Retail Therapy in the UK

Retail sales figures are a good indication of the economic state of affairs - increased consumer spending generally eases concern among both policy-makers and investors, and if sustained can lead to job creation and a cycle of economic growth. But recent figures for the UK have been mixed, and high street retailers have been quick to warn that the outlook for the sector might not be a rosy one.

Figures alone don't always tell the whole story, however. Let's take a look at how retailers are approaching the changes looming over the sector.

Retail sales: boost or bust

On 7 September the British Retail Consortium (BRC) released figures showing a 1% year-on-year increase in retail sales in the UK for August 2010. While this should be promising news for the economy, however, the story is not as clear-cut as it first seems. On 16 September the Office for National Statistics (ONS) released results disputing the apparent upward trend, revealing that UK retail sales for August had in fact fallen by 0.5% - compared to July, rather than August 2009.

It seems that the weakness of last year's numbers might be rendering the BRC's figures slightly misleading. This year's average results seem good only in comparison, and when you factor in the effect of food inflation the underlying reality is revealed to be significantly less optimistic. Necessities such as food have to be bought regardless of rising costs, and as a result food sales data can skew overall sales figures, leading to potentially misleading conclusions on the general state of consumer spending.

Bearing that in mind, the 14 September inflation figures released for the UK showed that consumer prices once again rose beyond government's 3% limit, as bread, cereals and vegetables were singled out. For the most part it's cost pressures which are driving these higher prices, as increased commodities prices and the current weakness of sterling put extra stress on the economy. [1]

But despite these harbingers of economic doom, shopping baskets still appear to be fuller this year than last and retailers are reporting steady profits and sales growth. So perhaps consumer spending really has turned the corner, and the indicators to the contrary are false?

What the retailers say

Leading retailers have had the following to say in various trading statements and reports released recently:

Associated British Foods (Primark)
'Sales and profit at Primark will again be well ahead of last year. Like-for-like sales growth of 6% is expected for the full year...'
'Higher cotton prices and freight costs and the increase in VAT...will put pressure on margins next year.' [2]

Home Retail Group (Argos, Homebase)
'Argos's sales trend saw an improvement compared to the first quarter, despite its market being more challenging.'
'Homebase's sales performance again beat expectations and continued to be ahead of its market.' [3]

Next
'We believe that selling prices of like-for-like product will rise in the region of 5% to 8% [in 2011]. Price rises are likely to moderate demand to some extent, but we think the effect is unlikely to be dramatic.' [4]

Debenhams
'We have said throughout 2010 that...we will judge our performance on profit improvement rather than sales.'
'...we believe it is correct to remain cautious about the level of consumer confidence going forward.' [5]

As indicated above, retailers have on the whole been able to return positive results so far this year, but the quotes make clear that almost all feel the future holds tougher times for the retail sector. Are they exaggerating these threats so as to cool expectations, or are retailers' concerns well-grounded?

Real retail threats

The VAT increase to 20% proposed for January 2011 will almost certainly drive down sales, though the extent of the price hike's influence will depend both on retailers' ability to offset losses elsewhere in the business and on consumers' appetite for spending. In this sense, forewarning consumers to expect price increases seems a canny move on the part of the retailers.

VAT is unlikely to be the only influence on prices over the coming months, however, as rising materials costs are also making it difficult for retailers to keep prices down. Fabric and the associated costs account for around 65% of product price in stores such as Next and Primark, so the effect of this year's poor cotton crops on high street sales figures seems straightforward to predict.

Pakistan and China's cotton crops have been devastated by floods in recent weeks, pushing prices to 15-year highs; cotton closed at an average price of $0.93 a pound on 15 September, and agricultural economists have suggested that price could hit $1.25 by January 2011. [6]

Take a position

With several retail stalwarts due to report six-month and full-year figures in the coming months, investors will be looking to take advantage of the ensuing fluctuations in share prices. An IG Markets CFD account gives you access to thousands of individual shares, with permanently low spreads and low margin requirements. You can also trade on the retail sector itself with our sector CFDs, or take a position on various commodities that might affect retailers in particular, from cotton to copper to a barrel of oil.

If you don't have an IG Markets account you can apply online in just a few minutes.

Updated: 17/09/10

Sources: [1][6] Bloomberg News (14 September 2010), [2] ABF trading statement (13 September 2010), [3] Q2 trading statement (9 September 2010), [4] Half-year results (15 September 2010), [5] Full-year trading update (14 September 2010)

The above comments do not constitute investment advice and IG Markets accepts no responsibility for any use that may be made of them.