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Is the Debenhams collapse peak pain for high street retail?

Amid the persistent challenges to the UK high street, are fund managers finding opportunities in consumer-focused companies?

Is the Debenhams collapse peak pain for high street retail?

Judging by the headlines, you would believe that the UK high street is now a ghost town only populated by tumbleweed.

Given the seemingly constant negative news, from Debenhams’ struggles to the collapse of Patisserie Valerie, it would be easy to think so.

But has the death of retail been overhyped, throwing up opportunities as the quality stocks are caught in the broader sector’s fall from favour?

Mark Swain, co-manager of the Smith & Williamson Enterprise fund, falls into the latter camp, albeit he admits the retail environment is savage, meaning investors have to be selective.

‘The general picture of UK retail isn’t particularly rosy, but there are still pockets that are still quite attractive,’ he said.

The positive results from Tesco show that it may not be all doom and gloom for UK retail. The supermarket's revenue and pre-tax profit increased by 11% and 29% respectively, according to its full year results. 

A boost to disposable income

Schroders is ‘cautiously optimistic’ on UK retail, despite widespread pessimism more broadly on consumer-focused sectors.

Andy Brough, head of pan-European small and mid cap at Schroders, said that UK consumer spending has proven resilient despite Brexit uncertainty and rose by £52.5 billion in 2018.

Citywire + rated Brough also points out that UK consumers will receive a boost to their spending due to tax changes in the 2018 Autumn Budget. Chancellor Philip Hammond upped the personal allowance from £11,850 to £12,500, and increased the basic rate limit to £37,500 for the 2019/20 tax year.

Swain echoed this, adding that: ‘Utility costs aren’t going up as much as wage growth. However, what people do with their disposable income is another thing. There has been a trend towards more spending on experiences rather than on the high street.’

The consumer picture is certainly not rosy, with Colin McLean, co-manager of SVM Asset Management’s UK Growth fund, noting that wage growth has been weak for the past 20 years, albeit the UK does have a ‘high propensity to consume versus other economies such as Germany’.

Undervalued stocks

Brough says that the fourth quarter sell-off in markets was to a degree indiscriminate and means that there is a disparity between earnings and valuations.

‘Shares fell sharply without any marked change in underlying earnings expectations, as investors became concerned there could be further bad news to come,’ he said.

‘This exacerbated a trend for UK domestic companies to underperform UK overseas earners.’

Brough added that international investors have been avoiding UK equities, and that clarification over Brexit could encourage cash to flow back into the UK market:

‘The negativity of international investors towards UK equities is entrenched – global fund managers have been consensually “underweight” the UK for three years.

‘Should the tide turn and capital flow back into the UK, the more domestically-focused mid cap equities, home to many of the UK’s quoted general retailers, could do relatively well. The scope for any potential recovery looks good considering that UK mid caps have only risen 21.7% over the past three years.’

Swain added: ‘UK assets have been off the radar since the referendum, and there have been significant flows out of UK funds, but the US is already warming to UK assets.

‘The UK is one of the most under-owned geographies, and UK assets are trading at a discount. There is an opportunity, as UK consumer companies are trading at an even greater discount.’

However, McLean is more cautious, noting the potential downsides. He also says that there are more favourable ways of building UK mid cap exposure than by holding retailers.

He said: ‘Retailers like Mothercare and HMV are going through the same narrative as Woolworths. I don’t see an easy fix for high street retailers.’

McLean fears that the performance of some of the UK’s large retailers may actually be even be worse than touted.

Where are the opportunities?

Swain cites JD Sports as a favoured play in the sector and it is a 2.5% long position in his fund. He highlights that the growing popularity of ‘athleisure’, paired with JD Sports’ acquisition of Finish Line in the US, has made the firm a strong investment prospect.   

McLean said that although ‘retail is pretty much non-existent’ in SVM’s portfolio, the firm is overweight supermarkets and holds Tesco. McLean said that SVM also likes disruptive e-commerce firms like On the Beach, and pawnbroker, H&T Group.

Swain is also optimistic about Tesco, with a 3.5% long position in Smith and William’s Enterprise fund, the largest long position that the fund holds.

‘Tesco’s market growth has been exceeding its space growth. After a decade of headwinds, these have now reversed for the supermarket. The Sainsbury’s/Asda deal also looks to be dead in the water, and that isn’t going to do Tesco any harm,’ he said.

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Related Fund Managers

Colin McLean
Colin McLean Average Total Return:
123/129 in Mixed Assets - Aggressive GBP (Performance over 3 years)
Mark Swain
Mark Swain Average Total Return:
27/74 in Alternative UCITS - Long/Short Equity (Performance over 3 years)
Andrew Brough
Andrew Brough Average Total Return:
25/54 in Equity - UK Smaller Companies (Performance over 3 years)

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