The return of retail fever has been one of the building blocks of the U.K. economic recovery, with the country currently experiencing the longest period of growth in retail sales since 2007. The rosy statistics for overall sales, however, have contrasted sharply with regular news stories about High Street carnage among individual retailers, including some erstwhile investor darlings.
High-profile retailers that have gone bust this year include La Senza, the lingerie chain, and Athena, the poster and art chain. However, the biggest shocks have been generated by the vicissitudes of supermarket chain Tesco, which has lost its status as a role model of corporate success, though it remains Britain’s biggest retailer. In August it slashed its dividend after its second profit warning in two months, amid falling market share in its core area of food sales. Then it announced it had overstated first-half profits by £250 million ($408 million).
“A lot of the traditional companies within the retail sector — the ones that had the biggest market share, based on a large number of brick-and-mortar stores — haven’t been great investments for quite a long time,” says Colin Morton, a Leeds-based U.K. equity portfolio manager at $921 billion U.S. asset manager Franklin Templeton Investments. “Generally, over the past four or five years, this has been a really bad place to be for investors.” He blames the growth of Internet shopping, which has made customers more price-sensitive because of their newfound ability to compare prices. It has also increased competition by reducing retailers’ barriers to entry.
Responding to this tough environment, investors espouse a variety of solutions.
One counterintuitive approach is to dive into the toughest, hardest-hit sectors, on the principle that what doesn’t kill you only makes you stronger. “I like survivor bias — investing in the last man standing because others have fallen by the wayside,” says Martin Cholwill, a fund manager specializing in the U.K. at £75 billion Royal London Asset Management in London.
Cholwill has a holding in Dunelm Group, a 133-store chain in the U.K. homeware market, in which competition has been reduced by the failures of a long line of smaller competitors. “One of the attractions is the fact that not everyone has necessarily heard of Dunelm,” says Cholwill. The company’s regional profile has kept it relatively unknown: The company’s stronghold is in the East Midlands and northwest England, with no stores yet in London and the southeast, where City of London analysts work and live.
Another option is to avoid what Cholwill describes as “the squeezed middle” of retailing — with Tesco, a midmarket retailer, the ultimate example. “I’ve not invested in Tesco for a number of years now,” he says. “It faces a really big challenge: The discounters are gaining share, and the upmarket retailers are also gaining share.” They’re taking share from those in the middle, like Tesco.
In U.K. food retailing, it can be difficult for equity investors trying to avoid the middle to access market segments above and below, since the major chains there are not listed. However, this strategy can be followed in other retail sectors. Franklin Templeton’s Morton has put money into Associated British Foods, which owns Primark, a discount fashion retailer that has rapidly expanded in recent years. “We have a throwaway culture now, with everyone wanting the most up-to-date fashion,” he says. “Primark has played the value-for-money game very well, producing fashionable product at very attractive prices.”
Another strategy is to move away from trying to make a return from pure U.K. retail by investing in British companies diversifying into high-growth overseas markets. Germany’s €345 billion ($440 billion) Allianz Global Investors has a position in Mothercare, which sells baby goods. “Mothercare has had troubles in Britain recently,” says Simon Gergel, chief investment officer for U.K. equities at Allianz Global in London. “But it has good franchise operations abroad, particularly in the Middle East.”
Morton of Franklin Templeton likes Next, the clothing retailer, in part because of its foreign expansion, though he also praises its successful customer-friendly U.K. business, much of which is Internet-based. Next has built on the success of its home operation, and “the other interesting thing is what could happen overseas,” Morton says. “It is in about 30 countries, but it’s doing it in a very low risk way, moving into countries with links to the U.K., where some people have lived in Britain and already know the brand.” Morton notes that Next’s overseas operations are also only online, a low-cost way of going international.
Morton likes this cautious approach, noting, “Most U.K. retailers have been a bit of a failure when they tried to go overseas.” He warns that if they stumble abroad after opening lots of brick-and-mortar stores, the price of failure can be very high.
The history of U.K. retailing is littered with vainglorious attempts by companies to expand overseas, with Tesco’s 2013 disposal of its 199 Fresh & Easy stores in the U.S., at a cost of £1.2 billion, one of the most spectacular examples.
