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Retail: Where next?

9 April 2019

In recent years, the retail sector has undergone a major structural change owing to the rise of internet shopping and consumers engaging in new ways to shop. Some of GAM Investments’ fund managers discuss the select opportunities that exist within retail sector as its evolution continues.

It has been a rough ride for High Street retail over the past few years with a number of well-known retailers entering administration, prompting thousands of job losses and triggering widespread fears about the outlook for the retail sector.

In the UK alone, Toys R Us, Maplin, HMV and PoundWorld are among the retailers to enter administration in the last two years, with a number of other established players such as M&S and New Look admitting to challenging trading conditions over the most recent Christmas period.

A key contributing factor behind these struggles are that the retail sector has undergone a major structural change owing to the rise of internet shopping and consumers engaging in new ways to shop. However, at GAM Investments we believe that select opportunities still exist within retail sector as its evolution continues.

Niall Gallagher, Investment Director, European Equities:

It is well known that the ongoing shift to e-commerce has contributed significantly to declines in consumer traffic on the High Street and created a vexing climate for High Street brands and retailers. However, the winners of this shift are often tarred with the same indiscriminate retail brush. This has unfairly penalised farsighted companies that have invested heavily into IT and logistics capabilities to be able to match their inventory seamlessly to meet the consumer wherever he/she is shopping – whether online or offline. Inditex, best-known for its Zara brand, is one such example, with its integrated approach to stores/offline – providing consumers with a myriad of choices – buy online, collect in store, return to store etc – all while still maintaining a mid-teens operating margin levels in a sector that’s barely breaking even. Zalando, a pure play online retailer, is presently disrupting itself to future proof its business model by becoming a platform that can enable retailers to access their own stranded inventory to service the platform’s 26 million strong customer base in a manner of their choosing.

What is common to these two companies is a problem of inventory – too much, too little, not the right kind or not in the right place. Inditex’s solution to this is to take a holistic view of its inventory and to mix an art-and-science approach to effectively match its offer with demand – which involves liaising with individual store managers who feed upwards their views on local fashion tastes/demand and top-down proprietary algorithms that allocate stock to stores.

Swetha Ramachandran, Investment Manager, Luxury Equities:

Despite the higher weight of experience in the luxury shopper’s purchase journey and the service element that as yet cannot be completely replicated online, the industry is not entirely immune to the same dynamics of declining footfall as has befallen lower-priced retail. Luxury companies have attempted to respond to this by doubling down on innovation to spark interest in their physical locations – most notably through leveraging pop-ups – Chanel and Tiffany have not just deployed these short-term, novelty physical stores with a heavily curated selection of products as a marketing tool but also to boost profitability from tapping into the luxury consumer’s growing thirst for newness as well as personalisation. Collaborations between established luxury players and emerging brands have generated significant customer interest – the Louis Vuitton x Supreme collaboration saw queues overnight in many of its retail locations, reminiscent of Apple stores during the heyday of the iPhone.

For these brands this is a win-win – with the consumer’s delight at having nabbed a limited edition, exclusive product in these channels exceeded only by the brand’s satisfaction at having attracted a likely younger, newer customer base that has now discovered the brand and may gradually progress to higher priced products.

The growing trend towards experiential luxury lends itself well to the rise of innovative concepts to capture the attention of newer luxury shoppers who embrace the role of narrative in luxury – likely boding well for the upcoming launch of the London branch of Prada’s luxury bakery concept Marchesi 1824, to follow on from the success of its Milan location. We cannot wait to see what the queues will look like!

Adrian Gosden, Investment Director, UK Equities:

A major structural shift is happening on the High Street owing to a move towards internet shopping amid rising costs for physical retailers in the form of the minimum wage, big rents and business rates. We believe that it will take government intervention (reversal of cost hikes) and local council action (town planning – parking) to ease the headwinds. Still, some stores such as Shoe Zone have managed to defy the gloom on the High Street by posting impressive like-for-like sales growth. This is rare example of retailer that is not burdened by a legacy store estate. With an average lease length of only two years it has the flexibility to react to market changes. It also means cash flow is not weighed down by upward only rent reviews, which has been the downfall of other retailers. This cash flow underpins the progressive dividend policy and recently announced special dividend.

Tim Love, Investment Director, EM Equities:

With the middle class moving from a projected 12 to 73% of the Chinese population from 2009 to 2030, Chinese consumption is projected to be 2.5 times that of the US. Already more Chinese consumers use mobile phones to access the internet than those in America, Brazil and Indonesia combined. About half of China’s online sales take place via mobile, compared to barely a third in the US. We are now entering a period of new retail with digitisation across the entire value chain. Smartphone, social media, mobile payments and e-commerce have quickly become ubiquitous in most urban areas. Meanwhile, India’s retail sector is on a faster roll than ever before where rapid urbanisation and digitisation coupled with rising disposable incomes and lifestyle changes are a boost. We believe that the Indian retail sector is at an inflexion point where organised retail and consumption are on a higher growth trajectory. The Indian retail sector is highly fragmented with 97% of its business being run by unorganised retailers like the traditional family run stores and corner stores, meaning the growth potential here is huge in our view.

The bottom line is that retailers will constantly need to evolve, innovate and unify their efforts so that shoppers’ paths to purchase are as frictionless as possible. Success in the evolving retail environment is not about this quarter or the next - it's about next year and the years to come. Companies need to think about getting the most lifetime value out of their customers as opposed to the most near-term value and depending on the model this may mean a new way of looking at business investments and margins.

Mark Hawtin, Investment Director, Technology Equities:

The disruption of the retail sector in particular is fascinating; it is no longer sufficient to purely be an online retailer. Five years ago companies were commanding a huge premium as fast growing, online retail brands. Now, online is just another route to market – it is essential to have an omnichannel presence, which is why we have seen companies such as Amazon buying Wholefoods. The combination of all the different channels to market makes a huge difference and we believe there is no reason to pay a significant premium for a pure online retailer, hence why companies like Asos, which do not have an omnichannel strategy, have struggled recently. We believe that retail stores are not just about bricks and mortar anymore – it’s about the multiple ways in which you sell to consumers and it’s very clearly shown that if you have an omnichannel strategy you tend to sell lots more products.

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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Reference to a security is not a recommendation to buy or sell that security. Past performance is no indicator for the current or future development.