The pressure has been mounting for some time. The squeeze on consumers’ living standards is now the longest in 60 years and cost increases from the weaker pound since the Brexit vote and the National Living Wage (NLW) are ongoing. This pressure is now turning into distress. In 2017, 47% more large retailers were in financial distress, compared with the previous year. Recent high-profile high street failures show that this trend is continuing: Toys R US, the UK’s biggest toy retailer, entered administration at the end of February after talks failed to find buyers for the business. More recently the Bargain Booze and Wine Rack brands were successfully sold through a pre-pack deal. We expect more of the same as the year progresses.
Consumers are already playing it safe and they expect their circumstances to deteriorate further in the coming 12 months. On balance, households expect their disposable income to fall this year, according to the April 2018 PwC Consumer Survey.
Even considering the recent announcement that real earnings are in positive territory, the levels are still well below the pre-crisis peak; as a result, many employees may still not feel better off. Real household expenditure has grown by 2 percentage points a year more than disposable income, as households have borrowed to fund their spending. There are limits to how much further household borrowing can rise, particularly with interest rates starting to edge up and the housing market losing momentum. While we expect any increase to be small, it will have a material effect on the spending power of some consumers.
As a result, in both retail and leisure, consumers will simply spend less. According to our survey, consumers plan to rein in their spending this year, particularly on eating out and big-ticket items such as furniture. Of our survey respondents, 32% plan to spend less on eating out and 26% on clothing. Intentions vary across different demographic sectors - what counts as discretionary spending varies with age. Older consumers (55+) plan to reduce spending on clothing, while for Consumers aged 18-24 are likely to rein in spending on eating out.
Businesses face a wide range of cost pressures; rent, rates, wages and inputs impacted by foreign exchange rates. This April, for example, the National Living Wage will increase by a further 4.4%. Changes to the customs code, under the new Union Customs Code introduced in May 2016, mean higher customs duty on imported goods.
But this year brings additional challenges, as businesses must also contend with changes to accounting standards. Under IFRS 16, which came into effect at the beginning of the year, operating leases must be brought on balance sheet. This could create problems for already stretched businesses by putting pressure on loan covenants and leverage ratios. The new standard is likely to have a significant impact on businesses with large portfolios of short-leasehold property, such as retailers and restaurant chains. Lenders are likely to assess companies on a case-by-case basis, but we cannot discount the possibility that some lenders may take a broader approach and use the accounting changes to trigger an event.
Companies with structural weaknesses are most likely to suffer distress, such as those with high levels of debt. The on-going structural erosion of bricks and mortar retailers’ market share by online sales will continue to create pressure, particularly for those companies with large and/or poorly located legacy store portfolios. Although some retailers have recently turned to the CVA process to reduce their store portfolio and ‘cram down’ rent costs, we do not think this is the panacea to solve businesses’ lack of funding, weak product offering, or poor quality management. Any restructuring must combine with a clearly defined and funded customer proposition.
From a demographic perspective, clothing retailers with a proposition aimed at older consumers are likely to feel the pinch. Discount fashion retailers are also unlikely to escape unscathed, given consumers’ intention to spend less, rather than trade down. In the restaurant sector, chains geared towards the millennial segment may suffer from the expected fall in spending on eating out among younger age groups. Retailers selling big-ticket items, such as furniture, are another area where sales are likely to come under pressure; we have already seen casualties such as Multiyork in late 2017.
Within retail, grocery, while less discretionary, will not be immune from trading down and switching. In our April survey 29% said they would shop around more in the grocery sector in the coming year. Over the Christmas trading period the value grocery retailers and the Big 4 captured a larger share of the consumers’ spending, with the large multiples benefiting from customers’ ability to trade up and down within store. This suggests that the upmarket grocery retailers may be the ones to feel the pain this time round rather than the middle being squeezed.
Overall, we expect an increase in financial distress in the retail and restaurant sectors in the next 12 months. The greatest effect of the ongoing impact of Brexit is likely to be continued economic uncertainty. This uncertainty has the potential to extend the period of increased levels of distress beyond the next 6-12 months. This extended phase of turbulence has the potential to further heighten the effects of the market, be they opportunity or distress.
For businesses facing potential distress, the focus should be on working capital and inventory management, while ensuring that the business footprint is appropriate to the level of demand, which in many cases will entail rationalisation of stores/restaurants. Engaging early with all stakeholders – landlords, suppliers and lenders – is also key.
For those with a little more headroom, investing in supply chain automation and digitisation is an important part of creating a streamlined business. From managing stock levels, through to customer delivery and returns, technology is a crucial part of the equation. Looking to the future, retailers should be investing in artificial intelligence and predictive analytics to get ahead: to know the customer better and to anticipate their needs.
It’s not all doom and gloom. As times get harder, trading performance diverges and the gap between those businesses that seize their opportunity and those that succumb to pressure widens. If businesses can stay ahead of the curve, they will be first in line to reap the rewards. The winners in this environment have confidence and conviction and are on top of current and emerging themes, such as lifestyle and sustainability.
A successful digital strategy is a crucial part of being among the winners. Firms that offer no reply to the increasingly mobile, connected, and digitally savvy customer may be most at risk. Genuine investment is digital is increasingly a necessity rather than a nice-to-have. Over the important Christmas trading period, for example, online fashion retailing was once again a notable area of outperformance. For those with the right proposition and business structure the current slowdown is an opportunity to steal a march on the competition.
Manager, Deals, PwC United Kingdom
Tel: +44 (0) 7843 330122
Senior Associate, Deals, PwC United Kingdom
Tel: +44 (0) 77 5381 2635