High Yield – Bifurcation creating opportunities in the retail sector

Thomas Moore explores opportunities for bond investors, with many household names coming under scrutiny.

With many household retail names coming under scrutiny in recent months, are there opportunities to be found by the discerning bond investor?

  • Consumer habits continue to evolve. Ease of cost comparison and demand from the ‘buy now, wear now’ approach are disrupting retailers
  • This does not mean we need to say goodbye to household names, some can thrive
  • We have not written off the retail sector and are actively seeking opportunities

Recent months have seen non-food retailers in the news for all the wrong reasons, particularly in the UK. Whether seeking lower rents and closing stores (New Look and House of Fraser), or even entering liquidation (Maplin and Toys R Us), traditional retailers are under considerable pressure. But the news is not all bad. Some retailers are thriving – particularly at the top and discount ends of the market – and the past year has seen a number of successful operational turnarounds and refinancings.

Underperformance of non-food retailers

Retailers face a number of specific challenges at the moment, most notably changing consumer habits. Established retailers have struggled to adapt to the structural challenges that online competitors have created. This is particularly the case with branded goods, technology, and toys, all areas where direct price comparisons are easy.

In fashion, consumers are more short-term oriented than has historically been the case. Instead of buying in predictable seasonal patterns several months ahead, shoppers are increasingly adopting a “buy now, wear now” approach. This change represents a challenge for supply chain managers and puts upward pressure on costs, but also offers the opportunity to maintain leaner inventories and in theory reduces the impact of fashion missteps.

Other retailers find themselves the victims of competition from discount competitors. Most of you will be familiar with Zara’s quick-to-market, low-cost business model, but this group also includes the likes of Poundland, who are expanding beyond their traditional areas of focus into grocery and clothing.

Finally, department store operators are finding it hard to stay relevant. Their challenges differ somewhat by geography – for instance, the US has proportionately much more square footage devoted to the category than the UK and Continental Europe – but every player is working hard to stay relevant. In the UK, John Lewis has probably had the most success, while Debenhams and House of Fraser have struggled.

In the UK, these challenges have been exacerbated by the weakness in sterling, which has driven up the price of imported goods, while at the same time rising business rates and increases in the National Living Wage have pushed domestic costs higher.

The opportunity

Yields in the sector have risen, both in absolute terms and relative to the broader market. Some companies are effectively managing through the challenges that they face, and in my view are trading unreasonably cheap because of investors’ discomfort with the sector overall. It is my belief that, while we will see more insolvencies in the sector over the next couple of years, those retailers that navigate this difficult period will end up better placed to grow earnings and cash flow in the new consumer landscape.

Investment Risks

The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.

Issued by Invesco Perpetual

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All data is as at March 2018 and sourced from Invesco Perpetual unless otherwise stated.

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