UK retail stocks: where to next after Debenhams delisting?

Debenhams fights for survival but investors are wiped out

The UK high street faces losing yet another stalwart member after Debenhams fell into administration earlier this month. The department store, now in the hand of its lenders, still has a chance of surviving after entering a company voluntary arrangement (CVA) that will allow it to renegotiate its long and pricey leases – one of the key burdens that has weighed down the company – and hopefully find a buyer willing to pay off its £500 million-plus debt and inject the huge sums needed to turn this two-century-old business around.

Sports Direct and its owner Mike Ashley, which had spent £150 million building a near-30% stake in Debenhams over recent years, was openly eager to purchase the ailing company and raced to offer loans to try to get Sports Direct named as not just a shareholder but a lender. However, he was rebuffed several times by the Debenhams board, which Ashley had tried to oust so he could take control, hence why relations between the two were frosty. The department store was handed over only to lenders when it collapsed, which left shareholders – including Ashley and Sports Direct - with nothing.

Debenhams shares suspended as administrators take control

There is still hope for Debenhams but there is little reason to be optimistic. Even if Debenhams could reset its leases and cost base, some still argue it is far from fit for the digital age and it is clear that having a renowned British brand isn’t enough: BHS was just as much a staple of the high street as Debenhams but didn’t manage to come through the other side of its own CVA, neither did Woolworths or Toys R Us.

While Sports Direct is not attracted to Debenhams at its current price, there is still a chance that Debenhams could join Ashley’s empire (and probably merged with House of Fraser, which Ashley bought out of administration) in the coming months. If Debenhams survives but finds itself struggling again in the future, then Ashley will be sure to at least have a gander.

For investors, however, the journey with Debenhams is over and all of them have been completely wiped out. It has been a bleak couple of years for retail and a period that has tested who can keep up with the major structural changes occurring in the market but, while many have fallen and more continue to fight for survival, there are plenty of bright spots.

We have a look at the UK retail sector and, following the delisting of Debenhams, outline which retail stocks investors should still consider and those that could be about to follow a similar path to the department store chain.

How is the UK retail sector performing?

The overall picture for UK retailers, particularly old traditional ones still selling out of bricks-and-mortar stores, is bleak but not disastrous. Retail sales are still growing, rising 0.6% in the first quarter (Q1) of 2019 according to the British Retail Consortium (BRC) and KPMG, but that is a significant slowdown from the 1.8% growth reported in early 2018. Sales in March were down 0.5%, and represented the second consecutive month when growth has been slower than the same month the year before. The fact Easter falls in Q2 this year whereas it was in Q1 in 2018 somewhat distorted the figures, but retail sales were still down regardless.

'March marked a truly disappointing end to the first quarter of 2019 for retailers. Not only did total sales fall 0.5% compared to the same month last year, but no further clarity around Brexit came to light, and shoppers continue to waver,' said Sue Richardson, retail director in the UK for KPMG.

Even though wages have started to improve and unemployment remains at record low levels, it seems confidence among the UK consumer is weak, with much of it being put down to the uncertainty over Brexit. The European Commission (EC) released a survey in March showing consumer confidence had declined to -12, which was considerably lower than peers such as Germany on -2. It was the lowest reading for the UK in eight years.

The BRC and KPMG data showed, however, that some sectors of retail have fared better than others. Food sales have remained resilient as expected. Clothing sales saw a 'welcome reprieve', although separate data from Barclaycard suggested clothing sales fell for the sixth consecutive month in March. It seems consumers are happy with their day-to-day spending but refraining from making larger purchases: Richardson said 'mainly big-ticket items including furniture, remain overlooked' and Helen Dickinson, chief executive officer (CEO) of the BRC, added 'shoppers were generally cautious not to overspend, particularly on larger items'.

UK retail stocks: biggest risers and fallers

Meanwhile, UK retail stocks have seen a big improvement in 2019. The FTSE 350 General Retailers index ended 2018 at its lowest level in almost six years but has bounced back by rising over 26% since the start of the year.

Below is a table outlining the share price movement of a selection of UK retail stocks, organised by gains/losses seen since the start of 2019. The table is correct as of 17 April 2019.

5 UK retail stocks on the rise in 2019

Dunelm: strong in-store and online

Dunelm is enjoying huge success at a time when others are struggling. The homewares company operates 171 stores, virtually all of which are large out-of-town outlets. It recently released its Q3 results to the end of March which showed its expansion is working: Like-for-Like (LfL) sales growth in-store was just shy of 10% in the first nine months of its current financial year while online LfL sales jumped by almost one-third. New stores added a further £53 million boost to revenue, which was more than the previous year. Gross margins widened after it closed down non-core offerings including Worldstores and Kiddicare, and net debt was reduced.

Dunelm has said if it can keep up the current momentum until the end of June, then it should report annual pre-tax profit slightly ahead of analyst expectations of £115.6 million to £118.5 million, which would compare to the prior year’s £102 million.

The stellar rise in Dunelm shares is unsurprising given its performance: it is delivering an effective online strategy when it is needed but it is also reporting surging sales growth in-store at a time when others are losing custom to new online rivals. Investors should also welcome the fact that its success has prompted the firm to raise investment to capitalise on the opportunity further.

JD Sports: taking a step up while the going is good

JD Sports recently released its annual results for the year to 2 February 2019, which showed the premium lifestyle and sportswear seller is another retailer bucking the challenges of the high street. Although margins tightened, revenue leapt over 49% to £4.7 billion to push pre-tax profit up by more than 15% to £339.9 million, which saw its dividend raised.

JD Sports is benefiting from opening new stores in Europe and Asia and the investment made refreshing existing stores, although it has warned it is 'not immune' to the declining footfall affecting its neighbours. However, it has new growth opportunities going forward after spending on footwear firms. It has already bought Finish Line, which is fuelling its expansion into the US, and is now in the process of acquiring Footasylum.

JD Sports has conceded that Brexit is still a severe threat but has argued it is focused on the 'international potential' of the business. It is continuing to deliver LfL growth across Europe and Asia and the tighter margin seen last year should be temporary as it was caused by its acquisition spree.

Greggs: on a roll with special dividend on the way

The food-to-go market is booming and Greggs, having proven agile with its introduction of new social media-savvy products such as its vegan sausage roll, is benefiting. The baker saw revenue rise 7.2% in 2018 to break through the £1 billion threshold for the first time, pushing pre-tax profit up to £83 million from £72 million the year before.

Greggs sales hit £1 billion for the first time thanks to healthier options

The company said it has started 2019 in 'great form' and that momentum had continued to build, so much so that it expects to be in a position to pay a special dividend when it releases its interim results in July. That would be in addition to the ordinary dividend, which was raised 10.5% to 35.7p last year.

The annual results, released in early March, pushed the Greggs share price to a new highs and it has continued to rise since, currently trading at its highest ever level.

Next: smooth transition online while growing EPS

Next is one of the traditional bricks-and-mortar clothing retailers that is adapting well to the digital age. It is successfully handling the transition from customers buying in-store to online. Full-price sales were up 3.1% in the year to the end of January 2019 as a 15% rise in online sales offset a 7.3% decline in-store, but overall pre-tax profit only dipped 0.4% to £722.9 million. However, Next prefers to focus on earnings per share (EPS), which was up 4.5% to 435.3p. The reason EPS improved while overall earnings dipped is because Next, which has been balancing investment into the business and returning cash to shareholders, has been buying back shares to reduce the amount of shares in issue.

Investors have taken comfort from the fact Next expects EPS to grow a further 3.6% this year but will remain cautious about the potential slowdown in growth at a time when other challenges like Brexit loom round the corner. But they will also be bullish after Next said it could 'see no evidence that the uncertainty is affecting consumer behaviour in our sector'.

Next’s CEO Simon Wolfson has been at the helm for 18 years and has become renowned for number crunching. He disagrees with the wider view on retail: as others close stores Next has actually expanded store space while focusing on reducing costs elsewhere and supports this with 15-year ‘stress tests’. Its most recent one, which it says should not be taken as forecasts, said Next expects its online operations to generate £12 billion worth of net cash over the next 15 years compared to just £400 million from stores.

WHSmith: travelling to more profitable sales

WHSmith has carved out a rewarding chunk of the market for itself as stores in travel destinations like airports and train stations continue to deliver stellar growth. While the high street empties out, WH Smith’s latest interim results to the end of February showed high street sales declined by a mild 1% year-on-year – its 'second best sales performance in the past decade'. But that was comfortably offset by the 18% surge in sales in its travel stores. It is continuing to open new travel stores (20 new ones should be opened over the full year) while returning cash to shareholders, with the interim dividend raised 8% to 17.2p.

Travel generates over 70% of total operating profit and WHSmith is not only growing sales but reaping the rewards of the premium prices it is able to charge in travel locations, with travel margins continuing to grow last year.

The next springboard for growth will come from the US, where WH Smith has recently bought 115 InMotion outlets spread over 43 flight hubs.

5 UK retail stocks in decline in 2019

Majestic Wine: getting Naked

Majestic Wine shares took a hit last November after it released its interim results and they have failed to recover since. The wine retailer reported a 5.4% rise in sales in the six months to the start of October but saw adjusted profit sink 63% and turned to a minor £200,000 loss on a reported basis from a £3.1 million profit the year before. The dividend was maintained at 2.0p, despite cashflow turning negative, and has since been placed 'under review'.

Investors didn’t bite when Majestic Wine went on to deliver growth across all its units over the busy Christmas period as shares continued to slump. They took another turn south when the firm released a 'transformation plan' in late March that will involve closing stores, selling assets and channelling attention to its online Naked Wines business, which grew underlying revenue by over 11% in the first half compared to just 1.9% from its core Majestic Wine business.

Majestic Wine should meet expectations when it releases its results for the year to the start of April but investors are bracing themselves for a tough future. Not only will it have to contend with a tough environment, but it will have to spend big to ensure it is fit for the future and, with the dividend already threatened, investors are understandably nervous.

French Connection Group: will it find a buyer?

French Connection has been closing stores and cutting costs to try to shore-up the business but it is currently completing a strategic review that was launched last October designed to evaluate all options, including a potential sale. The situation has improved since then: it has got itself back into the black in terms of underlying profit and overall revenue nudged slightly higher last year. But margins are still tightening and LfL sales have fallen into decline.

The strategic review is expected to end in the H1 of 2019 and the outcome will be pivotal for the future direction of shares. If it can find a real answer to its problems, like a sale or merger, then shares could pop as they did when the review was first announced but, if it fails to formulate a convincing plan, then French Connection could continue deteriorating.

There are bright spots within the business and ones that may appeal to potential buyers. Although its retail division is suffering alongside the wider market, its wholesale and licensing divisions are getting stronger. Wholesale revenue jumped over 10% in the year to the end of January. Sports Direct, one of the firm’s largest shareholders, will certainly be paying attention – the firm is buying struggling brands to bring them all under one roof and French Connection’s strength in supplying others via wholesale could be an ideal fit for its strategy.

Halfords: taking it down a gear

Halfords, which sells accessories and parts for cars and bikes, downgraded its guidance in January because of continued consumer uncertainty and unfavourable weather. Both revenue and LfL sales grew over the nine months to 4 January, but both contracted in the latest quarter to suggest things have taken a turn for the worst. Halfords had previously said it expected underlying pre-tax profit of £58 million to £62 million over the full year, having previously said it was going to deliver a broadly flat result from the prior year’s £71.6 million.

The longer-term outlook has deteriorated too, having warned profit in the 2020 financial year would be roughly the same as the downgraded profit guidance issued for the recently-ended one. It has said it is confident it can maintain its current dividend policy and that cashflow will rise in the recently-ended financial year.

Moss Bros: returns to the red with the dividend scrapped

Moss Bros, which sells and hires out suits, has struggled to move online and although it has been closing stores and readdressing its lease terms the company has been hit by both self-inflicted wounds and the wider retail conditions. Stock shortages, price cuts and 'substantial external cost headwinds' all played their part in pushing Moss Bros to its first adjusted pre-tax loss in seven years of £400,000 in the year to the end of January 2019, swinging from a £6.7 million profit the year before.

LfL sales declined, margins tightened, and the final dividend was scrapped to 'give the business maximum flexibility for investment, while retaining a strong debt free balance sheet'. That meant the annual payout was just 1.5p versus 4.0p the year before and going forward the dividend is to be reviewed 'considering the overall yield, balanced against the wider investment needs of the business'.

With its stores struggling, Moss Bros will have to step up its game online. It is delivering progress: online sales rose nearly 20% over the year after accelerating from the 13.5% growth the year before. But investors are wary that online makes up a very small part of the business, accounting for just 14.5% of total sales (up from 12% a year earlier).

Laura Ashley: long journey to becoming profitable lifestyle brand

Laura Ashley, which is transforming itself into a lifestyle brand offering homeware, interior decoration, furniture and clothing, said continued market turbulence in the first half meant it would fail to meet expectations for the full year that runs until the end of June 2019. Revenue fell by 8.7% in the first half to £122.9 million and LfL store sales were down 4.2%, pushing it to a pre-tax loss of £1.5 million from a £4.3 million profit the year before.

The company is making several changes to try to revive the business. There are green shoots within its clothing unit, where LfL sales rose 12% in the first half, and Laura Ashley is looking to capitalise on that momentum after launching a new online site to help improve sales going forward. Its other major focus is an expansion into hospitality. It currently has one licensed Laura Ashley hotel and four tea rooms, with more to be open in 2019. Laura Ashley is also signing more international licensing agreements as a cheaper model to expand abroad, having agreed new deals in the likes of Japan, India and Thailand. It has said Asia will be the 'key focal point' for its international expansion plans.

While Laura Ashley faces several headwinds at a time when it is looking to expand into new areas and geographies it is in a better position to tackle them than a year ago after clearing all its long-term debt.