Barclays Wealth staying clear of retail sector

While a week may be a long time in politics, it can feel like an age in markets. Last week, equities were hammered as investors continued to fret about the ongoing effects of the sub-prime debacle in the US and the seeming reluctance of US policymakers to use TARP funds to purchase ‘toxic’ assets.
So far, this week has been rather better, although recent policy moves on both sides of the Atlantic have served to underline the severity of the current economic malaise as well as helping to boost sentiment.
Investors have taken some heart from further intervention on Monday to stabilise the US financial system but it remains to be seen whether recent moves from Downing Street will do anything to support either markets or indeed the ‘real’ economy. The ongoing trauma at high-street stalwart Woolworth’s, for instance, merely represents the thicker end of the wedge as far as the retail sector is concerned.
In the short term, analysts at Barclays Wealth (BW) believe that the 2.5% VAT cut should be mildly helpful to the UK high street; after all, some good news is better than none, and there has been very little to cheer about in recent weeks. However, BW analysts think the reduction is unlikely to find its way to the consumer quickly, given that shelf price changes are laborious to implement. So, the VAT cut may help retailers mitigate some of the negative impact from rising costs and unfavourable currency moves but it is not enough to change our negative view on the sector.
Another headache for retailers is the 0.5% rise in National Insurance rates, which is less than ideal for a wage-heavy sector (Woolies alone has some 25,000 store workers). Meanwhile, trading is continuing to deteriorate rapidly, as evidenced by the 15% decline in like-for-like sales at John Lewis last week and both M&S and Debenhams running significant ‘discount days’ (M&S is already rumoured to be planning another.) Results are due from Kingfisher and DSG International this week and we expect both to give further evidence of a rapidly-worsening consumer environment. Kingfisher may benefit from being a strong euro earner with cost-cutting measures providing some further cushioning but the outlook for DSG remains very poor with Best Buy waiting in the wings.
From a valuation point of view, retail sector earnings forecasts for 2009/10 are starting to look much more realistic and given the VAT cut and probability of further reductions in interest rates, it might be tempting to think that now is the time to ‘bottom fish’ the retail sector for a few bargains. However, in the past, the lag between the bottom of the earnings cycle and a period of sector out-performance has been between six and twelve months, so BW analysts still think it is too early to be investing in the sector on valuation grounds just yet. On top of this, BW analysts feel that earnings estimates are likely to take another hit after Christmas and expect January’s trading statements to provide evidence of a fairly dire festive season.
“We retain a favourable stance on Carphone Warehouse and Burberry, as these represent our attempts to diversify away from the UK high street, but on an absolute basis we would still steer clear of the retail sector despite the obvious attempts to revive its flagging fortunes,” conclude Barclays Wealth analysts in a research note dated November 26, 2008.