Value on the high street

The demise of Wilko is the latest sign of the challenges facing Britain’s general retailers. But while the sector’s woes may yet worsen, there are still stocks worth buying, says David J. Stevenson

It’s only when you walk past the suddenly empty windows – maybe already boarded up – that it fully sinks in. This shop was one of your regular haunts. Now it’s gone. Stores on Britain’s high streets have experienced years of tough trading. More and more UK non-food retail outlets are shutting down. 

The most recent high-profile chain-store failure was the 93-year-old, 408-outlet, hardware and general merchandise retailer Wilko. It entered administration on 10 August 2023. Most of the stores will be closed, making this the biggest retail collapse since Woolworth’s in 2008. Indeed, 2023 has seen “lots of problems in the retail sector, but particularly in areas which looked to have high demand and plenty of well- heeled customers – prestige fashion and sports cycling”, notes the Centre for Retail Research (CRR). 

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Recent years have seen the failures of shirt maker T M Lewin, camera dealer Jessops, stationers Paperchase, department stores Debenhams and Beales, clothing retailers Arcadia, Bonmarché, Edinburgh Woollen Mill, Jaeger, Joules, Laura Ashley, M&Co, Peacocks, Petar Petrov, Harveys Furniture, Sofa Workshop, builders merchant Tile Giant and off-licence chain Oddbins. 

Even landlords haven’t been immune. Intu Properties, owners and managers of some of the country’s top retail malls, entered administration in June 2020 as many of its retail clients couldn’t pay their rent bills, leaving Intu unable to service the interest payments on its £4.5bn debt mountain. Almost 18% of shopping-centre units were vacant in this year’s second quarter, according to the British Retail Consortium’s (BRC) Local Data Company (LDC) Vacancy Monitor, while 14% of high street outlets were lying empty.

Business rates have been a major problem for retailers. They are a tax on the right to occupy commercial property and typically equate to around 50% of annual rent, according to Knight Frank, making them one of the largest business costs.

However, in March 2020 the government launched a review with the aims of cutting the burden. The October 2021 Final Report of the Business Rates Review announced changes to cut business rates by £4.6bn between 2022-2023. Further support worth £13.6bn over five years was announced in the 2022 Autumn Statement. 

That’s a start, and more progress on this score is likely. Meanwhile, though it’s sad to see so many big names depart Britain’s high streets and shopping centres, there is one consolation for businesses strong enough to survive: future competition will be diminished, so making money in non-food retail will become easier. 

What’s more, inflation will fall eventually, easing the cost-of-living squeeze. Yet even if UK physical non-food retailing is widely considered to be in structural decline, there’s another beneficial aspect for contrarian investors. Gloom and despondency has lowered the sector’s stockmarket valuation, creating buying opportunities for existing pockets of value that have recovery potential. The time to acquire these is when they’ve fallen right out of favour, such as now.

What to buy now  

Today we highlight two general retail stocks that qualify. Their lease liabilities – what they have to pay to maintain their high street/shopping centre stores – are under control. They enjoy a strong online presence. And their share prices could rebound sharply over the next few years. 

We wrote about Associated British Foods (LSE: ABF) 18 months ago, since when the shares have risen by more than 20%. ABF has a world-leading food business. It also owns Primark, the largest fashion retailer in the UK by volume, and boasts a growing US presence. It has more than 410 stores in 15 countries across Europe and the US.

Previously hit by Covid lockdown effects, in the 24 weeks to 4 March 2023, Primark contributed almost half of ABF’s total adjusted operating profit. And in the latest trading statement for the 52 weeks to 16 September 2023, ABF says the overall outlook for this financial year is slightly better than previous expectations of a moderate increase in group adjusted operating profit.

Primark’s turnover in its last financial year was £9bn, 15% ahead of the previous 12 months, with 9% like-for-like sales growth. This has been “driven by selective price increases, well received ranges and strongly performing new stores... we continue to expect a substantial recovery in gross margin as a result of lower material costs, the weakening of the US dollar against sterling and the euro and lower freight costs”, says ABF. Primark’s adjusted operating profit margin should “recover strongly in the next financial year.” 

Eighteen months ago we had ABF on a prospective price/earnings (p/e) ratio of 11.5. Despite the subsequent rise, improved profitability means it now trades on a p/e of below 12 for the current year and 11 for the following 12 months. More than 40% below its 2015 highs, the stock is still worth buying for an ongoing recovery. 

Kingfisher (LSE: KGF) is an international home improvement company with about 1,980 stores, nearly 1,200 of which are in the UK and Ireland. It operates in eight countries across Europe under retail banners including B&Q, Castorama, Brico Dépôt, and Screwfix. Lockdowns hit the firm’s profits, while the stock price was also affected by a derating (a lower value placed on its earnings by the market). 

And the pain hasn’t ended yet. In the six months to 31 July, like-for-like sales fell by 2.2%. Profit dropped 23% to £433m, reflecting higher operating costs in the UK, Ireland and Poland caused mainly by increased pay rates and energy costs. As a result, Kingfisher is cutting its 2023-2024 full-year adjusted pre-tax profit guidance to £590m (the previous guidance was for £634m). 

However, “trading in the UK & Ireland continues to have positive momentum”, says the firm. “We remain very positive on the medium-to-long-term outlook for home improvement.” Many new homes will be needed in future. Kingfisher is “confident” in its scope for growing market share. A new £300m share buyback programme reflects its bullishness. 

Earnings estimates put the stock on a p/e of 9.4 for next year, dropping to 8.3 for the following 12 months. Though the price may drop further, that is a distinctly cheap valuation. Future profit growth would make the stock even better value. Meanwhile, the yield is 5.7%, with the dividend almost twice covered by prospective earnings. Buy.