Sector Foresight - The UK Retail Sector
Retail therapy required
KPMG’s analysis of UK retail paints a bleak picture for the immediate term and foreseeable future. Within the sector, some segments have held their own, but the trend for most is declining volumes and values, coupled with rising costs on products and operations. The pattern of like-for-like sales is downward, creating an unsustainable situation for many retailers facing reduced profits, lack of cash availability and difficulties meeting financial obligations.
Today's tough economic conditions are bringing the UK retail sector's underlying problems to the surface. Many retailers which expanded rapidly when times were good are now suffering in the absence of a cogent business plan and often lack management teams experienced enough to downscale growth and weather the storm.
What's more, with inflation rising and therefore discretionary spend shrinking, it is anticipated demand in many sectors will remain flat for 2012. Particularly at risk are retailers selling household electrical items and white goods, furniture and DIY goods, plus automotive retail will take another hit without the cash back scheme as consumers delay making a trade-in. At best, the period from 2013 to 2014 will be one of slow growth and some retailers may not have the resources to endure.
The UK market
The UK retail market was, in part, buoyed by relatively low inflation and interest rates at the start of the recessionary period in 2008. As a result disposable income in real terms actually rose. That position has now reversed with a rise in inflation to over 4% and a slowdown in wage growth to 2-3%, which means real incomes are forecast to fall by between 1.5 and 2% over the next 12 months. This position coupled with under confidence in the global economic position and the threat of a second recession in the UK looming, means many retailers will need to take drastic action very soon to safeguard their business position and preserve the interests of stakeholders.
There have been over 40 profit warnings from major retailers in the year to date, CVAs in the sector have risen by 30% over the past 12 months, and the volume of administrations has risen by 55% over the same period.
The volume of insolvencies in the sector is expected to continue rising. At the heart of most difficulties is the shortage of cash or refinancing options available to retailers who have not planned for the worst. With constraints on lending to businesses, tighter banking covenants and restrictions on consumer credit and spending power, there is not enough cash to lubricate the market and keep businesses ticking over. Those businesses that have insufficient funds to invest in stock, refurbish stores or even keep pace with rent, will lose out to competitors and continue to struggle.
Another challenge to the traditional UK retail model is the continuing switch to a multi-channel approach and the adoption of online purchasing. An anticipated rise in annual online sales from £25bn in 2011 to £35bn by 2014 does not represent growth in UK retail, but a cannibalisation of high street income. Those retailers who do not have an effective online offering married to their high street presence may lose sales.
There are proven steps which management should take during this stressed environment.
- The first is to have a clear strategy specifically geared to the current economy. Such plans do not need to overpromise growth or expansion, but instead give lenders and other stakeholders the confidence that management know what they are doing and have anticipated and dealt with the key risks faced by the business.
- In these times, it is vital to have seasoned retailers at the helm – those who know how to get the business to perform and how to minimise the risks associated with below-par trading performance.
- Understanding the key drivers for the particular sector and getting the basics right, such as channels to market, promotions, pricing, store layout and product type or quality, is essential.
- Test the business model to ensure it is appropriate to future circumstances – good or bad.
In an environment where high street presence alone is no longer viable, the multi-channel offering is currently providing retailers with a glimmer of hope. Take an example of carpet retailing – a comprehensive online presence enables shoppers to browse and request quotes online before visiting a store to complete the purchase. Combining the channels allows the retailer to reduce store portfolio, while showing product to a wider audience at their convenience.
Cash flow, as always, remains critical. According to KPMG restructuring partner, Chris Laverty: “Having the ability to monitor and anticipate key inflows, outflows and peak demands for funding on a daily, weekly, monthly and quarterly basis is now a basic requirement. Those businesses that can use cash flow information to quickly adjust their business activity will fare well or survive when a sudden change in circumstances demands cash headroom but, of course, many have core costs that take some time to reduce or eliminate. This also needs to be adequately reflected”
To govern well demands high levels of visibility on performance and accurate management information. Accurate, open and timely communication to stakeholders is crucial in times of crisis.
If performance continues to falter, the remedies to address potential failure and avoid administration or insolvency are harder to implement in this climate, but still achievable with the right approach. Understanding what those options are means having a plan B if plan A is not working.
Survival guide: the retailer watch-list.
1. Stakeholder engagement. Retailers need to be cognisant of just how many stakeholders there are in their business eg funders, landlords, suppliers, credit assurers, and their specific and competing needs
2. Cash visibility. Daily and weekly cash forecasting shows pinch points and which levers you can pull to react to a sudden change in circumstances, eg credit lines cut or credit terms changed., thereby giving stakeholders comfort.
3. Communicating with the market. Give lenders and other stakeholders the confidence that management know what they are doing. If you have a viable business plan, say so.
4. Testing the business model. Does it work? What’s your in-store proposition? How do the stores appear? How advanced is your online presence?
5. Planning for the worst. Run scenarios; if things do change, you can then adapt.
The warning signs for likely distress in retail businesses are well known. Failing sales, rising costs, eroding margins, cash flow difficulties married to maturing term debt, supplier credit issues, high staff turnover and rising absenteeism are tell-tale signs that a retailer is in difficulties. The position for these businesses can change rapidly, particularly at times when significant changes in demand from suppliers is experienced.
As one of the key overheads of any prime-sited retailer, premises cost management is fundamental to survival, and allowing landlords to participate more in the business, eg through taking an equity stake, is a route that some retailers are taking.
Banks and other lenders will increasingly regard retail operations as high risk, which in turn will limit the supply of finance and push up the cost of lending. Retailers with a shaky relationship or with a history of poor engagement with lenders will be vulnerable to finance shocks. Strong relationships with other critical stakeholders such as shareholders, suppliers, landlords, pension providers, employees and tax authorities will also improve the chances of a retail business enduring the current economic climate.
The overall outlook for the sector for 2011-12 is therefore one of decline. Many retailers will struggle during this phase and then have little fuel left to deal with the anticipated period of low growth from 2013 to 2014.
In relative terms, the food retail and health and beauty sectors have fared far better than others. Tim Clifford, KPMG retail partner comments: "This pattern is likely to continue, albeit volumes are expected to be down, as growth in consumer spending is low, and inflation is still running at 4-5%. The major grocers seem to have kept pace with the public mood and have maintained sales volumes by extending and varying the essentials, own brand and value-style ranges. In addition, online continues to grow and promotional lines are expected to be strong. That said, across all subsectors, promotional activity and increases in operational costs will inevitably hit both margins and cash flows. Most balance-sheet management will therefore continue to be focused towards preserving or renewing existing lines of finance."
Taking all this into account, sector participants must now take stock and adjust to tough times ahead. It is crucial to look at business models, including the size of the retail estate, and of course it has never been more important to watch cash and costs.
For all those financing the sector now is the time for engagement, communication and planning: if a retailer does not voluntarily engage with you then you should take the initiative. Ensure that all companies which may be struggling are identified and plans are in place for the worse-case scenario. Providing the required support proactively is preferable considering the risk of an insolvency and value destruction.
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