The UK’s retail sector has always presented a mixed picture, with winners and losers at both sub-sector and individual business levels. Autumn 2023 is no different but there is a worrying industry-wide increase in its financial vulnerability.
The recent collapse of the Wilko chain has highlighted that failure is possible even in the most apparently advantaged part of the market. Equally illustrative of the challenging market is the sight of two broadly comparable retail icons heading in diametrically opposite directions. M&S surprised pundits by hiking this year’s profit forecast not long after the John Lewis Partnership posted a £234m annual loss.
A sharp reversal in online sales (down 10% since 2021) has also hit some of the pure play, online only retailers hard. Major fashion e-tailers BooHoo and ASOS had their trade insurance cover cut earlier this year.
Market Background
We last reported on the retail sector in October 2022 just as businesses had largely emerged from the worst disruption of the pandemic but were grappling with the unexpected shocks caused to supply chains and input costs by Russia’s invasion of Ukraine. The long term outcome of the WFH phenomenon was still uncertain, which it remains today although maybe less so.
We listed a number of key challenges faced by retailers. Eleven months on many still apply:
- Labour supply shortages continue to drive up staffing costs.
- Consumer spending constraints caused by the cost of living crisis, savage mortgage hikes and soaring rents, which show little sign of abating even if pay increases are at last starting to match inflation.
- Cash flow pressure from repaying additional borrowings taken on during the pandemic.
- Sharply higher interest rates on variable rate borrowings.
Predictably, the thorny subject of business rates reform remains lost deep in the government’s long grass, with the threat of yet another £400m being added to retailers’ costs in April 2024 according to the British Retail Consortium (BRC), but without any action to level the playing field between bricks and mortar retailers and online players or correct the tax’s other shortcomings.
On the upside, supply chain disruption caused by the war in Ukraine and China’s zero-Covid regime has settled down, while input and overhead cost inflation seems to have peaked, except perhaps for labour costs.
Retail performance trends are difficult to track, principally because the ongoing indices (such as the retail sales trend data published by the Office for National Statistics and by the BRC) fail to reflect fully or meaningfully what is happening across the sector. In addition, they suffer from being focussed on the retail sector’s obsession with top line sales, as opposed to the reality of bottom line profitability.
The most recent data appear to suggest that retail activity is defying the cost of living crisis, but is at the mercy of the UK’s notoriously unpredictable weather after the washout of July 2023, although the conclusions appear to be rather more anecdotal and a good deal less statistical.
More concerning is the outcome of the latest CBI barometer of retail activity in August 2023. The result was a fourth monthly decline in a row to the lowest level since March 2021. Retailers told the CBI that they foresaw cuts to investment and a reduction in staffing over the next year.
Financial Risk
We have used the Company Watch financial health monitoring system to research the latest financial statements filed at Companies House by every company registered in the UK, which operates in the retail sector. Our research covered a total of 138,180 companies.
The stand out feature of this latest profile compared to the picture in October 2022 is that the average financial health rating (H-Score® – see below) of the whole sector has dropped significantly from 41 to 37 out of a maximum of 100. The sector was already well below par ten months ago, now it is in a much worse position. The average H-Score for the economy as a whole is around 48.
What is even more striking is that this deterioration can be seen right across the size spectrum, from the largest chain retailers to the smallest independent:
- Retailers with total assets over £1m – average H-Score is down from 63 to 62
- Assets £125k to £1m – down from 48 to 46
- Assets £50k to £124k – down from 39 to 36
- Assets £25k to £49k – down from 36 to 33
- Assets less than £25k – down from 30 to 28
Insolvency Risk
Company Watch uses complex analytics to generate an H-Score for every company out of a maximum of 100. This is based on its latest published accounts and a number of key measures within those accounts. An H-Score of 25 or less indicates that the company concerned has a one in four risk of going through a formal insolvency process or a significant financial restructuring at some point during the next three years.
Out of our sample of 138,180 companies, 58,887 or 43% (October 2022: 39%) are in the Company Watch Warning Area with H-Scores of 25 or less. Once again, we broke our results down according to the size of each company. For businesses with:
- Total assets between £50k and £124k, 40% were in the warning area (36% in October 2022)
- Total assets between £25k and £49k, 47% were in the warning area (44% in October 2022)
- Total assets below £25k, 58% are at serious financial risk (56% in October 2022)
Even with major retailers there is a higher percentage at risk – 18% now vs. 16% in October 2022.
This confirms that while there are some much larger retailers with serious financial issues, the vast bulk of financial risk in the sector lies with the smaller, less well capitalised businesses.
Zombie Companies
We also identified any ‘zombie’ companies with negative balance sheets (by at least a de minimis figure of £20k). 17,884 (13%) were zombies with a combined excess of liabilities over their assets of £2.3bn. The good news is that the number and percentage of zombies has gone down (from 23,994 and 18% respectively), with the major falls being for the smallest companies. Never the less, it remains worrying that one in eight retailers has posted a balance sheet that is technically insolvent.
Negative Working Capital
We also looked at companies with negative working capital, where their liabilities falling due within a year were greater than their current ‘quick’ assets (again by at least £20k). We found there were 19,284 (14%) such companies. As with zombie companies, this figure is down from October 2022 when there were 23,809 (17%) similar companies.
Debt
In our last review we noted a sharp increase in debt levels across the sector. This picture has now stabilised, with overall sector borrowings falling back marginally from £65.8bn in October 2022 to £65.7bn now, which reflects the wariness of the lending community about the sector and the inability of many smaller retailers to digest any more debt after the borrowing binge during the pandemic through the various government-backed Coronavirus loan schemes.
A more detailed summary of our research can be found here.
Retail insolvencies
The latest figures from the Insolvency Service show retail failures in England & Wales for the first six months of 2023 have jumped 61% by comparison with the previous comparable period in the first half of 2019 pre pandemic and by 27% as against the first half of 2022. 9% of all corporate insolvencies in the first half of 2023 occurred in the retail sector, with 1,090 retailers failing. In the same period pre-pandemic in 2019, only 675 retail companies filed for insolvency (8% of all insolvencies). These percentages compare unfavourably with the sector’s lower 5% share of GDP.
Major retail failures
The Centre for Retail Research maintains statistics covering the failure of major retailers in the UK. These figures capture the number of companies affected, as well as the number of retail stores and retail jobs put at risk.
Looking at recent history, 2020 was the worst year for collapses since their records began, surpassing even the previous record set in 2008 at the start of the global financial crisis when the numbers were heavily distorted by the collapse of Woolworths. In 2020, 54 major retailers failed, putting 5,214 stores and 109,407 jobs at risk. After the cull in 2020, the figures for 2021 were the lowest for many years with only 19 major companies filing for insolvency, affecting 1,758 stores and 26,274 jobs and reflecting the protection against creditor enforcement action brought in by the government during the pandemic.
The outcome for 2022 was a busier year, with 49 major failures, including high profile names such as M & Co, Joules and McColls, but overall the failures were of smaller companies so that only 2,318 stores and 34,907 jobs were affected.
This year has again been one for smaller failures, at least until the Wilko Administration. By mid-August there had been 39 major failures, impacting 962 stores (of which 408 are Wilko units) and 19,046 jobs (of which some 12,000 are at Wilko). Other failures this year have been Paperchase, Cath Kidson (again) and Tile Giant.
These statistics do not include companies undergoing a Company Voluntary Arrangement (CVA) unless they subsequently go into Administration or Liquidation.
Retail profit warnings
The consultants, EY Parthenon publish quarterly reports on profit warnings issued by listed companies. The statistics for H1 2023 make worrying reading for the retail sector, which provided 10 profit warnings, although this was lower than the 16 in the same period of 2022. Retailers also accounted for a fifth of the quoted companies in another warning zone – those which have issued three profit warnings within twelve months.
The fact that such sophisticated companies face sufficient business disruption and uncertainty that they were unable accurately to predict their profitability, should cause serious concern, not least for their smaller, less-well capitalised retail brethren, who face the same problems but with far less capacity to cope. At a time of an ongoing consumer cost of living crisis and input cost inflation, retailers are particularly vulnerable.
Shop occupancy
The myth that the health of the retail sector and indeed the UK high street can somehow be discerned from statistics on shop unit vacancies (the ‘boarded up high street’ syndrome) should have been dispelled long ago, especially with the WFH phenomenon changing shopping habits and placemaking proceeding apace to facilitate the transformation of retail space into leisure and other use.
A recent announcement by the BRC was led by a headline that the UK had lost 6,000 store fronts in the past five years, provoking outrage among many in the retail and placemaking communities. Too much media commentary looks only at one side of the hight street equation and overlooks new store openings and re-purposing.
A better balanced report released by the Local Data Company (LDC) indicates continued but cautious recovery overall for the UK retail market. 2022 saw the gap between store openings and closures narrow to its smallest since 2016. Net change in units (openings minus closures) was -3365 units during 2022, which was a 57% decrease from the 2021 reduction of 7902 units. Without the prevailing economic uncertainty, supply chain issues and rising inflation, more ambitious new store opening plans may well have been implemented.
The overall vacancy rate also experienced a notable boost in 2022, ending the year at 13.8%, which represents a drop of 0.6% on 2021— the greatest year-on-year decrease since LDC records began in 2013. The very latest LDC figures show a marginal rise in the vacancy rate in H1 2023 to 13.9%.
Conclusion
Retailing remains hugely challenging, especially for smaller operators now struggling to service a higher debt burden than before the pandemic and with increasing numbers facing sharply higher interest rates. The cost of living crisis may be showing signs of abating, but retailers face ongoing issues both at the top line as consumers reduce their spending and at the bottom line as they deal with the pressure to limit the amount of cost inflation they pass on to customers. Our risk analysis highlights that the finances of the sector are significantly weaker than just eleven months ago.
As always, the greatest financial risks are focused most heavily among smaller retail businesses, but there will be further failures among high profile brands. The keys to not just surviving, but to thriving remain the same: flexibility, adequate funding, good management, top quality customer service and a sound business model.
September 2023
If you would like to discuss any of the points in the report or believe you have been affected by any of these issues, you can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.