5 shares for a tough week in retail

Traders pound sterling, sterling hits retailers

A tough week for UK stocks, particularly retail stocks, was made worse on Thursday by a largely unforeseen upsurge of hawkishness at the Bank of England. May retail sales day released on the same day compounded existing pressures on the pound, keeping retail shares in red. Sales fell more sharply than expected in May, with a 1.2% monthly decline when a 0.8% fall was forecast by economists. The slide came after a large surge in sales in the month before.  The pattern ties in with the view that British inflation is beginning to bite, as retailers push up prices to offset rising import prices linked to sterling’s collapse. This week separate data showed UK earnings after inflation contracted at the fastest pace since 2014 in the three months to April, and that prices leapt 2.9% in the year to May, the biggest rise in four years. In its Thursday Retail Sales release, the ONS noted "Increased retail prices across all sectors seem to be a significant factor in slowing growth."

These consumer-related economic readings have created a cocktail of sour sentiment for British retail stocks.

Few ‘winners’

• Online ‘fast fashion’ retail firms boohoo.com and ASOS, remained in relative favour on Thursday, falling the least, followed by Burberry, the FTSE 100-listed haute couture house that has more to do with luxury retail demand from overseas than on the high street per se.
• Supermarkets, Tesco, Morrisons and Sainsbury’s also fell a more modest 2%-3% than most retailing peers. The ONS had pointed out earlier that “Non-food stores were the main contributing factors to this slowdown”

Contenders and strugglers

Since we believe investors are continuing to rate retail shares both on their ability to grow sales and their resilience to segment-specific slowdowns, we think cash flow remains a sharp differentiator. We offer 5 shares that reflect that view.

• With JD Sports Fashion hands down the best cash flow generating retail share in the UK over the last five years, we expect it continue showing the best resistance to any impact on so-called non-essentials
• Whilst we’re warier of the very best performing retail stocks over the last year and this year—those volatile online fashion shares ASOS and boohoo again—rises of 75% and 322% (not a typo) since last June are difficult to ignore. Investors appear to discount their relatively modest profit growth due to much lower overhead costs from not operating from physical stores. Boohoo also appears to have a premium from ultra-strong focus on the low-cost but high-volume 17 year old to age 27 segment
• We continue to avoid the most challenged store-operator names like Debenhams. It’s not the worst cash flow growth story with a 2.6% fall over five years, but we find its trailing price/earnings ratio of 26 times compared to our top pick JD Sports on 23 times unjustified
• We expect Travis Perkins to keep attracting negative scrutiny due to its barely-covered dividend combined with an elevated yield vs. sector and weak cash flow