You wouldn’t think it, to look at the endless ‘death of the high street’ stories in our papers. But things are looking up for British retailers.
Consumer confidence is at its highest level since November 2007. And the most recent Confederation of British Industry survey found that retail sales are growing at their fastest rate for 15 months.
Much of this is politically driven. It is pretty clear that chancellor George Osborne is determined to engineer a pre-election boomlet via the Help-to-Buy scheme. This boomlet probably won’t turn into sustained long-term growth. In fact, it looks more like an attempt to reflate the property bubble that got us into this mess in the first place.
However, in the short-term, this should all be good news for retailers. Rising house prices tends to mean rising consumer spending.
So now that several top retail chains have published their latest financial updates, which are the best of the bunch to load up on?
My favourite retail share
I’ll start with my favourite retail share – Next (LSE: NXT). I’ve owned shares in this company for some time. The share price has soared by 150% in the last three years. And yet, I think it still looks reasonably valued on 15 times earnings.
Next managed to keep both profits and dividends growing all through the recession. Dividends per share have risen at an average rate of 13.8% a year for the last five years, while pre-tax profits jumped by 8% in the first half of this year.
What’s more, the company is still able to generate decent returns from its investment in new stores. New branches are exceptionally profitable, with a 22% profit margin. These extra stores also contribute to the success of Next’s online business – around 40% of internet sales are collected from bricks and mortar stores.
Meanwhile, the chancellor’s reflating housing bubble should help Next’s nascent homeware business. And, if the economy hits trouble again in 2015 or ‘16, history suggests that the company can cope and continue to deliver for shareholders.
What’s not to like? Next is certainly more attractive than its main rival – Marks & Spencer (LSE: MKS). M&S currently trades on 17 times earnings. Yet the company has spent the last 15 years going through an endless cycle of ‘promising early signs of recovery’, followed by yet another profits warning or slowdown.
M&S is currently investing money in stores and its range, but I have no intention of taking the risk of these investments not living up to the PR hoopla.
The best food retailers aren’t on the stock exchange
Of course, you might feel a little reluctant to invest on the back of an election-driven economic rally. If you really want to reduce your risk, food stores are often seen as the best bet. Supermarkets rarely go bust and offer great defensive qualities to investors.
However, the frustrating thing is that some of today’s most successful food retailers aren’t listed. There’s a clear trend of consumers moving away from the mid-market supermarkets to players at either end of the market. That means Waitrose at the top, with Aldi and Lidl serving bargain hunters.
All three chains are growing their market share – around 11% in total – yet none is listed on the stock market.
So when you look at the three listed players in the UK – Tesco, Sainsbury and Morrison – you might be drawn to Sainsbury (LSE: SBRY) on the basis that it’s a bit ‘posher’ than most other supermarkets. It’s the closest to a listed version of Waitrose you can get.
What’s more, Sainsbury’s chief executive, Justin King, now has a long track record of success – same-store sales have risen now for 35 successive quarters, which is impressive. The trouble is, King has struggled to increase margins, which are currently around 3.8%.
That’s in contrast to Tesco (LSE: TSCO) where the operating margin is at 5%, even though the company is right bang in the middle of the retail market.
However, despite these decent margins, Tesco’s recent results were very disappointing. Profits in its central European business slumped by two thirds, the South Korean business has serious problems, and even the UK supermarkets need work. Indeed, Tesco failed to deliver sales growth in any of the countries in which it operates. Pre-tax profits fell 23%.
The big issue for Tesco is whether it can turn around the performance of its UK stores. The brand feels tired, and the company is stuck with a large number of out-of-town hypermarkets that have been badly damaged by the rise of online shopping. Driving 10 miles to get a cheap TV no longer seems so attractive when you can buy one for the same price online.
Tesco is trying to tackle this by diversifying its business quite radically. It recently renovated its Watford hypermarket with new attractions such as a Giraffe restaurant and yoga classes. Early signs look promising – so it’s possible that the new format will be able to revive sales.
But clearly there’s execution risk here – running cafés and keep-fit classes is a different business to stacking shelves – and even if things improve in the UK, Tesco could be dragged down by poorly-performing businesses overseas.
That brings us to the final listed option, Morrisons (LSE: MRW). This is a purely UK-focused business. It’s trading on a relatively low price/earnings ratio of 11 and has a dividend yield of almost 4%.
On the downside though, the chain is late to the party when it comes to smaller convenience stores as well as online shopping. Morrisons will finally launch an online offering in January while its first convenience shops were only opened this year. Morrisons is also especially vulnerable to attack from discounters such as Lidl and Aldi.
So clearly they all have their problems. If I had to choose one supermarket, I’d opt for Sainsbury’s. That’s because it now has a decent track record of consistent success and it’s well-positioned in the market.
But in truth, if I was only going to buy one retailer, I’d steer clear of the supermarkets and go for Next.
• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.
Our recommended articles for today
The financial industry can learn a lot from Wonga
Payday loans company Wonga is hated by many, but it’s the best role model the financial industry has, says Merryn Somerset Webb.
Big data is changing this $3trn global industry
Farming is undergoing a transformation thanks to ‘big data’. David Thornton looks at one tech stock that’s leading the change.