While UK retailers continue to face a number of significant challenges investors shouldn’t write them off completely, according to Schroders’ Andy Brough and Jean Roche, who argue that the sector has been unfairly treated.
Brough, head of pan-European small- and mid-cap, and fund manager Roche said that despite the threat from disruption and the cloud cast over the UK economy by Brexit, some retailers have demonstrated strong performance.
As the below chart shows, the food and drug retailers have vastly outperformed the broader market with the sub-sector up by 26.01 per cent total return compared with a 4.43 per cent gain for the FTSE All Share index.
Performance of indices over 1yr
Source: FE Analytics
The Schroders managers said the gap between the perception of how retailers are trading and their actual performance “appears to be a classic case of ‘confirmation bias’”.
“Rather than being dire, trading can perhaps be better summarised as ‘tough but not getting any worse’,” they said. “Slowly the message is getting through, driving powerful share price recoveries of the kind seen this year.”
This trend has been ongoing for a while, said the pair, with improving revenue and margin trends seen since last spring. However, profit warnings and administrations have dominated the headlines.
As such, low expectations have set the scene for a further recovery for retailers, particularly against a backdrop of growing confidence among UK consumers.
Brough and Roche said recent surveys indicate that the UK public is more confident about their personal economic circumstances than they are about the country’s economic prospects.
“It appears that Brexit uncertainty has yet to have much of an impact on consumers’ outlook and overall household spending,” the managers explained.
“In fact, spending rose by an estimated £52.5bn in 2018, following similar rises in prior years. While spending on vehicles has fallen for structural reasons, UK households have spent more on clothing, furniture, restaurants and their pets in each of 2017 and 2018.”
Public sentiment has been bolstered by an extremely strong jobs market and unemployment at 3.9 per cent – the lowest level since November 1974 to January 1975, according to the Office for National Statistics.
This in turn has helped boost wages, with median gross weekly earnings up by 3.5 per cent in 2018 the fastest rate since 2008 and outstripping the consumer prices index (CPI) rate of inflation of 1.9 per cent.
Yet, despite the improving economic backdrop and sentiment among consumers, retailers – and general retailers in particular, as seen above – de-rated in excess of the wider market towards the end of last year.
This de-rating occurred without any marked change in underlying earnings expectations, but as a result of greater concern among investors of further bad news to come in 2019, said Brough and Roche.
“This exacerbated a trend for UK domestic companies to underperform overseas earners, which has been in train since 2016,” they added.
Performance of indices over 6mths
Source: FE Analytics
Yet, since falling at the end of last year the sectors have recovered much of their losses so far in 2019, boosted by stronger-than-anticipated trading updates.
“A number of the more challenged retailers reassured that trading had not deteriorated further,” said the pair. “But, with expectations so low, the mood didn't need to lift much for shares to bounce back.”
As such, the Schroders mangers are cautiously optimistic about the outlook for the sector, noting the historically close correlation between real wage growth and retail sales.
“Consumers should also get a boost to their disposable income this year from tax changes announced in last autumn's Budget, in part funded by an improvement in the UK's fiscal position as tax revenues have been strong,” they added.
As well as this, any clarification of the post-Brexit relationship between the EU and UK could also provide a catalyst for overseas investors to come back to the UK equity market, which remains one of the most-shunned among global asset allocators.
“Should the tide turn and capital flow back into the UK, the more domestically focused mid-cap equities, home to many of the UK's quoted general retailers could do relatively well,” said Brough and Roche, highlighting the strong financial fundamentals of such companies.
These include attractive dividend yields which are well-covered by earnings and therefore sustainable. Rents are also falling, which should help many bricks & mortar retailers.
Among the retailers, the managers prefer specialists that have well-developed multi-channel strategies blending in-store and online offerings.
“Some major bricks & mortar retailers have suffered sharp sales slowdowns resulting in multiple profit warnings last year and this,” they said.
“But among businesses that are better adapting to the structural shifts reshaping the high street, the news has been encouraging; many have capitalised on their competitors' weaknesses.”
In addition, the threat from online appears to be deteriorating and has started to be addressed by ‘self-help’ measures aimed at driving e-commerce sales, the managers concluded.
FE Alpha Manager Brough is manager of the £1.1bn Schroder UK Mid 250 fund, which includes retailer Sports Direct International among its top 10 and has overweight positions in the consumer goods and services sectors.
Performance of fund vs benchmark & sector under Brough
Source: FE Analytics
Since Brough took over management of the fund in November 1999, it has made a 444.25 per cent compared with a 426.72 per cent gain for the FTSE 250 (ex investment trusts) index and a 143.08 per cent return for the average IA UK All Companies peer.
Schroder UK Mid 250 has an ongoing charges figure (OCF) of 0.91 per cent.