UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond

 
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UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond
UK Retail sector:
trading in 2018
Rising to the challenge in
the year ahead and beyond
UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond
Retail: is 2018 the
beginning or the end?
With turbulence and disruption
in the sector, what risks and
opportunities lie ahead and
what are the priorities for future
success? An EY panel with a
wealth of retail experience held
a webcast in January 2018
to discuss their views and ask
participants for their insights.
UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond
1

Contents

2    2018 peak season trading overview

3    The retail transactional and IPO market

4    Stress in 2018: the margin vice continues to tighten

5    Mapping out the future of retail

7    Summary
UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond
2                                                                       UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond

    The 2018 peak season
    Non-food sales through stores
    continue to suffer
    Since the peak season trading results started                                         event, as digital sales increased to 27% of the total in
                                                                                          November, and discounting intensified in the run-up to
    to come out in early January, the UK retail
                                                                                          Christmas. While overall like-for-like sales edged up by
    sector has had blanket coverage in the                                                0.6% in December,5 this rise was driven almost entirely by
    press — much of it negative. However, beneath                                         online and food spend.
    the unpleasant headlines there has been a fair                                   This overall picture masks wide variations in performance.
    amount of good news, with pockets of strong                                      Interestingly, compared to 2017, 17 fewer retailers
    performance emerging in many areas of the                                        announced their peak season trading by mid to late January
    industry. That said, an analysis of the figures                                  2018.6 Most of those that have reported have seen growth in
                                                                                     sales, while some more established names have struggled.
    reveals that non-food sales through stores are
                                                                                     Meanwhile, at a subsector level, strong brand owners and
    in sharp decline — a particularly worrying trend                                 accomplished online players came out as winners in the
    for all retailers with a heavy reliance on sales                                 apparel space, while almost all the major food retailers saw
    through their physical channels.                                                 sales growth — albeit in most cases largely driven by inflation.
                                                                                     Despite a strong sales performance across the sector, only
    Headline economic statistics underline the key themes that                       the two large discounters gained share in the grocery sector.
    impacted peak season trading in 2017. These include:
                                                                                     Looking across the peak season figures, the statistics that
    ►► A 0.4% 1 fall in real earnings in the three months to                         spell out the industry’s underlying divergence most clearly
       October 2017.                                                                 are that online sales increased by 7.6%,7 while non-food sales
                                                                                     through physical stores dropped by 4.4%.8 Of course, many
    ►► Food inflation running at 3.7% in the three months to
                                                                                     online sales are collected from stores — and shops are used
       December.2
                                                                                     for browsing and discovering products that are then bought
    ►► Consumer Confidence Index (CCI) at -13 in December,3 its                      online. But what the peak season figures make clear is that
       lowest since 2013.                                                            the operational challenges of the decline in-store sales, with
    ►► A 3.5% decline in December footfall,4 the steepest fall in                    largely fixed costs, are becoming more and more intense.
       five years. Black Friday became even more of an online

    UK like for like (LFL) retail sales growth, including online non-food growth

                                                                           Food sales: +2.6%
               20                                                          Non-food in-store sales: -4.4%                    12 month mov. avg.
                                                                           3 months to Dec. 2017 LFL                         (online non-food growth %)
               15
                                                                                                       Online:               Online (non-food) growth (%)
               10
                                                                                                       +7.6%                 12 month moving average (growth %)
    % growth

               5
                                                                                                                             Growth (%)
                                                                                                          Total:
               0
                                                                                                          +0.6%
               -5    Q2     Q3     Q4     Q1     Q2     Q3      Q4      Q1         Q2      Q3       Q4
                    2015   2015   2015   2016   2016   2016    2016    2017       2017    2017     2017

    Source: British Retail Consortium (BRC)

    1
         ‘Analysis of real earnings: December 2017’, ONS,                           5
                                                                                         ‘Some glitter but no gold for Christmas’, BRC,
         (accessed via www.ons.gov.uk, 19 December 2017)                                 (accessed via www.brc.org.uk/retail-sales-monitor/reports,
    2
        ‘Bumper Christmas as UK shoppers spend £1 billion more than last                 12 January 2018)
         year’, Kantar Worldpanel,                                                  6
                                                                                         Result of EY analysis
         (accessed via www.uk.kantar.com, 10 January 2018)                          7
                                                                                         ‘Some glitter but no gold for Christmas’, BRC,
    3
        ‘UK Consumer Confidence drops one point in December to 13’, Gfk,                 (accessed via www.brc.org.uk/retail-sales-monitor/reports,
         (accessed via www.gfk.com, 24 December 2017)                                    12 January 2018)
    4
        ‘December trading report’, Springboard, (accessed via www.spring-board.     8
                                                                                         ‘UK retail spending dipped in December’, Independent, (accessed via
         info/updates/articles/BRCfvmnews-december2017, 17 Jan 2018)                     www.independent.co.uk, 9 January 2018)
UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond
UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond                                                                    3

The retail transactional
and IPO market
Still quiet
When asked to assess investor and lender                                               two retail IPOs.9 In fact, similarly low levels of retail IPOs
                                                                                       have been a consistent trend since the peak of 13 achieved in
confidence in the retail sector for the
                                                                                       2014. A look at the relative performance of quoted retailers
year ahead, webcast participants gave a                                                against the overall FTSE 350 index from 2015 through to
decidedly downbeat response — with less                                                January 2018 shows that retail stocks have generally under
than 2% rating the mood as ‘positive’, and                                             performed, with general retailers’ shares in particular well off
                                                                                       the pace. Food retailers have been more stable, and actually
over 80% opting for ‘cautious’. Compared
                                                                                       outperformed the FTSE 350 over the last quarter — although
with last year’s vote, the bright spot is that                                         this trend has been distorted by two particular stocks with
the proportion characterising investors’                                               specific events driving an increase.
mood as ‘reluctant’ declined from 27%                                                  Turning to the transaction environment, the number of
to 17.5% — suggesting that the prospects                                               retail deals has been at a relatively consistent level since
for investments into the industry may                                                  the trough of 2013. However, retail acquisitions by UK
                                                                                       private equity have generally remained at subdued levels,
be improving slightly, as 2017’s cost
                                                                                       reflecting the lack of confidence in retail as a whole, the
pressures ease off.                                                                    perceived lack of debt capacity in retail, and a reduced
                                                                                       willingness to lend to the bricks-and-mortar retail segment
However, it is clear that funding remains wary of the                                  in particular. However, one measure that appears possible to
industry — a situation reflected in the sector’s IPO activity.                         increase in 2018 is the number of distressed situations: these
While 2017 saw notable growth in UK IPO volumes generally,                             are already starting to drive deals, and are likely to do so
with 77 IPOs generating £13 billion, this total included only                          increasingly in the coming months.

Jan. 2015–Jan. 2018 retail share performance vs. FTSE 350

                      130

                      120

                      110                                                                                                 FTSE 350
    Index (rebased)

                      100                                                                                                 Food and drug retailers

                                                                                                                          General retailers
                      90

                      80

                      70

                      60
                             Q1   Q2   Q3     Q4     Q1     Q2     Q3     Q4     Q1     Q2     Q3     Q4       Q1
                            2015 2015 2015   2015   2016   2016   2016   2016   2017   2017   2017   2017     2018
                                                                                                            (estimate)

Source: Capital IQ

9
    Result of EY analysis, Mergermarket, (accessed via www.mergermarket.com, January 2018)
UK Retail sector: trading in 2018 - Rising to the challenge in the year ahead and beyond
4                                                                          UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond

    Stress in 2018
    The margin vice continues to tighten
    The challenges faced by the retail industry                                      A good indicator of the resulting stress was the level of profit
                                                                                     warnings. Some 33% of general retailers issued at least one
    in 2017 were not new. Existing operational
                                                                                     profit warning in 2017, up from 26% in 2016.10 This was
    and structural issues behind the well-                                           in stark contrast to food and drug retailers, only 10% of
    known ‘margin vice’ — such as the shift                                          whom warned, down from 25% the previous year.10 Most
    to omni‑channel, increasing overheads,                                           of the general retailer warnings came from the home and
                                                                                     big ticket spend subsector, 45% of which warned in 2017.10
    discounting and overcapacity — were
                                                                                     A large number of these companies referenced consumer
    exacerbated by intensifying external tensions                                    spending, confidence and footfall as problems, indicating
    such as the rising pressure on consumer                                          pressures on the top line. These factors — plus many of those
    spending, falling consumer confidence, and                                       mentioned earlier, such as the pressure on non-food sales
                                                                                     in-store — appear to be reflected in the webcast attendees’
    weaker sterling. As a result, 2017 saw the
                                                                                     view of the subsectors facing the greatest pressure in 2018,
    industry’s existing issues intensify and have a                                  with department stores and home and furniture retailers
    cumulative effect.                                                               topping the list.
                                                                                     Against this background, four key trends are emerging
    Existing operational and structural challenges will                              in retail:
    continue to be exacerbated by external tensions
                                                                                     ►► There is a declining appetite for the sector among some
         Top line pressure                      Margin pressure                         key stakeholders, for example, credit insurers reducing or
         Reduced consumer                       Promotions and discount                 withdrawing cover.
         spending (disposal                     landscape, weak sterling             ►► Many businesses have exhausted ‘no-regret’ self-help
         income and confidence)                                                         measures like reviewing store portfolios, optimising
                                                                                        labour scheduling and seeking supply chain efficiencies.
                                                                                     ►► Retailers are considering more fundamental measures
                                 Margin vice
                                                                                        such as restructuring, disposals, retrenching back to core
                                                                                        areas and even Credit Valuation Adjustments (CVA).
         Cost base pressure                     Structural change                    ►► Businesses are looking for external support from lenders
         Increasing operating                   Continuing shift                        or their shareholders, ranging from cash injections
         costs e.g., National                   to online and                           through to renegotiating banking governance.
         Living Wage,                           omni‑channel model
         Apprenticeship Levy                                                         It is not all doom and gloom: many retailers, particularly
                                                                                     those with strong brands and operational fitness, are
                                                                                     performing well, and certain subsectors will be more resilient
                                                                                     than others. But the reality is that the current trading
         Pressure on cash                             Banking facilities
                                                                                     environment for retailers is tough, and that the cumulative
         Also brings                                  Need to manage
                                                                                     weight of these pressures does expose operational and
         working capital            Funding           facilities in
                                                                                     financial weaknesses.
         and capital                pressure          an uncertain
         expenditure                                  environment
         challenges

    10
         Warning signs, Analysis of profit warnings: Issued by UK quoted
         companies, Q4 2017, EYGM Limited, 2018.
UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond                                                            5

2018 and beyond
The changing fabric of retail
Given the extreme and ongoing structural                                         The future of retail can be considered through three lenses:
pressures on the retail sector’s operational                                               The macroeconomic backdrop — and here it is vital
and financial state, it is clear that the handle                                    1      to remember how critical consumer spending is
                                                                                           to the overall UK economy. The good news is that
of the margin vice will continue to turn.
                                                                                           the squeeze on the consumer seen in 2017 should
Faced with such a situation, it is all too easy                                            ease during 2018 as inflation falls back and real
for retail businesses to look inwards and                                                  wages start to rise again. However, the upside to
think about how to react internally to those                                               consumer spending is likely to be limited by slower
                                                                                           employment growth and the uncertainty that
pressures, rather than directing at least
                                                                                           Brexit has caused around business investment.
some of their attention outwards to the                                                    So the wallet for UK retail is stable at best —
market, to consumers and the competition.                                                  and given the rising competitive intensity and
To survive and thrive, this is what they will                                              proliferating alternative uses for that wallet,
                                                                                           ‘stability’ for traditional retail appears unlikely.
need to do.
6                                                                         UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond

    2018 and beyond
    The changing fabric of retail
                   The changing fabric of retail itself, as the                                  What will the UK retail landscape look like in
         2         disruptors redefine consumer expectations by
                   bringing them control, transparency and speed.
                                                                                       3         10 years’ time? In our view, consumers will
                                                                                                 become more asset-light, and will shift towards
                   Consumers are looking for the right experience:                               choosing a smaller number of products — because
                   in a recent EY survey of more than 2,500 UK                                   the rest will be done for them by algorithms. So,
                   consumers, 86% of consumers noted shopping                                    the fight for that small choice will be even more
                   experience as the top influencer on their buying                              intense, and consumer businesses will need to
                   behaviour.11 Given that footfall and online traffic                           focus less on product and even more on lifestyle.
                   are the new currency, the question is whether                                 Similarly, the trust equation will become ever
                   retailers can provide an experience that competes                             more important. Obviously, this future will bring
                   with the leisure experience and is also consistent                            challenges. But for those players with good brands
                   across the ‘micro-moments’ that make up the                                   and good strategic assets, there are exciting times
                   customer journey. This requires personalisation,                              ahead — and they absolutely can play to win.
                   which demands data. Retailers must be able to
                   use data to target customers across channels
                   and segment them by behaviour, while also — as
                   General Data Protection Regulation (GDPR) looms
                   — maintaining security around their customer
                   data. This brings us to trust, which is increasingly
                   imperative, with 74% of consumers telling us they
                   would boycott a brand that they didn’t trust,11 and
                   78% saying their purchasing decisions are strongly
                   influenced by how a brand treats its employees.11

                                            86%                          82%                          78%

                                                                                                        Good
                                            Customer                    Brand’s clear
                                                                                                     treatment
                                           experience                     purpose
                                                                                                       of staff

                                                               Impact on shopping habits

    11
         If brand + trust = value, how are you solving the equation?,
         EYGM Limited, 2017
UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond   7

Summary
The time for half‑measures is over
The picture emerging from our retail trading 2018 webcast
is of a fast-changing retail environment in which non‑food
bricks-and-mortar retailers are especially exposed,
and those with strong brands and differentiated online
capabilities and customer experience have the edge.
At the same time, the industry challenges seen over
Christmas 2017 continue to be reflected in limited
acquisition lending and lukewarm private equity interest,
and the likelihood of more M&A driven by distress situations.
Yet, some very interesting and positive things are happening
in terms of innovation — particularly around consumer
experiences and trust.
A new retail paradigm demands new thinking — and for
those able to develop and apply it — 2018 is the beginning,
not the end.
UK
8 Retail sector: Trading in 2018 Rising to the challenge in the year ahead and
                                                                           UK beyond
                                                                               Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond
                                                                                                                                                                 8
UK Retail sector: Trading in 2018 Rising to the challenge in the year ahead and beyond                                                        9

                                                  Contacts
                                                                                  Julie Carlyle
                                                                                  Partner, Head of Retail
                                                                                  UK & Ireland
                                                                                  Ernst & Young LLP
                                                                                  T: + 44 20 7951 3034
                                                                                  E: jcarlyle@uk.ey.com

                                                                                  David Larsson
                                                                                  Partner, EY-Parthenon
                                                                                  UK & Ireland
                                                                                  Ernst & Young LLP
                                                                                  T: + 44 20 7951 8239
                                                                                  E: dlarsson@uk.ey.com

                                                                                  Jessica Clayton
                                                                                  Partner, Head of Retail for Transaction Advisory Services
                                                                                  UK & Ireland
                                                                                  Ernst & Young LLP
                                                                                  T: + 44 20 7951 3034
                                                                                  E: jclayton@uk.ey.com

                                                                                  Christian Mole
                                                                                  Associate Partner, Transaction Diligence
                                                                                  UK & Ireland
                                                                                  Ernst & Young LLP
                                                                                  T: + 44 20 7951 3034
                                                                                  E: cmole@uk.ey.com

                                                                                  Martin Carr
                                                                                  Strategic Retail Advisor
                                                                                  UK & Ireland
                                                                                  Ernst & Young LLP
                                                                                  T: + 44 20 7760 9219
                                                                                  E: mcarr3@uk.ey.com
EY | Assurance | Tax | Transactions | Advisory

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