Don't be tempted by cheap retail stocks

By Associate Editor David Stevenson Jan 06, 2009

David Stevenson

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Shoppers on Oxford Street

More retailers will go to the wall...

If you work in retail, you almost certainly won't thank anyone for reminding you about the parlous state of the industry right now.

Unless you sell food – and even that's becoming more difficult - it's a horror story out there. After the toughest Christmas trading season for years, another chain seems to be going bust every week.

Woolworths, MFI, Rosebys, USC, Officers Club, The Pier, Zavvi, Adams Childrenswear, Passion for Perfume… the list of failed retailers is mounting fast.

And for those that are managing to survive, it's been a real struggle. Today, both Next and Debenhams were taking solace in being able to report 'just' a 3% sales decline over the latter part of last year. But both were warning about how tough an environment they're facing in 2009. Even the mighty Marks & Spencer is being forced to slash 1,000 jobs.

Yet when you look at the backdrop to the growth in UK retail sales, none of the sales slide comes as such a surprise.    

Because the boom was based largely on borrowing. By the end of November 2008, UK personal debt had grown to £1,456bn, and has overtaken the amount the country produces every year in GDP – i.e. annual output.

That just had to stop – and to end in tears as well.

Another of the Bank of England's stats that emerged just before New Year was the latest update on HEW – housing equity withdrawal, in other words how much money people have been "withdrawing" from their homes. And like the money supply figures I mentioned yesterday, which showed how fast Britain's companies are running low on cash, the picture is shocking. After more than £300bn was "extracted" over the nine years to the middle of last year, the trend has now been savagely reversed.

The third quarter of 2008 actually saw households putting almost £6bn into the housing market (e.g. through mortgage repayments) rather than take money out. That was the biggest injection since records began in 1970.

And with UK house prices still plummeting – today's Nationwide survey saw the largest decline (-15.9%) since at least 1991 in the overall index, after a 2.5% December drop – that's almost certain to continue. Particularly as consumer confidence is plunging as well – today's Nationwide report also hit a new low.

Why's this so important for retailing?

Because we're just hooked on housing. Consumer spending in Britain has had an 80% gearing to house prices over the last quarter of a century, compared to nearer 50% in the US, 10% in Germany, and 5% in Italy, says Citigroup, who sees house prices falling a further 15%, with a high risk of an "overshoot" which would have traumatic effects on consumer spending.

So with no pick-up in sales on the horizon, the next rent 'quarter day' (when retailers have to find the cash for their three-monthly rental payments) on 25 March is already looking like D-day for the high street.

But just when you reckon it can't get any worse for retail, think again. "A weaker sterling is just what you need in the current situation," said David Owen at Dresdner Kleinwort last month, talking about Britain's exporters taking advantage of the 20% fall in the pound to boost profit margins, and getting a vital cushion to help survive the collapse in lending.

Yet for retail, of course, the effect is the opposite.

Britain's retailers buy many of their products from China and the Far East, paying in dollars, and the pound's slump against the greenback to $1.45 has left companies facing sharply higher bills, says The Telegraph. "The vast majority of retailers will have hedged their currency exposure to protect themselves in 2008 but many of those hedges will come off this year, leaving companies facing sharply higher costs."

"The recent death of full-price UK retailing is a major worry", says Nick Bubb at Pali International. "Most retailers are hedged on their Far East buying at $1.85/$1.90 until around mid-year, but after that there'll be a lot of pain. Retailers will either have to absorb big increases in import costs from their Far East suppliers or try to pass price increases on to unwilling consumers".

In short, it never rains but it pours. Unless sterling manages to stage a major rebound within the next few months, which isn't looking too likely right now, even more retailers will be going to the wall. Don't get tempted by rock bottom stock prices – the bargains are in the shops, not at the London Stock Exchange.

Published in Stock markets | More articles by David Stevenson

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