson wants Asos to continue to dominate. He will add maternity wear to the site this autumn and launch Asos Red in September, offering a clearance channel for brands such as French Connection. Value retailers have been slow to embrace the internet. Robertson’s move may well forestall them. Already, Asos has hired two former buyers from TK Maxx, a successful brand discounter.

Clearance retailers can feel more like bazaars than attractive stores, but Asos will be able to present clearance lines more stylishly, and with the convenience of internet shopping.

Key strengths

Asos also has an advantage over high-street retailers, with websites that cannibalise their high-street sales.

Others have sought to be the ‘son of Asos’ by developing niche sites. But if they develop a niche market Asos can muscle in and present it better.

David Stoddart of Altium has a target price of 385p, forecasts sales to grow by 58% this year and expects profits to rise to £12.1 million (EPS 11.1p). David Jeary of Investec forecasts profits of £12.3 million, and Nick Coulter of Numis has a 400p target price and forecasts profits of £13.3 million.

Brokers recognise Asos would be a tasty morsel for another retailer wanting to strengthen its existing online presence or launch an online clothing arm. Daniel Stewart regards the company as ‘an extremely attractive acquisition target’. Stoddart believes the company ‘represents [for others] an interesting way to leapfrog competitors and gain both scale and technology in the fastest-growing sector of retailing’. However, any predator would have to pay a hefty premium to persuade the institutions to sell.

So far, the company has failed to pay a dividend, preferring to reinvest in its infrastructure. We do not expect the company to pay a dividend when announcing its results next week but we anticipate a maiden dividend next year.

Few retailers can look forward to sales and profits growth this year. None can expect the dramatic growth that Asos will enjoy. At 300p the shares are selling on a PE of 47.3 falling to 26.7. With the publication of the results next week the emphasis will turn to the medium-term prospects, which could result in further strength in the shares.

The writer owns shares in this company

30 second - ASOS

• asos.com was launched in 2000.

• Chief executive – Nick Robertson started his career in 1987 with the advertising agency Young and Rubicam.

• The site launches 200 new items every week.

• At any time, over 6,500 products are available across womenswear, menswear, footwear, accessories, jewellery and beauty.

• asos.com attracts over 2.6 million shoppers every month and has 1.7 million registered users.

CHARTING THE SECTOR

Few riches in rags

The sector as a whole looks dowdy, but one or two bright colours distinguish themselves from the rest of the tired wardrobe

by Simon Griffin

Despite apparently positive retail sales numbers last week, the market is bearish. As the ultimate expectations discounting mechanism, the market begins sector or share recovery before resurrection news hits front pages. So ongoing decline suggests, from a chart view, little general positivity.

The chart shows the sector, which by late Q1 this year had fallen by nearly 50% over the preceding ten months, seems to have returned to almost free-fall, suggesting the aborted base of the autumn 2000 lows was a pennant (usually seen halfway through a move) and that the sector will fall much further.

Patience is a rewarding virtue

Bottom-timers must see the last of distressed selling by weak holders giving up on recovery before that recovery materialises. Yet we may be in the early stages of an inverse head and shoulders pattern. If so, we are forming the head.

Should this prove to the be the case over the coming months then the sector still needs to recover some 27% from current levels and thereby climb well above the early May high, in order to signal that a new up trend is in place.

Though I suspect we may need to see at least a further 15% decline, there is no real telling, at this point, how deep the potential ‘head’ will drop and there will be plenty left to go for as and when the May high is breached in the future.

Technically therefore, there seems no reason to rush into the fashion retail sector in general at present, it’s likely to get even cheaper over coming weeks. It’s not called the rag trade for nothing.

Brown (N) (BWNG)

BUY - 184p

TARGET - 234p

STOP LOSS - 179p

The online retailer’s shares have fallen by over 47% in the past year and an apparent large head and shoulders pattern seems to target an eventual move way below the 87.5p low of April 2003. Yet other chart features could just suggest a bounce might just be the more likely short-term event.

The shares are clearly nestling on the bear channel’s lower support line at present. The Fibonacci 61.8% retracement line of the up-move from 87.5p in 2003 to 353p in February 2007 also comes in close by at 189p and could be expected to influence, not least because it supported the shares three times in 1997. Lastly, we seem to have a bear flag pattern that developed from the end of last November to the start of June. While this would call for further weakness, the target from this recent formation seems to have been all but reached.

All this leads me to feel selling has been overdone, at least for now, and that a bounce toward congestive resistance near 234p might be the next move, though this would require the neckline of the head and shoulders pattern, currently at 206p, to be broken.

Buying in now is a risky, but a close protective stop can be employed and, should it be broken, then the opportunity to turn tail and trade the bear tack would still be an option.

JJB Sports (JJB)

BUY - 114p

TARGET - 173p

STOP LOSS - 99p

Despite the gloomy feel to the sector, opportunities may yet offer prospects of gains for bulls. Having fallen in value by nearly 70% between last May and mid-January, the sportswear retailer’s shares seem to have plateaued of late, evidently breaking the bear trendline that defined the decline and January’s spike low. This nearly tested another spike low from October 1998, and seems now to limit downside risk.

Also evident on the chart is clear resistance close to 133p, which has twice capped advances since and is also a level through which the 200-day average is presently descending.

As a result, the shares are seemingly consolidating in a range, the conclusion of which will hopefully be an upside breakout that might reasonably be expected to take the shares up toward a test of strong resistance close to 173p, coincident with the 38.2% Fibonacci retracement level of the

preceding move down.