Corporate Research 27 November 2017 Contents Retail apocalypse: The growth of e-commerce 1 Time is running out for retailers to go digital 2 Retail trade: A historical perspective 5 Interview: Investors have legitimate concerns 8 Online race will go on, retailers need to respond 12 Interview: Ready for any e-commerce scenario 25 Spotlight: Primark – refusing to go online 29 Interview: Convenience is key for online growth 32 Spotlight: Zalando – Euro no. 1 in online fashion 38 Interview: Retail is all about the experience 40 Retail property: Reinventing itself 46 Interview: Going for convenience and community 50 Disclaimer and legal disclosures Nordea Markets and Nordea Corporate & Investment Banking Corporate Research 27 November 2017 Retail apocalypse: The growth of e-commerce Online retail is taking off, shifting from price to convenience E-commerce has grown since its beginnings in the 1990s, with growth accelerating in the past few years, making online account for 10% of Nordic retail sales in 2016 – almost on par with the US. A competitive price was critical in the early years as a differentiator versus physical stores, but now convenience has taken over as the key driver for consumers to go online. Innovation and investments in technology and logistics are making click-based browsing, buying, paying and quick delivery easier and more accessible. We have yet to come across a retail industry participant who does not believe in strong continued growth in e-commerce. Help, I run physical stores! What should I do? Many retail industry players believe omni-channel will be the successful future concept: following all the channels that customers go through. The customer can browse the market online, check or try products in physical stores or showrooms, then choose to buy from the shelf or take home delivery. We believe online, offline and omni concepts can all succeed, but it is high time for incumbent retailers to decide on a future model they believe is viable. As much as brick-and-mortar retailers may hesitate investing in digital platforms at the expense of today's more profitable offline business (still typically 95% of their business), they have to ensure that they remain relevant in a future likely to be much more biased towards consumption via mobile devices. How to make sure shopping centres are not emptied in the digital age Retail property owners also need to consider how to prepare for digital disruption. Their job is to attract visitors to the centres where their retailer tenants have stores, which is tougher if customers are increasingly able to shop more easily with their phones. Shopping centres need to offer a richer experience than just shopping, with more entertainment and services and a strategic location to drive visitor traffic. We believe non-weather protected shopping centres reachable only by car and offering little other than shopping will be most at risk of being half-full. Views from the experts: Interviews with retailers, shopping centre owners and Nordea analysts Mia Brunell Livfors, CEO of Axel Johnson Group, and Johan Ryding, CEO of Sportamore, share their views on how continued growth in e-commerce will affect retailers. Lars-Åke Tollemark, Managing Director Nordics at Unibail- Rodamco, and Citycon's CEO Marcel Kokkeel and CFO Eero Sihvonen describe their respective strategies for continuing to lure customers to their shopping centres as the e-commerce share of retail sales grows. Retail analysts Stefan Stjernholm and Stellan Hellström from Nordea Equity Research argue that equity investors have some legitimate concerns over the modest inroads into e-commerce that most Nordic incumbent retailers have made so far. Nordea Markets and Nordea Corporate & Investment Banking 1 Corporate Research 27 November 2017 Time is running out for retailers to go digital As an introduction to this month's Nordea On Your Mind, we ask Nordea's Global Co-Head of Corporate & Investment Banking Mathias Leijon about the meteoric rise of e-commerce, what it means for incumbent Nordic retailers, and how investors' view of the outlook may differ from that of the industry players. JT: E-commerce has grown very fast since its inception some 20 years ago, and is capturing a growing share of retail sales. How do you expect the retail industry to change, and how do you think incumbent retailers with their roots in physical stores should respond? ML: My 72-year-old father-in-law has started buying tyres and spare parts online, which has been quite an eye opener for me, highlighting how quickly things that were unthinkable five years ago have become the new normal. In the US, retailing accounts for one out of nine jobs, and the online sales trend has only just started. Some 8.5% of global retail spending is now online, and penetration will typically accelerate once it passes 10%. I think we are likely to see far more closures of retail stores in the US this year than we did at the low point of the global financial crisis in 2008. Retail shops used to compete by offering a combination of selection, price, service and convenience. E-commerce's most obvious edge is in selection and convenience, essentially helping us save time – which is an increasingly scarce resource these days. On top of this, online retailers are able to collect ample data about our shopping behaviour, far in excess of what any shopping assistant in a store can muster. This data can potentially be used to make customised individual offers to consumers. E-commerce share of total retail sales turnover in the US, Nordics and Europe, 2011-16 12% 10% 8% 6% 4% 2% 0% 2011 2012 2013 2014 2015 2016 US Nordics Europe Source: Source: Eurostat, PostNord and US Census Bureau I think it is only a matter of time until Competition from online retailers is typically oriented around logistics and all major cities in Europe have business processes, where we are seeing the fastest pace of innovation. I same-day delivery, and potentially think it is only a matter of time until all major cities in Europe have same- also return-on-demand, for goods day delivery, and potentially also return-on-demand, for goods purchased purchased online online. I guess it doesn't help that Amazon has conditioned consumers to think delivery should be free. Similar to how metadata aggregators like Booking.com and TripAdvisor have revolutionised the travel industry, I expect the retail industry to be transformed both by new, innovative e- tailers like Ocado, Asos, Amazon and Zalando, and by low-cost, offline retailers like Primark of the UK. The ones left in the middle will struggle, if not disappear. Nordea Markets and Nordea Corporate & Investment Banking 2 Corporate Research 27 November 2017 I think omni-channel retailers – those selling in all online and offline forums the customers go to – might potentially become the new norm. Recent evidence of this is Amazon's acquisition of Whole Foods in the US, but the jury is still out on this. Even though change is accelerating, many brick-and-mortar retailers have a great starting position and could still have an important role to play, but time is running out to adjust business models. In addition, an omni-channel strategy raises complexity in a very challenging transition period, which pressures retailers' returns and cash flow. The pure online players have adopted a strategy of growth ahead of returns, meaning the entire profit pool for the industry is pressured. Some equity analysts claim that a one percentage point increase in the online penetration of retail sales shaves 50 basis points off retailers' margins. How retailers communicate with their shareholders and what long-term support they can mobilise will be important. JT: Is digital disruption of retailing mainly in the form of price pressure from increased transparency? ML: I think the common perception that Amazon and Zalando compete on price is simply wrong. They reduce friction in shopping online with same- day delivery (requiring huge network investments), free shipping, financing, and goods "always" in store. Given that online shopping provides a superior customer experience at the same time as saving customers a lot of time, it is difficult not to expect that total current retail floor space will decline in the future. The three big listed US department store groups have seen severe declines in their market caps over the past two years, suggesting that investors expect returns to come under severe pressure. This will have consequences for their whole value chains, including real estate owners. As seen in the graphs below online retailers are sacrificing short-term returns for future ones. Despite offline retailers still showing a high ROCE and margins, they will have to be courageous enough to do the same as online players: sacrifice short-term returns for more sustainable long-term ones. ROCE of online retailers EBIT margins of online retailers 40% 10% 30% 5% 20% 0% 10% -5% 0% -10% -10% -15% -20% -20% -30% -25% -40% -30% -50% -35% -60% -40% Source: FactSet Source: FactSet Nordea Markets and Nordea Corporate & Investment Banking 3 Corporate Research 27 November 2017 ROCE of offline retailers EBIT margins of offline retailers 35% 14% 30% 12% 25% 10% 20% 8% 15% 6% 10% 4% 5% 2% 0% 0% Source: FactSet Source: FactSet JT: Do you think the Nordic retail industry is prepared for the technological and consumer behaviour change that is happening? Do you see any differences between how retailers and investors view the industry's prospects today? ML: The entire value chain needs to be assessed, since suppliers to brick- and-mortar retailers that need to reduce their footprint will also be exposed.