Comment: Why now is the best time to close your loss-making stores

News that Mamas and Papas may need go through some form of restructuring, primarily due to having too many stores, comes as no surprise.

It follows hard on the heels of Kiddicare (owned by Morrisons) being put up for sale, which might lead to it retrenching back to its internet roots by discarding the Best Buy sites it took on to expand into bricks and mortar.

Some will know the saying, “you only know who has been swimming naked when the tide goes out”.

This sentiment was expected to apply in the event of rising interest rates; the outcome being that consumer spending would dry up.

I take a different view, irrespective of interest rates remaining low. I believe the tide has gone out but for other reasons.

Changing use of physical space

It is common knowledge that internet sales, whether in the form of home delivery or click-and-collect, have significantly changed retailers’ requirements for physical space.

There has been a certain amount of denial by retailers about the number of sites that should be closed. Over the past seven years I’ve heard a number of excuses.

“Since consumer spending is so weak, we cannot identify which sites are profitable and which ones are not.”

Or, “the Government will be changing their view on business rates imminently – ie, reducing them – which will change the landscape.”

“Instinctively, retailers should by now be aware of which loss-making stores need to be closed”

Barry Knight, Legacy Portfolio

As far as I can see, consumer spending is no longer weak and while the Government has alluded to the possibility of changing the rates system (cutting or capping them), the implementation of any such changes is a long way off.

Instinctively, retailers should by now be aware of which loss-making stores need to be closed. 

While there are many benefits to closing stores at a heady pace, this can be a challenge. For any retailer getting out of leases it is not cheap and it takes up significant management time.

As a result, divesting surplus stores to a specialist firm where the exit cost can be fixed is becoming more common.

Cost of closing stores

Now we are in a period of growth and what some call a ‘borrower’s market’. Banks are willing to lend money to see profit improvement.

For those who made it through to 2014 there is survivors’ optimism. They are perceived as backable even though their business model needs fine-tuning, as some stores may be dragging down the rest of the portfolio.

As interest rates are still very low, there is an arbitrage between return on the cost of closing down stores against the interest cost on the borrowing to do so, and that can lead to a marked increase in the value of the business.

“The market is set to become increasingly complex”

Barry Knight, Legacy Portfolio

An example, from a ‘live’ situation: retailer x has 200 sites of which 50 are loss making (£10m pa).

The cost to exit the stores is £30m, ie there is a 33% return on capital.

The retailer takes out a fixed cost borrowing at 4%. The saving on loss-making stores repays both principal and interest in just over three years. (£10m x 3.24 = £30m debt plus Interest of £240k.

In effect, the retailer has a certain net pre-tax return of 33%, ie 29%.

The surviving retailers who have been able to ride the online shopping wave and build a successful omnichannel offering should act quickly and dispose of their dark and loss-making stores.

The market is set to become increasingly complex. The Local Data Company recently reported 44 independent retailers opening for every 16 chain stores closing.

In addition, with increasing in-store technology and the development of areas such as click-and-collect, the sooner said stores are exited the better.

Barry Knight, director of retail, Legacy Portfolio