The UK Retail Market – warning signs of trouble ahead
Sector resilience
When we last looked at the UK retail market’s finances in March 2022, the economy had staggered out of the darkness of the pandemic, only to find itself facing new storm clouds from the war in Ukraine and rapidly rising inflation. The energy crisis had started but the nightmare of its full impact on businesses and consumers was not yet fully apparent.
The financial data available then did yet fully reflect the impact of the pandemic, with the exception of some of the major listed retailers. The filing deadline regime at Companies House means that even now the figures available in the public domain for the vast majority of retailers still date back into the pandemic period, but the picture of its effects is becoming clearer.
On the whole, the financial profile they reveal has not deteriorated during the past few months as much as general media and industry comment might suggest, but the warning signs of trouble ahead are only too clear, especially for smaller, owner-managed retailers.
Last market study
In our last market study, we commented on the uncertainty about how the WFH revolution would play out in the medium and long terms, as it might affect footfall and spend in different retail locations. We asked whether the initial sharp shift in the first eighteen months of the pandemic to online shopping and the transfer of consumer spend from town and city centres to local high streets might be a permanent feature of merely a phase.
We noted the continued government hesitancy over desperately-needed Business Rates reform. Unfortunately, that problem remains deliberately buried deep in the long grass. As a result of these endless delays, businesses in general are now staring down the barrel of a £3bn annual cost increase gun next April if this September’s inflation figure of 10.1% is used to uprate Business Rate liabilities, as the present system says it should be. The extra bill for retailers will be £800m in 2023/24.
The surge in placemaking activity we highlighted last March has not just continued but intensified, as town centres and high streets rush to diversify their offering and reduce their dependency on retail. The latest Local Data Company report into the retail and leisure sectors in H1 2022 notes in particular a distinct trend for retail units to be replaced by leisure businesses as part of this process, as well as a significant reduction in the stock of retail/leisure sites as these units are re-purposed away from commercial usage.
The surge in the online share of shopping spend triggered by Covid lockdowns and biosecurity concerns has been partially reversed. The latest ONS analysis suggests it is now 26.4%, down from a pandemic peak of 28.9% in 2021 but still higher than pre-pandemic in 2019 when it was 19.4%.
Having battled through the Coronavirus crisis, UK retail is now facing a whole new cocktail of major challenges:
- Labour shortages driving up staffing costs
- Additional supply chain disruption caused by the war in Ukraine and China’s zero-Covid regime
- Severe and ongoing input and overhead cost inflation, especially energy bills
- Consumer spending constraints caused by the cost of living crisis and mortgage hikes, which will inevitably intensify over the winter and well into 2023
- Cash flow pressure from repaying additional borrowings taken on by retailers during the pandemic
- Higher interest rates on retailers’ borrowings following the failed Trussonomics experiment.
Our latest research using analytics provided by financial health monitoring specialists, Company Watch shows the following overall financial characteristics:
- Total Assets Employed – £236bn (pre-pandemic £240bn)
- Total Debt – £66bn (pre-pandemic £70bn)
- Total Net Worth – £88bn (pre-pandemic £84bn)
Financial Risk
We have used the Company Watch system to research the latest financial statements filed at Companies House by every company registered in the UK and operating in the retail sector. Our research covered a total of 136,622 companies.
This demonstrated that the overall sector profile has changed little since March 2022, but with the same warning signs we noted then, most noticeably for smaller retailers. Company Watch uses complex analytics to generate a financial health score (H-Score®) for companies out of a maximum of 100. 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. Our research highlighted four main areas of concern:
No 1: Warning Area
Out of our sample of 136,622 companies, 52,929 or 39% (March 2022: 40%) are in the Company Watch Warning Area with H-Scores of 25 or less. We broke our results down according to the size of each company. For businesses with total assets between £25k and £49k, 44% were in the warning area and for those with total assets below £25k, 56% are at serious financial risk. These percentages have not changed since March 2022. Major retailers with assets over £125k have a warning area rate of 16%, which is very significantly down from March 2022’s figure of 26%. 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 smaller businesses.
No 2: Zombie Companies
We also identified any ‘zombie’ companies with negative balance sheets (by at least a de minimis figure of £10k). 23,993 (17.5%) were zombies with a combined excess of liabilities over their assets of £2.6bn. These figures are largely unchanged since March 2022.
No 3: 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 assets (again by at least £10k). We found 23,809 (17.4%) such companies, which had a combined working capital deficit of £7.6bn. As with zombie companies, these figures are broadly in line with the position in March 2022.
No 4: Debt
Amid the general stability in the overall finances of the sector since our last review seven months ago, one deeply worrying deterioration is obvious. Across all retailers, borrowings of £65.8bn are actually down slightly by 1.3%, but for smaller companies the picture is completely different, as set out below:
- Retailers with assets under £25k – up 37%
- Retailers with assets between £25k and £49k – up 62%
- Retailers with assets between £50k and £124k – up 64%
- Retailers with assets between £125k and £1m – up 31%
This reflects the easy access to loans under the various Coronavirus Support loan schemes, especially Bounce Back Loans. The ability of these fragile, small enterprises to service and repay such increased debts must be in considerable doubt. The distortion to their balance sheets will also make it difficult, if not impossible for their suppliers to obtain adequate trade insurance, without which many will not continue to trade with them.
Plus some insolvency stats for retail
Figures from the Insolvency Service show that 8.2% of corporate insolvencies in the eight months to August 2022 occurred in the retail sector, with 1,237 companies failing. In the same period pre-pandemic in 2019, 936 retail companies failed (7.6% of all insolvencies). These percentages compare unfavourably with the sector’s lower 5% share of GDP.
Major retailers
The Centre for Retail Research maintains statistics regarding 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.
Their analysis confirms that 2020 was the worst year for these collapses since their records began, surpassing even the previous records set in 2008 at the start of the global financial crisis when the statistics were distorted by the collapse of Woolworths. In 2020, 54 major retailers failed, putting 5,214 stores and 109,407 jobs at risk. Major insolvencies included Arcadia, Debenhams, Oasis & Warehouse.
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.
The outcome for 2022 looks broadly similar to 2021 so far after almost ten months, during which 19 major retailers failed, affecting 1,668 stores and 28,786 jobs. However, at the time of reporting two more major retailers are experiencing what may turn out to be terminal financial difficulties. Should they and any other big retail businesses file for insolvency in the run up to Christmas, this will turn out to be a far worse year than 2021.
These statistics do not include companies undergoing a Company Voluntary Arrangement (CVA) unless they subsequently went into Administration or Liquidation.
Profit Warnings
The consultants, EY Parthenon publish quarterly reports on profit warnings issued by listed companies. The statistics for Q3 2022 make stark reading for the retail sector. Out of the 86 profit warnings, 11 (13%) were in the retail sector, making it the sector with the highest number of profit warnings.
The fact that such sophisticated, major companies were facing so much business disruption and uncertainty that they were unable accurately to predict their profitability, is a cause for serious concern, not least for their smaller, less-well capitalised and resourced retail brethren, who face the same problems but with far less capacity to cope.
Shop vacancies
Much justified irritation among retailers continues about the media’s persistent focus on empty and boarded up premises, which completely fails to reflect what is actually happening in many locations, where intelligent placemaking is transforming usage patterns. The Local Data Company (LDC) has just published data for H1 2022, which shows that the vacancy rate for retail units in the first half of 2022 was 15.4%, down from a peak of 15.8% throughout 2021.
However, LDC points out that this reduction owes much to the change to leisure usage of some empty retail units and an overall reduction in the stock of retail units, particularly in major town centres. The leisure switch will of course be threatened now by the impact of the cost of living crisis on eating and drinking out.
LDC also reported a significant improvement in the net change (openings vs. closures) in the number of retail units in H1 2022. The net fall was only 923, the most positive outcome since H1 2017. The number of closures was down 7% year-on-year at 24,832, which is even below the pre-pandemic figure of 25,762 for H1 2019. It is the lowest closures figure since H1 2018.
Future Projections
Retailing remains hugely challenging, especially for smaller operators now struggling under a far higher debt burden than before the pandemic. There are still too many physical outlets, the future of many of them plagued by ongoing uncertainty about what the final outcome of the WFH trend will be and the savage impact of the cost of living squeeze on their customers.
Business Rates remain a grossly unfair differentiator between pure play online retailers such as Amazon as opposed to more traditional bricks and mortar-orientated businesses, as well as between different parts of the UK. Even so, some online retailers have run into significant financial setbacks recently as online shopping has slowed and the fast fashion craze has cooled, leaving many with expensive fixed costs for the greater operational capacity they created during the pandemic.
The impact of the cost of living crisis and rampant inflation is producing some startlingly contradictory retail sales statistics, with sales volumes falling while sales values rise. It remains to be seen what impact this will have on profit margins, especially as retailers come under public pressure to help lower income families with the prices of basic foods and other essential goods.
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 not just to surviving these deeply troubled times, but to thriving remain the same: flexibility, funding, good management, top quality customer service and a sound business model.
October 2022
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 book a confidential chat without charge or obligation: