While it’s easy to paint all retailers with the same brush, there’s actually a lot of variety across the sector.
Investors should be aware that not all retailers are created equal, and not all retailers react in the same way to changing economic conditions.
In a very general sense, retail can be divided into two categories – food retail and non-food retail.
Food retail encompasses things like supermarkets and convenience stores. If conditions are getting tough, you can usually trade down to cheaper alternatives, but you generally can’t go without for too long. As a result, sales tend to be fairly robust, but any potential growth is unlikely to shoot the lights out.
Non-food retail includes clothing, furniture, electronics, DIY, and much more. This area is typically much more discretionary – if things are getting tough, consumers can generally delay buying until things are better. That leaves non-food retailers more exposed to factors like real wage growth and consumer confidence.
This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future and ratios also shouldn’t be looked at on their own.
Does the economy really matter for retailers?
Given its cyclical nature, the state of the macroenvironment plays its part in how investors feel about the sector and how it performs.
In the run-up to Christmas, annual real wages grew by 2.5% (excluding bonuses). That boosted household spending power, which is a positive for retailers and the broader economy.
Sentiment is also important. If consumers are concerned they might lose their job, they probably won’t buy a new iPhone or laptop. On the other hand, if consumers think they’re in line for a good bonus, they might go and splash out.
Understanding how consumers feel is very important, but ultimately, it’s very tricky. It’s not a science and there’s no crystal ball.
The consumer confidence index (CCI) is by no means a perfect instrument, but it’s about the best measuring stick we have. Historically, it’s shown that as confidence increases, the amount consumers spend rises too.
In December, the CCI rose marginally, suggesting a slight improvement in consumer sentiment. While this uptick was encouraging ahead of the Christmas shopping frenzy, it’s no guarantee it will translate into meaningful increases in spending.
More recent data shows that consumer confidence dropped in January, likely due to a muted outlook for the UK economy. As a result, we remain cautious about seeing a long-lasting increase in spending.
Cash is key, but so is inventory
In the retail industry, businesses typically buy goods and pay for them upfront before selling them to customers.
That means a lot of cash value can get tied up in inventory.
In the meantime, rent, utilities, marketing expenses, and staff costs all need to be paid, causing a real demand for cash.
Carrying too much, or carrying the wrong inventory, can be costly.
Businesses typically start offering discounts on stale inventory to clear it and help bring some cash in the door. But this can hurt margins and profits.
JD Sports is one company that looks to be staring down this barrel.
For now, in a bid to retain its reputation as a more premium store, it’s resisted the temptation to ‘fire sale’ its stock, unlike many of its competitors. That’s propping up margins, but overall profits are still feeling the negative effects of this, and full-year profit guidance has been lowered as a result.
On the flip side, a better-than-expected trading period saw Next issue its fourth profit upgrade in little over five months.
This upgrade comes as Next has managed to increase its full-price sales by 6% over the Christmas period. Thanks to strong inventory management, Next has achieved this growth, while increasing its product range and limiting the amount of stock going into sale.
Get our expert research team’s key share insights from the week, direct to your inbox every Friday.
Concentration matters
For years, JD Sports and Primark (owned by Associated British Foods) have been able to keep opening new stores in the UK to help drive sales higher. However, that can only last for so long. Eventually, your stores become so concentrated in an area that opening another store starts to eat into the sales of your other stores.
Despite JD Sports and Primark's very different price points, both appear to be reaching their saturation point in the UK, and the outlook for growth in this market looks muted in the near term.
JD has known this for a while though, and it’s been proactive in expanding abroad and acquiring new brands across America and Europe. While this has been a drain on cash resources, we commend the courage to expand capacity at a time of market volatility, in an attempt to get ahead of the game.
The near-term picture for JD looks tough, but we’re cautiously optimistic that it will be in a strong position to hopefully benefit when the sports fashion market picks back up. Although of course there are no guarantees.
Primark finds itself in a similar position, facing declining growth in the UK as it loses market share to competitors. As a result, the retailer has been forced to lower its full-year revenue expectations.
Growing its store estate in international markets is paying off for Primark, and more than offset the UK’s declines in the first quarter of its financial year. Expanding overseas is likely to remain the direction of travel, and continued double-digit growth in the US is encouraging.
Food retailers
Some of the food retailers had a cracker this Christmas, with many of the big names reporting strong performances as consumers stuffed their trollies with much more than just turkey.
After sharpening its proposition further, Tesco recorded its highest market share since 2016, solidifying its position as the UK’s largest supermarket. This is down to its ability to appeal to both cost-conscious customers and those shopping the Finest range, and we’re impressed with the group’s execution.
Food volumes at Sainsbury were growing ahead of the market average thanks to things like Nectar prices and Aldi price matches enticing more customers through its doors. But its general merchandise sales aren’t so sweet. Sainsbury’s is more exposed than most to this area due to its ownership of Argos, and it’s likely to remain a slight drag to performance in the near term.
Marks & Spencer delivered strong growth in its food segment, with like-for-like sales rising 8.9% to £2.6bn. Operational changes and efficiencies are delivering cost savings, which are being used to keep food prices down. That’s seen M&S’ volumes grow at the fastest pace across its store-based competition this festive season.
Ocado Retail (a 50/50 joint venture with Marks & Spencer) revenue jumped an impressive 17.5% higher to £0.7bn in the fourth quarter. That was helped by customer numbers and average orders per week both climbing at double-digit rates.
While Ocado Retail’s revenue growth is impressive, we must point out that it’s struggling to convert that into profit. It’s still loss-making and there’s no timeline for reaching the land of profitability, so potential investors should tread with caution.
What should retail investors watch out for?
Retailers tend to have relatively high staff counts. That makes them highly exposed to the changes in the latest UK Autumn Budget, which announced increases to minimum wages and employer National Insurance contributions from April 2025.
The expected impact will add tens or even hundreds of millions of additional costs to many retailers. As a result, expect to hear plenty of cost-cutting announcements and potential staff layoffs in the near term.
Sainsbury’s early out the gates on this front, recently announcing it's going to cut 3,000 jobs and shut all of its cafés in a bid to trim costs.
While we’re confident that most retailers can find ways of softening the overall impact on profits, it’s likely to keep a lid on retail sector sentiment in the near term.
A director of Hargreaves Lansdown plc is a Non-Executive Director of Next plc.
The Non-Executive Chair of Hargreaves Lansdown plc is also a Non-Executive Director of Tesco plc.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Yields are variable and not guaranteed.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.