The retail sector accounts for £104 billion of the FTSE 350 index by value of its 22 constituents, making it of significant importance to the UK stock market and to any investor with exposure to UK equities.

The fortunes of retailers can tell us about the state of the consumer and in turn provide clues on economic activity. Therefore, even if you do not have exposure to individual stocks in this sector, it is important to monitor what retailers are saying.

The current outlook is far from rosy, despite pockets of good news such as inflationary pressures easing. Christmas trading updates imply the consumer is still cautious about spending and recent inflation figures coming in higher than expected have kicked the idea of near-term interest rate cuts down the road.

The message from the latest batch of trading updates has been fairly clear – consumers are happy to buy stuff that is essential, an affordable treat or an experience but they are thinking long and hard about anything more expensive or not vital.

That is evident in the latest Barclays consumer spending report which found that retail spending in December struggled to maintain the momentum seen in November, partially because booking holidays and trips to the cinema were more popular places for people’s money than three core retail items: clothing, electronics and home improvement.

Here are four challenges facing the retail sector for the year ahead:

SLOWDOWN IN SALES GROWTH

Marks & Spencer (MKS), B&M (BME), JD Sports (JD.) and Greggs (GRG) were among the retailers to report a slowdown in sales growth in their post-Christmas trading updates. This extends a trend already in place in late 2023 where Zara-owner Inditex (ITX:BME) and Asda were among the retail names to suffer the same fate.

A sales growth slowdown puts pressure on companies to be cleverer with their marketing and to ensure they have the type of products people want to buy. That must offer stuff that is excellent value for money where the customer feels like they are getting something decent for their cash.

They need to get it right from the moment the customer walks through the door and that extends to service, in-store décor and product availability. For those with an online offering, the website or app needs to be easy to navigate and orders dispatched swiftly.

Retailers have put up prices over the past few years as they passed on inflationary pressures to the customer. This strategy may not work in 2024 as inflationary pressures are easing and certain companies do not want to exploit their customer base by asking them for even more money per item. For example, there are reports that Marks & Spencer will not push up its clothes prices this year. Not necessarily good for its profit margins, but good for the customer and keeping the latter satisfied is vital for retailers in the current environment.

INVENTORY MANAGEMENT

Certain retailers held the wrong types of products on their shelves at moments in 2023 after making bad calls on which items to have in stock or the weather failing to follow seasonal patterns.

Historically, fashion retailers have filled their shelves with coats and jumpers in September in anticipation of colder weather spurring shoppers to buy warmer clothes.

Climate change complicates matters and has resulted in mild autumns and wild swings in temperatures and precipitation during the summer, leaving retailers flummoxed.

They will need to adapt to sudden changes in the environment so as to avoid shelves of shorts and summer dresses going unsold when there are weeks of rain, and thick jumpers gathering dust while everyone enjoys mild conditions in September to December, for example.

Getting it wrong with inventory management puts retailers in a difficult position. Unsold stock takes up warehouse space and consumes working capital. Just ask ASOS (ASC) which has struggled with mountains of unsold clothes, forcing it to launch sales to clear inventory and writing off up to £130 million in excess stock. Between its 2018 and 2022 fiscal years, ASOS’s stock levels doubled and so did its discounts, hurting gross margins and profitability.

Retailers have moaned about the widespread promotional environment over the past few months. If a rival is slashing prices, others are under pressure to do the same to stay competitive.

That is why retailers including Next (NXT) have been making a big song and dance if they have had full-price sales success, flagging any strength as a major win as it shows they have a position of power in the sector.

CONSUMER CONFIDENCE

The rise in interest rates has made consumers more wary about how they spend their money. In certain cases, there might not be any spare cash after settling up monthly bills which can lead to a reliance on credit and in a worse-case scenario, debt problems.

Any interest rate cuts this year may only provide minor relief to household finances. We are not going to suddenly see people with masses of extra money in their pocket as the pace of rate cuts could be slow. That means retailers still need to be on alert for tough market conditions and to offer value for money wherever possible.

Fragile consumer confidence suggests a difficult year ahead for big ticket retailers and sellers of goods that are nice to have, but not essential.

The property market is unlikely to bounce back to rude health the second we see a rate cut and so sellers of home improvement products or home furnishings need to be prepared for similar trading conditions to last year.

Any extra money that consumers do get as a result of a rate cut might go towards paying down debt or straight into the holiday kitty, as travelling remains a priority for so many. Consumers would rather cut back on certain areas to ensure a week or two in the sun abroad than fritter money away on the high street.

INTENSE COMPETITION

The business world has followed the same pattern for centuries. If someone has a clever idea and makes a successful business out of it, another person will copy that idea in the hope of getting a slice of the pie.

Retail is chock-a-block with similar propositions, each having a different spin on fundamentally the same idea. Competition is intense and the weak will not survive, particularly when market conditions are tough.

ASOS and Boohoo (BOO:AIM) have suffered in recent years from the rise of Shein as it is difficult to compete against the Chinese seller on price. Currys is one of the last men standing on the high street when it comes to electricals as a wave of internet competitors try to eat the lunch of physical shops. Amazon has enjoyed a strong position in the UK retail space (and elsewhere in the world) but Temu, another Chinese e-commerce firm, now poses serious competition. The list goes on.

Certain brands are trying to reduce reliance on wholesalers and retailers by going direct to the consumer. This includes Adidas (ADS:ETR), Birkenstock (BIRK:NYSE), Dr Martens (DOCS), L’Oréal (OR:EPA) and Nike (NKE:NYSE) which have their own e-commerce sites because they are looking to make a bigger margin on sales and learn more about the customer.

These brand owners are not cutting out wholesalers and retailers completely, merely adding an additional sales channel. Yet to the army of shops up and down the country it leaves a sour taste when certain key suppliers become direct competition.

A well-trodden path to fight back against competitive threats is to reward customer loyalty and provide an incentive to stay with the same retailer. This might be awarding loyalty points which convert into money off goods or access to cheaper prices if you scan your loyalty card. Tesco (TSCO) has used the latter approach as a key tool in its fight against Aldi and Lidl, and now Sainsbury’s (SBRY) and Co-op have copied this strategy with their loyalty schemes unlocking cheaper prices.

Unfortunately for them, the Competition and Markets Authority is casting its eye on matters amid concerns that grocers are restricting the bulk of price promotions to loyalty scheme members.

RETAIL TRADING UPDATES SO FAR IN 2024

B&M: Reported a slowdown in sales growth but remained upbeat. Its French operations and Heron Foods arm were standout performers in the group.

CARD FACTORY: Had a good Christmas with an increase in the number of transactions and average basket value.

CURRYS: Said full-year profit would be ahead of market expectations despite a dip in sales over the 10 weeks to 6 January 2024 . Customers have been happily buying mobile phones, but not so many TVs and computers.

DFS: Reported challenging conditions but has increased market share.

DUNELM: Chugging along while also improving gross margins.

GEAR4MUSIC: Sales fell 6% in last three months of 2023, weighed down by weakness in its overseas operations. Hopeful of improving margins in 2024.

GREGGS: Earnings guidance unchanged despite reporting a slowdown in sales growth.

HALFORDS: The retailer suffered a sharp downturn in trading during December 2023.

JD SPORTS: Slowdown in sales growth blamed on consumer spending nervousness and a highly promotional market hitting margins.

MARKS & SPENCER: Food was the star of the show in its Christmas trading update but sales growth has slowed in food and clothing.

MARKS ELECTRICAL: Issued a profit warning after saying consumers remain price conscious and that gross margins are under pressure.

NEXT: Full-price sales better than expected, leading the retailer to increase full-year profit guidance.

PRIMARK (ASSOCIATED BRITISH FOODS): A strong Christmas helped make up for weakness in the preceding months.

SAINSBURY’S: Strong food sales offset by weakness in general merchandise.

SUPERDRY: Reported a ‘difficult period’ and said its financial performance had weakened.

TESCO: Chief executive Ken Murphy said it was Tesco’s ‘best Christmas yet’ with a focus on value, quality and product innovation. The grocer upgraded full-year profit guidance for its retail operations.

TOPPS TILES: Like-for-like sales down 7.1% in the last 13 weeks of 2023. Blamed ongoing challenges to discretionary consumer spending. Sales to trade customers are proving more resilient than sales to homeowners.

WATCHES OF SWITZERLAND: Issued a profit warning, saying UK market had been tough.

WH SMITH: Issued an upbeat trading statement although no like-for-like sales growth in North America.

THE WORKS: Reported subdued demand over the festive period. Like-for-like sales down 4.9% in the 11 weeks to 14 January 2024.

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