The UK Retail Market that was already in transition before Covid

In this report, we look at the shape of this market and the way forward.

The UK Retail Market that was already in transition before Covid

The Shape of the Market

The UK retail market has been buffeted for many years by change on an historic scale. A simple analysis might point the finger of blame at the rise of internet shopping, which has lessened the dominance of bricks and mortar stores as the major sales delivery channel. According to the Office of National Statistics (ONS), internet sales have grown from 7.3% of all retail sales in 2010 to 19.2% by 2019.

This has not just reduced sales directly attributable to physical stores and therefore their profitability, but the accompanying returns phenomenon has also cut profit margins and caused operational stresses and strains.

Accepting this explanation ignores other potent negative influences. The basis of retail property leases had created an inflexible cost base, with too many long-term leases with fixed rents subject to regular upward only reviews and infrequent break clauses. Retailers have been struggling to find a better property occupation model for many years, with successive bouts of Company Voluntary Arrangement (CVA) mania under which some landlords were forced to concede less onerous terms.

The pandemic has sharply accelerated this trend, which will now inevitably end with the great majority of premises subject to turnover-related rents. Landlords and their tenants will effectively become commercial partners, rather than having the traditional master/slave relationship.

Business rates are an equally difficult area for retailers; liabilities have escalated in recent years to the point where they can be several times the rent payable on a unit. They have also served to create a savagely unlevel playing field between physical retailers and their online rivals. The likes of Amazon pay a very small percentage of the business rates imposed per square foot on retail space in stores.

Two more adverse factors are significant. The retail sector is probably the most slavish follower of top line, sales-driven management thinking. The old business school mantra ‘top line equals vanity, bottom line is sanity’ might have been written specifically with retail in mind, but it is a theory more often ignored than followed in the sector.

Price competition and market share dominates management trading updates. Retail is a market, which celebrates too many ‘busy fools’. This attitude has allowed the consumer to take control of pricing with disastrous impacts on profit margins.

The UK retail market has been buffeted for many years by change on an historic scale. A simple analysis might point the finger of blame at the rise of internet shopping, which has lessened the dominance of bricks and mortar stores as the major sales delivery channel. According to the Office of National Statistics (ONS), internet sales have grown from 7.3% of all retail sales in 2010 to 19.2% by 2019.

This has not just reduced sales directly attributable to physical stores and therefore their profitability, but the accompanying returns phenomenon has also cut profit margins and caused operational stresses and strains.

Financial Risk

We have used the Company Watch system to analyse 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 111,597 companies.

This highlighted some deeply concerning statistics. 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 over the next three years.

Out of our sample of 111,597 companies, an extraordinary 55,466 (50%) are in the Company Watch warning area with 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, 56% were in the warning area; for those with total assets below £25k, 63% are at serious financial risk. Major retailers with assets over £125k have a warning area rate of 34%. This confirms that while there are some much larger retailers with serious financial issues, the bulk of financial risk in the sector lies with smaller businesses.

We also identified any ‘zombie’ companies with negative balance sheets (by at least a de minimis figure of £10k). 20,552 (18%) were zombies with a combined excess of liabilities over their assets of £2.35bn.

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 27,947 (25%) such companies, which had a combined working capital deficit of £18.5bn.

It should be stressed that these results are based on accounts for periods ending before the Coronavirus pandemic, so any negative financial effects of the crisis are not reflected in our research.

Insolvency and Business Failure Issues

Figures from the Insolvency Service show that 7% of corporate insolvencies in the UK occur in the retail sector, with between 1,300 and 1,600 companies a year undergoing a formal insolvency procedure between 2015 and 2019. The rate has slowed in 2020 because some of the government’s coronavirus support schemes and measures have severely reduced the number of insolvencies across the whole economy since March 2020.

Major Retail Failures

The Centre for Retail Research maintains statistics regarding the failure of major retailer 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 is already 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. Up to 6 November 2020, 51 major retailers had failed, putting 4,206 stores and 82,880 jobs at risk.

Up to the end of July 2020, 53% of the stores affected had closed permanently and 44% of the ‘at risk’ staff had been made redundant. The equivalent figures for the whole of 2019 were 37% and 21% respectively.

These statistics do not include companies undergoing a Company Voluntary Arrangement (CVA) unless they subsequently went into Administration or Liquidation.

The Impact of the Pandemic

The first national lockdown caused the biggest fall in retail sales on record with a drop of 18.1% in April 2020 alone according to ONS figures. The easing of that lockdown in July prompted a recovery, which continued through to September to the extent that by then retail sales had climbed to 5.5% above pre-pandemic levels. It will remain to be seen what the programme of local lockdowns in October and now the second national lockdown in November has done to this picture.

This overall profile masks sharp differences between retail sub-sectors. The grocery trade has seen consistent growth at the expense of spending in the hospitality industry, apart from during the Eat Out to Help Out scheme in August. After the initial shock of the first lockdown, furniture and DIY retailers have flourished as the WFH revolution and social distancing restrictions have prompted consumers to spend on adapting and improving their living spaces. By contrast, fashion spending has plunged with the move to WFH and the reduction in social activity.

We have already noted the pre-pandemic trend away from physical shopping to online purchasing. Online sales have soared during the crisis from 19.2% in 2019 to 27.5% in September 2020. There is a lack of meaningful analysis of the different profit characteristics of the two styles of retailing, so the impact of this on retail profitability remains unclear. However, all retail pundits and the retail sector itself agree that this shift will be permanent, with its inevitable implications for retail employment levels, for landlords and for high street/town centre environments. A detailed study of these issues can be found in the Grimsey Covid 19 Supplement (June 2020).

It is also too soon to assess the degree to which retailers have chased and encouraged consumer spend during the crisis by discounting prices both in store and online. There is a plethora of data on top line sales, but the profitability picture is still unclear.

This study is published in the run up to what will be the most unpredictable but also the most important peak festive season in living memory. Not only is this vital season being disrupted in operational terms by the second national lockdown, but the latest ONS statistics on unemployment confirm the certainty of a reduction in consumers’ capacity to spend. Consumer confidence is another key element in the retail industry; this will also remain both fragile and volatile for many months yet, despite some positive news on the development of effective vaccines.

Crown Preference

The government’s decision to restore Crown Preference for the distribution of funds in formal insolvency proceedings as from the beginning of December could not have come at a worse time for retailers. It is likely to have a severe negative effect on the willingness of lenders to provide working capital finance through traditional overdraft and other short-term facilities, just when retailers will need all the support they can get.

Retail Transformation

The retail sector is experiencing a rapid escalation in what was already a steady rate of change, transforming it beyond recognition compared to even just five years ago.

It has too many shops, often now in the wrong locations. Fortunately, the previous overly-restrictive property lease model is being transformed into a more appropriate and flexible turnover-based arrangement. The inevitable outcome will be far fewer shops and reduced employment.

It went into the pandemic in a poor financial state, with unacceptable levels of financial risk. The pandemic will accelerate the clearance of dead wood from the retail forest. This process has already started among the major retail chains. Next year will see it extend into the middle market and to small independent retailers. Insolvencies will rise significantly.

Nimble retailers with good management, a sound business model and an attractive customer offering will flourish despite the many challenges; poor quality retailing will be punished.

 

January 2021

Key facts

Total UK retail sales were up 3.4% to £394bn in 2019, of which 19.2% were made through online channels. The industry generates 5% of UK GDP through 306,655 sales outlets. It employs 2.9m people, equivalent to 10% of the UK workforce. 

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