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Uk Retailers Snapshot: Why Have Margins Remained So Strong?

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Uk Retailers Snapshot: Why Have Margins Remained So Strong? Nov. 2015 UK RETAILERS SNAPSHOT: WHY HAVE MARGINS REMAINED SO STRONG? • The growth of e-commerce among major store-based retailers. • Trends in inventory turnover (i.e., how many times retailers sell their stocks per year) and how they coincide with trends in e- commerce. • The overall noncorrelation between extra costs of doing business and operating margins. • The apparent increase in gross margins among top-tier retailers, and how they may be insulating their bottom lines from the costs being piled onto them. DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY 1 [email protected] US: 917.655.6790 HK: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. Nov. 2015 UK RETAILERS SNAPSHOT: WHY HAVE MARGINS REMAINED SO STRONG? FBIC Global Retail & Technology has compiled a dataset of financial metrics for 14 of the UK’s top apparel retailers. This report offers a snapshot of how these data can be analyzed in order to yield business insights. We have used our retailer data to primarily analyze one issue: the performance of operating margins in the context of downward pressure from e-commerce and fast fashion. This report covers: • The growth of e-commerce among major store-based retailers. • Trends in inventory turnover (i.e., how many times retailers sell their stocks per year) and how they coincide with trends in e-commerce. • The overall noncorrelation between extra costs of doing business and operating margins. • The apparent increase in gross margins among top-tier retailers, and how they may be insulating their bottom lines from the costs being piled onto them. About Our Coverage Our dataset covers the 14 biggest UK-domiciled apparel specialists, department stores and home-shopping retailers with a strong presence in apparel. The data ranges from top-line sales figures to operating profit by segment. These are the companies in our coverage: Figure 1. Company Coverage Apparel Specialists Department Stores Home-Shopping Retailers Marks & Spencer (Incl. Food) John Lewis Partnership (Incl. Waitrose) Shop Direct Next Debenhams ASOS Primark (ABF and Primark Stores) House of Fraser (House of Fraser Stores and Highland Group Holdings) Arcadia Group (Taveta Investments) Sports Direct JD Sports Fashion New Look Group Matalan River Island Source: FBIC Global Retail & Technology Market Trends Have the Potential to Hit Margins We see two key trends in the retailing of fashion: the growing share of sales taken by e-commerce and the increased emphasis on faster fashion, i.e., more frequently changing ranges. As we show in the graphic below, both of these trends have the potential to impact fashion retailers’ operating margins, due to higher costs and the heightened risks of taking write-downs on stock. But we think the e-commerce trend is far more significant, as it can hit margins both directly, through greater investments and costs, and indirectly, through greater stock risk. DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY 2 [email protected] US: 917.655.6790 HK: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. Nov. 2015 Figure 2. Potential Direct and Indirect Hits to Margins Source: FBIC Global Retail & Technology The Context: E-Commerce Is Growing E-commerce is a growth channel for almost all retailers, and we estimate that our sample of 14 companies have seen their share of Internet commerce grow from 11.8% in 2010 to 20.5% in 2014. Figure 3. E-Commerce as Share of Top Retailers’ Total Sales 25 E-Commerce Share of Top Retailers 20.5 E-Commerce Share of Top Store-Based Retailers* 20 18.4 16.2 14.9 13.8 15 13.4 11.8 11.7 % 9.2 10 7.5 5 0 CY2010 CY2011 CY2012 CY2013 CY2014 Graph excludes Arcadia Group and River Island due to absence of data. *Excluding ASOS and Shop Direct. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY 3 [email protected] US: 917.655.6790 HK: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. Nov. 2015 For multi-channel retailers, the Internet’s contribution to sales in 2014 ranged from 4% at Matalan to more than one-third at Next. Among the multi-channel names, five drove up the Internet’s share of sales by more than 10 percentage points in the period from 2010 through 2014. Three of those are department store retailers—Debenhams, House of Fraser and John Lewis Partnership—each of which has reported surging online sales. Figure 4. E-Commerce as Share of Sales (2014) and Percentage-Point Change in Share of Sales (2010–14) E-Commerce as % of Sales, 2014 Change in E-Commerce as % of Sales, 2010-14 120 25 100 20.0 20 80 14.4 13.7 15 12.1 60 10.7 10.6 % of Sales 100.0 9.6 7.6 10 40 84.0 %-Point Change 3.3 5 20 38.0 2.1 25.2 18.6 18.0 15.4 14.2 13.5 0.0 6.2 4.3 0 0.0 0 Graph excludes Arcadia Group and River Island due to absence oF data. *Percent of sales is 2013 data. Percentage-point change is For 2010–13. **E-commerce Figure is For Next Directory in total, including catalog sales. ***Includes Food retail, i.e., Waitrose and M&S Food. Source: Company reports/FBIC Global Retail & Technology The Direct Costs of Doing Business Online Surging online sales are not all good news for store-based retailers, given the costs of doing business online. First, investment in the infrastructure necessary to offer a smooth multi-channel service can be substantial. M&S, for instance, spent around £200 million on its dedicated e-commerce distribution center at Castle Donington. Second, the costs of delivery and returns add to everyday operational costs, particularly given the pressures on retailers to offer these services for free. Return rates typically average 15%–20% at multi-channel retailers, but they can be higher for pure plays, trade sources have advised FBIC Global Retail & Technology. We would expect to see these direct costs reflected in operating margins for those retailers whose sales are migrating online. In other words, e-commerce should be making retailing slightly less profitable for legacy players. DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY 4 [email protected] US: 917.655.6790 HK: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. Nov. 2015 An Indirect Cost of E-Commerce? Inventory Turnover Is Falling We think there could be indirect costs associated with e-commerce, too, in terms of companies’ ratios of inventory to sales. As we chart below, a fall in average inventory turnover among our top 14 retailers in recent years has coincided with the steady increase in the online channel’s share of their sales. This correlation cannot be taken as a confirmation of cause and effect, but it is logical to conclude that e- commerce has contributed to the declining ratio of sales to stocks. Here is why: Online retailing typically results in an extension of product ranges, with brick-and-mortar retailers offering “online exclusives” to rival the choice found at pure plays such as Amazon and ASOS. If stores stock slower-selling or more niche lines, they risk depressing inventory turnover rates. At the same time, and in a similar way, if they move to fast fashion—with its shortened windows for selling on-trend stock—they may push down their ratio of sales to inventory. Source: RiverIsland.com Among our sample of 14 top retailers, the average inventory turnover rate has fallen consistently over the review period, bringing greater risk of stock obsolescence and consequent markdowns in-store, as well as income statement write-downs. Figure 5. Top 14: Average Annual Inventory Turnover Rate (Left Axis) vs. E-Commerce Share of Retailers’ Aggregate Sales (Right Axis) 7.6 25 7.3 20.5 7.1 7.2 18.4 20 16.2 13.8 6.7 6.8 6.9 15 11.8 6.3 6.4 10 E-Commerce Share (%) Average Turnover Mulbple Inventory Turnover 6.0 E-Commerce Share of Revenues* 5 5.6 0 CY2010 CY2011 CY2012 CY2013 CY2014** The turnover multiple is the nonweighted average of the top retailers. The e-commerce average is weighted, i.e., the aggregate of the top retailers. *Average based on aggregate data For 12 of the 14 retailers—no data was available For Arcadia Group and River Island. Includes ASOS, which is 100% online, and Primark, which is 0% online. **Calendar year 2014 inventory turnover excludes Shop Direct (no data) and so is the average oF 13 companies. 2014 e- commerce share oF revenues includes an estimate For Shop Direct. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY 5 [email protected] US: 917.655.6790 HK: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. Nov. 2015 Source: Next.co.uk As a result of the factors discussed above, we see Internet retailers such as ASOS, with its “long tail” of fast- fashion inventory, as bearing the greatest risk of stock obsolescence. ASOS adds more than 3,000 new lines each week, and boasts that it stocks more than 80,000 lines in total—all while having a distinct positioning as an in-style, fast-fashion retailer. Meanwhile, brick-and-mortar retailers, including Next, now commonly offer online exclusives to bolster their offering and compete with pure plays.
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