Continued fall in customer demand and reduced margins will hurt retailing in quarter one but costs will begin to have a positive effect on retail health
Ahead of the release of the ONS Retail Sales Index for December, and GDP figures expected to show the UK officially is in recession, the KPMG/Synovate Retail Think Tank (RTT) unveils its latest Retail Health Index (RHI). The RTT is a group of leading industry figures which provides a non-partisan guide to retail sector health ratings, which are based on the Members’ review of a comprehensive industry database (see below for examples). The ratings reflect both the quarter just ended (quarter 4 2008) and its forecast for quarter 1 2009 following their discussion during its quarterly sitting, held on 13 January.
The output chart below tracks the change in retail health quarter-on-quarter and shows that to the end of quarter four the health of UK retail has slipped for the seventh quarter running and is now at its lowest level ever since the group first met in early 2006. The base period for the metric (when the index value equals 100) is quarter one 2006.
Retail Health Index 2006 to date
The key points to emerge from the latest meeting, held on January 13th 2009, included:
- Looking back, the RTT concluded that the overall state of health had slipped in line with its prediction in quarter four to 86. This still represents the poorest state of health that the sector has been in since the RTT first sat in April 2006. Weak demand remained the key determinant of poor health in quarter four, slipping further behind its quarter three level. Heavy discounting put margins under increasing pressure in quarter four, negatively impacting retail health more than expected and more than in quarter three. The RTT was happy to agree that the impact on health of costs stabilised in quarter four, ahead of the expected timeline, bringing retailers some relief.
- Looking forward to quarter one, Members agreed that ongoing news of the credit crunch, bankruptcies and job losses had ‘spooked’ shoppers and that the outlook still looks distinctly unfavourable. It believes that the state of retail health will deteriorate still further in quarter one by five points to an RHI value of 81. Commenting on this trend the RTT said, “Demand will continue to suffer as the recession bites. This fear is founded on economic factors such as falling house prices, credit tightening by banks and signs that jobs will continue to be shed; thus seriously ‘spooking’ consumers. Benefits to the consumers’ pocket caused by reductions in mortgage bills (in some cases) and some impending cuts in utility and other domestic bills will not have an equalising effect.”
- The RTT believes that the recent Bank of England interest rate cut (to 1.5%) though helpful in the medium term will do little to affect the real world of jobs and consumer spending in quarter one.
Detail of quarter one expectations
- RTT members agreed unanimously that demand will continue to weaken in quarter one, although some were considerably more pessimistic than others. The panel acknowledged that food retailers will continue to benefit from stronger demand compared to non-food, as people sacrifice food last in a balance between essential and discretionary spending. They also agree that demand in quarter one might be weaker because of the strong flourish at the end of quarter four which helped to empty wallets and purses.
- The RTT fears that retailers will continue to suffer from declining margins in quarter one. It believes that in the last quarter discounts were bigger and introduced more quickly than anyone had anticipated. Looking forward, the public’s mentality is becoming ‘why pay full price?’ so that even the best retailers will find it difficult to get full price on new season’s goods.
- The panel agreed that the 2.5% VAT drop although it was, in most cases, rigorously passed on to consumers, was dust in the balance and had little or no impact on margins (or, for that matter, demand levels). The issue will have more impact in a year’s time if VAT were to rise to 20% (which may be a government policy necessity). Stronger foreign currency will continue to have little impact on margins in the short term until current hedging agreements begin to expire in late summer.
- Retailers’ ability to manage stock in the current environment continues to improve, as they take into account the downturn and adjust ranging and stock level control appropriately. This, Members see to be critical in maintaining margins.
- For food retailers, the impact of a weak pound won’t impact margins in quarter one because it will be offset by falling input prices. They are therefore likely to see their margins unchanged, but will continue to pass the reductions in price, where they exist, onto the consumer.
- The only driver to have a positive impact on health in quarter one is costs. Many retailers have taken decisive action already by cutting staff at head offices, distribution centres and at store level; building more flexible staffing systems; reviewing pension arrangements; cutting marketing budgets; and further squeezing suppliers. The falling open market rents (tertiary sites and warehouses in particular – where there is weaker demand and vacancies are rising) is also key. Members agreed that the rents that retailers are paying are now flat and that monthly (rather than quarterly) rents will continue to become more common, but variations in contract will be marked and always dependent on local conditions and negotiations. Flat rents will not impact on costs, but the move to shorter advance terms will on cash flows.
Nick Bubb of Pali International summarises the thoughts of the RTT: “In quarter four the impact of demand on retail health was in very negative territory, as were margins, which were slightly worse than predicted. Costs were slightly better, however. Overall we see that retailers are fighting very hard to ride out the increasing recessionary pressures, although food retailers are better placed than non-food retailers. Some have done much better than expected over Christmas and the New Year Sales periods by maintaining their pricing power and by slashing costs and rationalising wherever possible. The lull in the rise of operating costs will be welcome relief, but that light at the end of the tunnel may well be a train coming towards them at high speed, given the big rise in import prices feeding through from the collapse of sterling and the worrying rise in job losses.
“It’s important to remember, however, that every recession has winners as well as losers. The continuing banking crisis remains a serious problem for the economy, but those retailers with good credit lines and healthy cash flows are now in a position to expand into prime-pitch shop units which have been left vacant by failing businesses in the High Street; an opportunity which has already been seized by some.”
The RTT panellists rely on their impressive depth of personal experience, sector knowledge and also considered the following:
Total retail sales across the quarter as measured by the BRC-KPMG Retail Sales Monitor actually fell by an average 0.7%, down from 1.4% growth in quarter three. The fall in Like-for-Like sales was 2.7% across the quarter, a worse decline than the 1.1% drop seen in quarter three. Like-for-Like sales have been lower than a year ago in nine of the past ten months. Food and drink remains the only sector to show sales up on a year ago. Clothing and footwear remain poor and furniture, homewares and major purchases such as bathrooms and kitchens are well down.
The headline Consumer Price Index inflation measure fell to 3.1% in December, down from its high of 5.2% in September. The largest downward contribution to the change in December came from clothing and footwear. Food prices were up 10.4% on December 2007 as measured within the CPI. However, the index of shop prices measured by the BRC-Neilson index reported a 0.5% rise in shop prices in December, with food prices up by 6.2% (down from the peak rise in food prices of 10% we saw in August 2008). The sharp deceleration, particularly in non-food, where prices fell by 2.4% in December on a year earlier within the BRC-Neilson index, reflects the unprecedented levels of discounting on the High Street as well as the reduction in VAT. Going forward, we see the impact of inflation continuing to ease.
The GFK composite consumer confidence index remains in the -30s but did improve to -33 in December from -35 in November and -36 in October. Although on the face of it this shows an improvement in outlook, people’s expectations remain well below the trough seen in the early 1990s.
The rate of year on year growth of unsecured borrowings, excluding borrowing on credit cards, continues to slow – and was only 5% in the last quarter. It remains well below the long run average growth of 12%. The serviceability of households’ overall debt measured through mortgage and unsecured interest and principal debt payments as a percentage of income has fallen from its peak of over 20% in the first quarter of 2008, but is still some 19% (sources: Bank of England, National Statistics and Capital Economics). Although interest rates are now at an historically low level, many lenders are refusing to pass on this benefit to their customers given their own difficult financial situations.
House prices have fallen by 16% over the year to December, the largest annual drop in the history of the series (source: Nationwide). Mortgage approvals fell again to 27,000 in November, a 67% decrease on a year earlier. From the peak in property values in summer 2007, expectations of 20-30% price falls over the period to the end of 2009, early 2010 are now the norm.
Levels of unemployment have continued to increase over the quarter. UK unemployment rose by 131,000 to 1.92 million between September and November, the highest total since September 1997. The number of people claiming jobseeker’s allowance increased by 77,900 to 1.16 million, according to the Office for National Statistics. Economic prospects and recent announcements point to an acceleration in this trend over the coming months with another 500,000 to 750,000 expected to become unemployed during 2009. The RTT believes that the fear of unemployment, irrespective of actual unemployment levels, is one of the most significant factors likely to have a detrimental impact on demand going forward.
The pound had an appalling quarter with the $ and Euro strengthening against the £ and ending the quarter at approximately $1.46 and €1.03 respectively. This compares to average rates of $2.04 for the £ and €1.41 to the £ in the same quarter of 2007, making imports denominated in those currencies 35% to 40% more expensive than at this time last year. The impact of sterling’s weakness will impact clothing retailers most significantly, although many will have covered this exposure in the immediate term.
|Producer price inflation
Producer price inflation (‘PPI: the prices that retailers pay to manufactures – source ONS) fell to 4.7% in December, continuing the downward trend from the high 10% in July 2008 but still above the long run trend rate of approximately 2.5%. Food PPI inflation has driven this fall and was 7.9% in December and is expected to fall further as the fall in commodity prices feeds through. It therefore appears that we are past the worst and the challenges around needing to pass on price increases while remaining competitive will begin to alleviate.
|Producer price inflation – non food
Output prices for non-food have also fallen slightly to 5.0% in December from 5.6% in September. However, inflation in the prices that retailers pay for goods remains above the changes in shop prices – non-food shop prices are actually falling – again highlighting the detrimental impact on margins.
Based on CBRE’s monthly index, retail rents across all retail were unchanged in the quarter when compared to a year earlier, the slowest growth since 1994. Standard shop rents were up slightly, but warehouse and shopping centre rents were both slightly lower than a year previously.
Annual gas and electricity price inflation rose to 50.6%and 31.4% respectively in the quarter, compared to 49.9% (gas) and 30.3% (electricity) at the end of quarter three. The oil price of $36 at the end of December was well down from $140p.b at the end of June and was 61% lower than at the same time last year.
There are no current statistics available for retail average earnings – the latest figures from Thomson Datastream for October show an annual change of 1.9% including bonuses, well below the 3.7% rate for the overall economy. A number of retailers have announced job cuts in order to control people costs while the top line remains under pressure.
Note to Editors:
The RTT panellists rely on their depth of personal experience, sector knowledge and review an exhaustive bank of industry and government datasets including the following:
Members of the RTT are:
- Nick Bubb – Independent Retail Analyst
- Dr. Tim Denison – Ipsos Retail Performance
- Jonathan De Mello – Harper Dennis Hobbs
- Martin Hayward – Hayward Strategy and Futures
- Maureen Hinton – Conlumino
- James Knightley – ING
- Richard Lowe – Barclays Retail & Wholesale Sectors
- David McCorquodale – KPMG
- Martin Newman – Practicology
- Mike Watkins – Nielsen
First mentions of the Retail Think Tank should be as follows: the KPMG/Ipsos Retail Think Tank. The abbreviations Retail Think Tank and RTT are acceptable thereafter.
The RTT was founded in February 2006. It now meets quarterly to provide authoritative ‘thought leadership’ on matters affecting the retail industry. All outputs are consensual and arrived at by simple majority vote and moderated discussion. Quotes are individually credited. The Retail Think Tank has been created because it is widely accepted that there are so many mixed messages from different data sources that it is difficult to establish with any certainty the true health and status of the sector. The aim of the RTT is to provide the authoritative, credible and most trusted window on what is really happening in retail and to develop thought leadership on the key areas influencing the future of retailing in the UK. Its executive members have been rigorously selected from non-aligned disciplines to highlight issues, propose solutions, learn from the past, signpost the road ahead and put retail into its rightful context within the British social/economic matrix.
Definitions: The RTT assesses the state of health of the UK retail sector by considering the factors which influence its three key drivers.
- Demand – Demand for retail goods and services. From a retro-perspective, retail sales, volumes and prices are the primary indicators. When considering future prospects, economic factors such as interest rates, employment levels and house prices as well as others such as consumer confidence, footfall and preferences are used
- Margin (Gross) – Sales less cost of sales; the buying margin less markdowns and shrinkage. Cost of sales include product purchase costs, associated costs of indirect taxes and duty and discounts
- Costs – All other costs associated with the retail operations, including freight and logistics, marketing, property and people
The Retail Health Index – how is it assessed?
Every quarter each member of the RTT makes quantitative assessments of the impact on retail health of demand, margins and costs for the quarter just completed and a forecast of the quarter ahead. These scores are submitted individually, collated and aggregated in time for the RTT’s quarterly meeting. The individual judgements on what to score are ultimately a combination of objective and subjective ones, drawing upon a wide range of hard datasets and softer qualitative material available to each member. The framework follows the example of The Bank of England Agents’ scoring system on economic intelligence provided to the Monetary Policy Committee.
The aggregate scores are combined to form the Retail Health Index (‘RHI’) which is reviewed at that meeting and occasionally revised after debate if members feel it appropriate. The RHI tracks quarter on quarter changes in the health of the UK retail sector and as such provides a useful and unique measured indicator of retail health. The index ‘base’ of 100 was set on 1 April 2006. Each quarter, it assesses whether the state of health has improved or deteriorated since the previous quarter. An improvement will lead to a higher RHI score than that recorded in the previous quarter, and with a deterioration leading to a lower score. The larger the index movement, the more marked the shift in the state of health.
The RHI has two main benefits. Firstly, it aims to quantify the knowledge of the RTT members in a systematic way. Secondly, it assesses the overall state of health of the UK retail sector for which there is no official data.
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