The City has fallen out of love with retail, as share prices tumble on the back of disappointing Christmas trading. George MacDonald asks whether it is a trial separation or a case for divorce
The retail sector has been staging a Sale of jaw-dropping proportions, but it has not just been taking place in stores.
While shop windows have trumpeted swingeing new year discounts, the dramatic cuts in general retailers’ share prices have really grabbed attention.
In the past week alone, the valuations of the biggest retail names were subject once again to ferocious discounting as investors mounted their own clearance Sales to shift unwanted stock. You want M&S? Yours for 20 per cent off. Electricals giant DSGi? An extra 6 per cent reduction on top of a markdown of more than 50 per cent over the previous year.
As long feared, the impact of interest rate rises, the credit crunch and battered consumer confidence have holed the retail sector and left store chiefs reeling. “I’ve never seen such a rapid de-rating,” laments the chief executive of one of the sector’s biggest names. “Volatility has increased to such an extent. Even when there’s no change to earnings forecasts, shares are going up and down by billions.”
Investors’ flight from retail was thrown into stark relief last week when industry bellwether Marks & Spencer’s Christmas trading statement was greeted with horror in the City.
There is no doubt that M&S’s statement was disappointing – there had previously been nine consecutive quarters of underlying growth. Shareholders had hoped that the iconic store group would be one of the strongest performers in the key golden quarter. But the market reaction to the upset was of epic proportions.
In response to a 2.2 per cent like-for-like sales decline, more than a fifth of M&S’s value was wiped out. At the end of the week, M&S’s share price was 399p – below the emotive 400p a share offered by Sir Philip Green during his bad-tempered takeover attempt in 2004 – and analysts were questioning key planks of chief executive Sir Stuart Rose’s strategy.
Rose answered by spending more than£1 million of his own cash on M&S shares in the defiant conviction that the City’s reaction was way over the top but, so far, few investors have followed his example. As M&S’s shares slid, so did those of many other general retailers.
The great retail share sell-off has left many store chiefs feeling sore and they question whether present valuations reflect a company’s performance and prospects. N Brown chief executive Alan White, who on Monday beat City expectations when he reported a 14 per cent Christmas sales rise, believes share price falls have been “heavily overdone”. The retailer’s price plummeted 9.4 per cent last week. He says: “A lot of companies have had their share prices carved by the sector and not their own individual performance.”
Ideal Shopping Direct chief executive Andrew Fryatt, who notched up a 27.7 per cent sales rise over Christmas, also thinks the market is not valuing retailers fairly. He says: “We’ve gone up 5 per cent this morning on the back of very good news, but we had gone down a lot before that for no reason.”
Many analysts would agree that some companies’ share prices have suffered unfairly on the back of the wider downgrade. However, they believe that a low sector valuation is justified until there is strong evidence to the contrary.
It is hard to overstate the shock that M&S’s Christmas disappointment prompted. Ahead of the update, many brokers were buyers and were wrong-footed by the setback. So, even though some might have thought that likely bad news was priced into retailers, M&S’s upset made them think again. It will be scant comfort to Rose, but the scale of last week’s share price reversal was not a judgement on him alone.
Panmure Gordon analyst Christian Koefoed-Nielsen says: “It was an overreaction, but symptomatic of sentiment on the sector as a whole. The market is not differentiating between good, bad and indifferent. People are saying: ‘I’m not confident about retail, there are better places for me to put my money’.”
Seymour Pierce retail equities analyst Andy Wade points out that, following M&S’s update, brokers brought back forecasts for 2009, as well as the current financial year. The overall difference in profit expectations in some instances matches the 20 per cent fall in the retailer’s share price.
He says many investors had feared more bad news from the sector than had been priced in, but did not know what the catalyst would be. It turned out to be M&S. “The market in some ways has a herd mentality and thinks: ‘No, we’re not going to make money’. That’s when everyone starts selling,” he says.
But even retailers’ assets – such as property – may not be recognised in valuations at the moment. DIY giant Kingfisher’s property, for instance, was valued at£3.2 billion recently – on its own, it is worth more than the group’s capitalisation.
During tough trading periods, however, property’s value is subject to swings too. Koefoed-Nielsen points out that, when a retailer is doing well, its properties will be valued more highly. But, when times are difficult the properties may lose appeal and value because it is difficult to see how money can be made from them by, for instance, selling them off.
Wade says: “With property, how easy is it to monetise the estate? In the case of Kingfisher, a lot of the property is overseas, which raises other problems.”
Many retailers themselves can muster few arguments against investors’ shunning of the sector. An investor relations head at one big retailer says fatalistically: “That’s the value the market puts on us and that’s what we have to live with.”
Debenhams chief executive Rob Templeman says: “It is like all things – it’s cyclical.” Likewise, the other retail chief executive says: “Ultimately, if you’re a retailer, then you believe in markets of all types.” However, he believes that the credit crunch in particular has had two profound effects.
First, it has hit the outlook for consumer spending, which has dented store performance and valuations. Second, it has removed the share price floor under many retailer’s share prices, by bringing the private equity feeding frenzy, which swelled valuations in a bubble of bid speculation, to a juddering halt.
The chief executive adds that has provided opportunities for short-sellers to move in and gamble on share price falls. “It’s easy to short on any sort of bad news. There’s very little buying support,” he observes.
Short-sellers’ interest in stores has increased markedly in recent weeks. A fortnight ago, a quarter of Debenhams’ stock was on loan to short-sellers, while fashion group Next and bookseller WHSmith have also been targeted.
As well as affecting investors, extreme share price volatility has an impact on day-to-day retail operations. The chief executive says: “The reality is that the share price has a broad effect, particularly on internal morale, because a lot of people have options and shares. And, of course, people read the papers and feel it reflects on the company.”
An end to the slump looks some way off but, ironically, valuations have come back to such an extent that retailers may start to prick more investor interest.
Broker Landsbanki notes that the sector is trading on a price to earnings (PE) ratio “a little below 10 times, which is as low as we can remember”. Although Landsbanki is sticking to its underweight stance in expectation of more profit warnings and continuing fall-out from the credit crunch, it adds: “Having said that, the sector now has genuine value characteristics and we believe a run in sentiment is likely some time in 2008.”
Koefoed-Nielsen, who is neutral on the sector, says: “We got used to an environment where retailers were trading on PEs of 13 or 15 times. It was expensive in retrospect – the peak. Now we’ve got the trough.
“It’s going to take some time for the dust to settle, but we’ll probably see people coming back and taking a look because the ratings are looking good.”
In the perennial play-off between fear and greed that is said to characterise the stock market, fear has the upper hand right now. Things may get worse before they get better – lacklustre trading at big-name retailers over the next few months may have an impact on the industry out of proportion to the real significance – but they are likely to improve.
Wade says: “I guess the question is, when are retailers at the right price? That’s what’s being asked and, if you ask five different people, you’ll get five different answers.”
Until there is greater certainty, retailers seem destined to be categorised as remaindered stock.
Love’s labour’s lost
For much of the past 10 years, retailers enjoyed a golden period and valuations rose as a result.
Easy credit, low interest rates and rising house prices encouraged consumers to open their wallets. The reassurance of low mortgage repayments and the opportunity for mortgage equity withdrawal ensured a flow of cash through stores’ tills.
Retail share prices were also buoyed by speculative interest from private equity funds, culminating in last year’s£11.1 billion sale of Alliance Boots to KKR and Stefano Pessina.
The 2007 credit crunch has hit shoppers and businesses alike, contributing to lower sales growth and profits, and scuppering potential deals, while higher interest rates and falling house prices have also made conditions tougher.
How the share prices fared
Retailer, Capitalisation January 2007, Change in calendar 2007, Capitalisation January 11, 08, Change in week
Marks & Spencer,£11.68 billion, -21.90%,£6.69 billion, -23%
Kingfisher,£5.55 billion, -38.95%,£2.96 billion, -2.6%
Carphone Warehouse,£2.83 billion, +9.71%,£2.88 billion, -7.4%
Next,£4.43 billion, -9.78%,£2.78 billion, -6.6%
Home Retail Group,£3.68 billion, -20%,£2.39 billion, -5.4%
Burberry,£2.78 billion, -11.77%,£2.14 billion, -7.3%
DSGi,£3.64 billion, -48.17%,£1.28 billion, -6.2%
Kesa,£1.88 billion, -31.17%,£1.03 billion, -4.1%
Signet,£2.04 billion, -41.14%,£1.01 billion, -1.2%
Debenhams,£1.58 billion, -57.51%,£582 million, -10.6%