UK Retail – More pain to come ...?

Gavin George, European Managing Director of GA Asset Advisors Ltd, sets the scene for management and investors of retail assets as consumer indicators give warning signals for the autumn and winter seasons.

UK retail may have so far avoided the intensive care ward, but it's by no means out of the woods. The latest CBI data, showing almost 40% of retailers reporting declining sales volumes during the first half of June, is likely to be a taste of things to come. In fact, the sector is facing an unprecedented 'quadruple whammy' of bad macro-economic news:

• Increasing inflation - on the CPI measure, inflation hit 3.2% in June, well above the 2% target and the 'norm' for the EU zone, currently c2%. Exactly when and by how far is open to question, but interest rates will have to rise soon.
• A steep decline in the sterling-dollar exchange rate with far reaching implications for future sourcing costs. At $1.45, the pound is down almost 15% from its 12 month peak.
• An increasing burden of taxation for an already cash constrained consumer, including the January 2011 hike in VAT.
• Growing unemployment, particularly as the 25% or 40% public sector spending cuts begin to take effect. Latest figures show UK unemployment at 2.51 million, its highest level since December 1994.

Put another way, you would need to be a brave retail board to be signing off budgets with any significant LFL growth!

Of course, there are exceptions - the valuations of specialists such as Pets at Home, Hobbycraft and SuperDry Group demonstrate that it is still possible to sell a domestic growth story, especially if multi-channel is a component. Prospects for international expansion, particularly in emerging markets, look brighter and will continue to underpin the potential for our largest retail businesses including Tesco, Kingfisher and AllianceBoots as well as specialists such as Mothercare, New Look and Primark. And those retailers that can renovate their customer proposition will be well placed to reap the rewards. For example, DSG's new format looks like a formidable adversary to Best Buy's European ambitions and demonstrates just how far it is possible to refresh a tired looking business.

For the most part though, the market will remain very tough. Trying to manage a rising cost base, with a flat (at best) top line increases the pressures on cash. And it is unlikely that the HMRC's Time to Pay initiative, the liquidity of the clearing banks or the generosity of creditors (suppliers or landlords) are going to save the day.

So what should responsible retail boards be doing now to steer a sensible course through choppy waters?

• Increasing the hurdle rates on any capex and keeping a very tight lid on the operational cost base.
• Managing the forward cash position, probably a rolling 13 week forecast with the first 3 weeks daily.
• Securing forex hedges at least 12 months out, particularly against the sensitive US dollar.

• Keeping key creditors, both suppliers and property landlords, on-board with current trading.
• Planning any refinancing needs a long time in advance, probably also considering alternative sources of finance such as asset based lending.
• Actively managing covenant compliance (e.g. interest cover) – be aware of the reporting requirements.

By proactively managing all of the above then management should remain in control of the situation. Ultimately if the situation does worsen, be prepared to seek advice early. In my experience the costs of restructuring only ever goes up as the problem deepens.

With this in mind, don't lose sight of the golden rule: when things turn ugly the next bit of news is almost always bad…