After a challenging 2023, falling valuations and pent-up demand for deals could spark a revival in retail M&A as economic conditions stabilise, believes Erin Brookes

With the industry buffeted by a cost-of-living crisis and recession last year, valuations across the retail sector have plunged and several companies have fallen into distress or administration.

Now, deal activity is picking up again. Boots may be back up for sale, deal speculation is swirling around Space NK and Dr Martens, and there is potential for a mega-listing in London from Chinese fast fashion brand Shein.

Cheaper price tags are also attracting bargain hunters – especially foreign buyers. Mars completed its acquisition of Hotel Chocolat earlier this year and electronics retailer Currys attracted bid interest from Elliott Investment Management and JD.com.

At the same time, improving macroeconomic trends are boosting buyer confidence. These factors could create a sweet spot for deals in 2024, as cash-rich private equity funds and strategic investors look to pick up assets – distressed or not – particularly in sectors forecast to show strong growth.

“The polarisation within retail means some sectors are more primed for deals than others”

Companies that have shown resilience and agility amid market volatility and offer a differentiated proposition will be the most attractive targets.

British retailers grappled with strong headwinds in 2023. The cost-of-living crisis, fueled by the surge in inflation, dented sales, while rising interest rates tipped the economy into a recession. Moreover, supply/demand imbalances were exacerbated by geopolitical tensions.

The higher financing costs and economic uncertainty also resulted in fewer deals across the market. Global M&A activity was at its weakest since 2013, according to the London Stock Exchange Group.

While challenges remain, upbeat corporate updates from retailers such as Next and Primark point to a brightening picture for the industry.

Economic trends are also stabilising with inflation back to its lowest in two-and-a-half years in March. Quarterly retail sales showed improvement, rebounding from a Christmas slump in the first three months of this year. While wet weather likely dampened figures in April, the overall trend is positive.

“There is reason for cautious optimism for retailers who can survive the storm”

Many retailers are trading at low valuations compared to historical averages. Pureplay online and home retail brands have seen valuations decline significantly from pandemic highs as post-Covid trends normalised and consumers tightened their purse strings. The general underperformance of the UK stock market has also weighed on listed retailers.

However, as the unsuccessful bids for Currys showed, a cheap price tag alone will not be enough to drive deals. Buyers continue to be selective, placing a premium on businesses with a differentiated offering in an overcrowded market or a strong channel mix. Companies with a track record of maintaining performance in tough times and quickly adapting to shifting market dynamics will offer the best value.

The polarisation within retail means some sectors are more primed for deals than others. Food and grocery are forecast to show by far the highest value and growth rate, according to GlobalData, and clothing and electrics are also set to grow.

Distressed assets and companies going into administration also provide opportunities, with retail and hospitality businesses seeing high insolvency levels. The challenging conditions in recent years have seen several high street names struggle to stay afloat such as The Body Shop, Ted Baker and Matches.

“Smaller players may combine forces to weather a competitive market”

Despite some silver linings, many companies need to address longstanding balance sheet issues. The shock caused by inflation on operating costs over the past two years, coupled with slower consumer spending, has severely affected liquidity positions.

There is reason for cautious optimism for retailers who can survive the storm. Metrics ranging from retail sales to consumer confidence are better than they were a year ago, with the worst of the impact of high inflation behind us and expectations growing for interest-rate cuts and improving financing conditions later in the year.

This may bring more deals to the table from players who shelved talks or put off strategic reviews, spooked by earlier volatility.

Recent reports suggest Walgreen Boots Alliance is speaking to potential buyers for Boots, after scrapping a planned sale two years ago citing a dramatic change in global financial markets.

There are also opportunities for consolidation. We may see companies with strong balance sheets and a track record of acquisitions – such as Next, Frasers and M&S - picking up struggling names to strengthen their geographical or brand presence. Smaller players may also combine forces to weather a competitive market.

Ensuring balance sheet resilience, optimising operations and adapting to evolving consumer and market trends will be key for retailers to ride out the trough.