Archived article

Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.

Value retailers could thrive while DIY and fast food sellers could come under pressure
Thursday 17 Feb 2022 Author: James Crux

Already contending with red hot inflation, consumer-facing businesses are about to be severely buffeted by headwinds from another tick up in energy prices, higher National Insurance tax and rising interest rates putting pressure on family finances.

Consumers may pull in their purse strings with further inflation-driven price hikes expected over the months ahead.

Shares believes the cost-of-living crisis will see cash-strapped consumers either buy fewer items, cut back on non-essential spending or trade down to cheaper products, eschewing popular branded goods in favour of supermarket or retail own-label products.

In this inflationary environment, discounters and other value retailers should fare well, while affluent individuals will be able to take rising bills and taxes in their stride, shielding purveyors of premium products from the cost-of-living squeeze.

However, as spending disperses towards value and luxury, we think the near-term outlook for mid-market retailers looks uncertain.

 

COST OF LIVING CRUNCH

The prospect of rising UK energy bills has already had an impact on consumer confidence, according to analysis by YouGov and Cebr (the Centre for Economics and Business Research). While the overall index saw a modest one-point decline in January 2022 from 110 to 109, scores across every metric except home value measures and business activity for the year ahead fell, and dramatically so in some cases.

Cebr senior economist Sam Miley says: ‘This month’s drop in the YouGov/Cebr Consumer Confidence Index highlights the impact of the rising cost of living on household sentiment. Away from the headline indicator, consumers’ assessment of their finances over the coming year provides for a particularly stark reading – reaching a near nine-year low.’

Rising inflation and the planned uplift to National Insurance contributions are two likely factors behind this weaker outlook, explains Miley. ‘This sentiment is also mirrored in Cebr’s latest forecasts, with real disposable incomes expected to fall year-on-year and the household savings ratio set to narrow significantly.’

While the outlook for consumer income isn’t too bad and savings accumulated through the pandemic may provide a cushion, rising tax and more expensive household bills would suggest we could see plenty of profit warnings in the retail sector as the year progresses, particularly after mid-year once April’s National Insurance rise and higher energy price cap come into force.

Consumers have paid down debt and grown their savings during the pandemic, but as interest rates rise, the logic for consumers to accumulate via savings or pay down debt will only grow.

THE SQUEEZED MIDDLE

Marmite-to-Magnum ice creams maker Unilever (ULVR) warned on 10 February that shoppers face further price increases as it seeks to mitigate surging costs. Two months ago, Dr Martens (DOCS) said the price of its boots would go up by £10 a pair in summer 2022. And in January, fashion seller ASOS (ASC:AIM) said it had increased prices to offset a rise in costs.

Tesco (TSCO) chairman John Allan says ‘the worst is to come’ on food inflation in the UK, which could peak at over 5% by the spring. Allan says for the lowest income households rising prices and energy costs are especially regressive. For such households, food could rise to circa 15% of total expenditure, depleting their ability to spend on non-discretionary purchases.

This crisis will only drive low-income families further into the arms of German discounters Aldi and Lidl, while more upmarket supermarkets will either need to absorb price hikes from the big food and household goods product manufacturers including Procter & Gamble and Nestle or pass them on to consumers.

Names that look vulnerable in the current environment to weaker sales growth include Sainsbury’s (SBRY). While it has cut food prices to become more competitive, Sainsbury’s is still perceived as a supermarket selling premium ranges to the middle classes, though the grocer’s ownership of cut-price toys-to-home products retailer Argos may help lure cash-strapped shoppers through the door.

In the consumer discretionary space, we would also be nervous about the earnings outlook for pizza delivery chain Domino’s Pizza (DOM). Consumers fretting over their finances are more likely to grab a ready meal from the local convenience store than use their phone to order a £20 pizza, no matter how tasty the topping.

Fast food delivery platforms like Deliveroo (ROO) and Just Eat Takeaway (JET) could also see their earnings come under pressure if households avoid takeaways in favour of cooking something cheap and easy at home like spaghetti bolognese.

Over the past two years, people stuck at home for a large amount of time have finally got round to doing those DIY jobs which have been avoided for so long.

With plenty of money now sunk into doing up the home since Covid first struck, families under financial pressure may view further home improvement work as unnecessary spending.

That clouds the earnings outlook for B&Q-to-Screwfix-owner Kingfisher (KGF) after a long period of seeing analysts regularly upgrade their sales and profit forecasts. Indeed, the market already appears to be concerned, with Kingfisher’s shares having fallen 8% year to date.

 

In a similar situation is laptops-to-smart TVs seller Currys (CURY). Significant investment by households and businesses in technology during the pandemic mean homes and offices are already kitted out with new equipment. From a consumer perspective, if money is getting tighter, then holding off from buying a new computer or upgrading a phone is an easy way to keep a lid on spending. Currys’ share price is down 12% year to date.

LUXURY GOODS COMPANIES

Higher National Insurance tax, more expensive energy bills and higher borrowing costs are unlikely to trouble wealthy individuals, which suggests that luxury goods companies may not be hurt by the cost-of-living crisis for the public.

LVMH, the conglomerate behind Louis Vuitton, Givenchy and Tiffany, reported record sales and profits for 2021 amid buoyant demand in the US and China with an acceleration in fourth quarter sales growth.

Trench coats-to-scarves seller Burberry (BRBY) recently upgraded annual profit guidance after seeing an acceleration in higher margin full price sales for the third quarter to 25 December 2021.

On 10 February, Watches of Switzerland (WOSG) upgraded its full year outlook amid continued buoyant demand for high-end timepieces in the UK and US. The Brian Duffy-bossed retailer insisted demand for luxury watches continues to be ‘very strong’ in both the UK, where it highlighted a ‘thriving domestic clientele’, and in the US.

Johnnie Walker scotch maker Diageo (DGE), and Pernod Ricard, the French maker of Martell cognac, Mumm champagne and Absolut vodka, both toasted buoyant sales as global hospitality reopens.

They are benefiting as high-end spirits take a greater share of the global alcoholic drinks market and well-heeled consumers trade up to premium brands.

COMPANIES WITH THE RIGHT QUALITIES

So which retail stocks should investors buy in the current environment? Pets at Home (PETS) and Dunelm (DNLM) are two of Shares’ top picks.

Pets at Home will benefit from non-discretionary spend, namely the fact that consumers will keep spending on their pets no matter the state of the economy. They all need feeding and keeping healthy.

Cynics might argue homewares leader Dunelm is vulnerable because many of its wares are non-essential, but there is always going to be demand for towels, lights, cooking equipment and bedding. The company has also bulked up its value proposition, with more entry-price products and promotional deals, leaving it in a strong position for the straitened times ahead.

Other retailers selling products at low prices include Primark, owned by Associated British Foods (ABF), and Greggs (GRG). The Works (WRKS) has a reputation for selling cheap books, art equipment and toys, and Frasers’ (FRAS) Sports Direct chain is an established name on the high street for people seeking discounted sporting products and athleisure.

Liberum Capital says B&M European Value Retail’s (BME) value offering ‘positions it optimally given the current squeeze on consumers’, adding that the retailer will raise prices, but so may competitors. ‘We expect B&M to remain up to 15% cheaper,’ it comments.

‹ Previous2022-02-17Next ›