Welcome to Watson’s Monthly! The Monthly is a document that gives you insight into an industry or theme in more depth than is possible in the Daily.
*** N.B. the FULL version is ONLY available to subscribers. This preview is intended to give you a taste of the full report ***
In this edition of Watson’s Monthly, I will be having a look in greater detail at what is going on at the moment with UK retailers. I will do this by splitting the sector into smaller component parts and then addressing the main issues facing them to give you a general overview. Although I’ll be focusing on UK retail, I want to put it into practical context and will therefore mention other retailers where appropriate.
Overall, the retail sector has had a rollercoaster ride particularly since the Referendum and has been rocked by higher overheads, a nervy consumer and an uncertain economic outlook that makes investment more difficult to engage in with confidence. If you add into the mix changing consumer behaviour and the urgent need to refresh tired old formats, you can see why many trusted high street names are fretting about the future. Let’s take a closer look!
SO WHERE DO WE START? FOOD!
Given that retail is such a “big” area, I thought I’d break it down into smaller, more digestible morsels for the purpose of this report. I am going to break everything down into food, non-food and “others”, take a look at each area and then examine some of the issues that are facing them. The way that I am breaking them down is slightly different to the “official” classifications that you get in the FTSE or the MSCI, but I thought I’d do it this way to make things a bit clearer.
Food retail – in other words, supermarkets (aka “The Big Four” – Tesco, Sainsbury’s, Asda and Morrisons plus others such as the German discounters Aldi and Lidl). Here are my thoughts on some of the main players:
- Morrisons – Historically, was more northern in terms of geographical footprint but that changed when it bought Safeway (remember them??) back in 2004. They added more stores when Co-Op bought Somerfield as well in 2009 (the Co-Op had to shed a number of the Somerfield stores as a trade-off for getting the deal through), had a rough time and then David Potts joined them as chief exec from Tesco at the beginning of 2015. Morrisons uses Ocado’s technology systems and distribution infrastructure for its own online service and Morrisons made a real splash in 2016 when it signed a deal with Amazon to supply products for their Prime Pantry and Amazon Prime Now. The company announced its best results in nine years back in September just gone, so it is well and truly in the mix to take on its competition in the annual Christmas bun fight
- Ocado – Used to be supreme at cash burn but signed a few major deals with international deals such as Kroger in the US and Casino Group in France, which show the potential for the company to roll out its systems that it has been threatening to do for aaaaaages. The company is now being taken much more seriously following these deals
- J Sainsbury – Bumbling along but the main story here is the merger with Asda – a merger often referred to as “Sasda”. Like many of its rivals, it has flirted with overseas expansion over the years and gradually retrenched back to its home market. There are lots of critics of the Sasda deal as they are quite different supermarkets and I fail to see how getting together is going to achieve anything other than a few buying synergies and getting rid of a bit of overlap. I think that Sainsbury’s needs to do something more fundamental with its offering – but having said that, it seems like the Argos acquisition is bedding in. The Sasda deal will buy it time but I believe that a more comprehensive rethink is needed if it is to stave off the rampaging Germans
- Tesco – showing signs of life after a torrid time under “Drastic” Dave Lewis’ reign. There were rumours over the summer that he could move to Unilever to sort out their rather knotty problems, but as far as I am aware currently, “Drastic” Dave is staying put. He’s basically cut a ton of people across the board and most recently launched “Jack’s” which is Tesco’s discounter brand and their answer to the German retailers, although it just looks to me like a cr*p copy. There are only a few of these stores, so I guess it would be no big deal for Tesco’s if the brand didn’t work and it just quietly faded away
- Aldi – according to the most recent figures from Kantar Worldpanel, Aldi’s market share shot up by 0.9% – the biggest year-on-year gain by any retailer in almost four years – to 7.6% – with sales up by 15.5%.
- Lidl – Lidl’s market share increased from 5.1% to 5.5% according to the stats mentioned above from Kantar Worldpanel and sales went up by a very healthy 10.2%. The company also recently put pressure on everyone else by raising their minimum wage, meaning that everyone is probably going to have to follow suit to hang on to staff – which will squeeze margins even further
- Discounters are continuing to take market share from the Big Four – and there are no signs that this is going to stop any time soon. All the while, the discounters keep the pressure on by increasing staff wages
- It seems to me that supermarkets are just being reactive and not proactive and are so bereft of original ideas that they have resorted to copying the discounters – think of Jack’s at Tesco (although this is laughably small in the scheme of things at the moment). I fervently believe that supermarkets really need to work hard at carving out their own identity and make this part of the customer experience in order to survive otherwise they will all blend into each other, which will just end up driving traffic online ultimately
- Sainsbury’s is currently trying to buy Asda. The Competition and Markets Authority is looking into it at the moment so this deal has yet to be finalised. Sainsbury’s and Asda are saying that the grocery retail landscape has changed with the advent of the German discounters and so even though “Sasda” will be a larger entity, there is still enough competition in the market to give enough choice to the consumer. On the other hand, farmers are saying that they are concerned they’ll get screwed by “Sasda” and the supermarkets who aren’t in the deal are obviously saying how bad it will be for customer choice and that they’ll have to pay higher prices yada yada yada. Funny, that. Anyway, I think that the likeliest outcome is that it will go ahead and the enlarged entity will be ordered to divest a number of stores as part of the deal closure process. The fact that Tesco’s acquisition of Booker went through shows that the CMA is OK with two market leaders coming together, which would suggest that the Sasda deal is more likely to succeed
- Supermarkets are, like many of us, facing uncertainty in the short term with Brexit which is likely to weaken the pound further (making imports more expensive) but they will also be facing higher overheads as wage costs continue to increase because of the tight labour market and pressure from its rivals
FOOD VENDORS, RESTAURANTS/PUBS
This is a very fragmented bit of the high street and so I thought I would give you a breakdown of who owns what – you might be surprised by what you see below and it may make you look things a bit differently! I have tried to list many of the brands you might know – this list is not exhaustive but it is correct to the best of my knowledge as at the time of publishing this report.
- The Stonegate Pub Company (formed by private equity company TDR Capital) runs Walkabout, Scream, Slug & Lettuce, Yates’s, Sports Bar & Grill, Henry’s Café Bar, Popworld (which is replacing the brands Flares and Reflex)
- JD Wetherspoon (FTSE 250 company) operates about 900 pubs and has quite a colourful founder in Tim Martin, a prominent Brexiteer who this year ordered the deletion of all its social media profiles because of all the bad publicity surrounding social media generally with trolling etc.
- Mitchells & Butlers (a FTSE 250 company) owns All Bar One, Nicholson’s, Toby Carvery and Harvester
- Punch Taverns (which was listed on the FTSE SmallCap index until private equity firm Patron Capital bought it in 2016 and divvied up the pub estate with Heineken International) runs around 1,300 leased pubs
Casual restaurant chains
- The Restaurant Group (listed on the London Stock Exchange) owns Chiquito, Frankie & Benny’s, Garfunkel’s and is currently in the throes of buying Wagamama’s from private equity firm Duke Street Capital
- Casual Dining Group (a restaurant operator) owns Bella Italia, Café Rouge, Las Iguanas, Belgo, La Tasca
- Bridgepoint Capital (a private equity firm) owns Ask Italian, which itself was part of the Gondola Group which comprised of Pizza Express – which was subsequently sold to China’s Hony Capital – and Zizzi). It recently sold Pret a Manger to JAB Holdings
- Yum! Brands – listed on the New York Stock Exchange and S&P 500. Owns KFC, Pizza Hut and Taco Bell
- McDonald’s – you know who they are!
- Subway – purveyors of cheap-and-cheerful sandwiches
- Restaurant Brands International (which owns Burger King and Canadian coffee shop and restaurant chain Tim Hortons as well as Popeye’s Louisiana Kitchen – sorry, apparently it’s got no apostrophe officially but I just couldn’t help myself. It just doesn’t look right ;0)). Trades on New York and Toronto stock exchanges
- Greggs (FTSE 250), largest bakery in the UK. Has been doing OK, but very conscious about the challenges that lie ahead. Things could be worse – it could be Patisserie Valerie! Trying to keep costs down by renegotiating shops rents when they come up for renewal
- Eat – owned by Lyceum Capital (a private equity company)
- Itsu – private company
- Leon – private equity-owned.
- Pret a Manger – recently sold to JAB Holding company by Bridgepoint. It was all going well until the death of that poor 15-year old girl. I suspect that the company will be spending a lot of money on making sure this doesn’t happen again
- Starbucks – quoted on the NASDAQ and S&P. Going mainly sideways in the States, but its growth region in China is facing serious competition from Chinese super-start-up Luckin Coffee (yes, that’s spelt with an “L”)
- Costa Coffee – was owned until recently by Whitbread, but is currently in the process of being sold to Coca-Cola. Coke has been trying to diversify its beverage portfolio and caused a rush in cannabis stocks when rumours surfaced that it was going to make cannabis-infused drinks, but hey – that’s another story
- Caffe Nero – Privately owned
- AMT Coffee – Privately owned. Main presence is stations, so could it be benefitting from that captive audience as much as WH Smith has been?
- Higher labour costs due to higher minimum wage, lower numbers of Central and Eastern European workers coming to the UK and having to pay more to retain staff who could easily go elsewhere given the current tightness of the labour market
- Uncertainty in terms of Brexit impact on raw material costs
- Higher business rates and stubborn rents. The rates thing is ongoing but rents will continue to come under pressure as more companies go bust and big gaps start forming in the high street
- The list of eateries that have gone bust or are flirting with doing so continues to get longer. Prezzo, Byron Burger, Jamie’s Italian, Hummus Bros and Cau all went bust or came close to doing so this year. Landlords have started to complain about the massive rise in companies seeking CVAs to chop big percentages off their rent and are becoming increasingly resistant to doing so to keep the chains alive
- I also think that the customer base is inherently fickle as tastes change and restaurants will have to up their game more and more as their punters get more sophisticated. However, the good news is that customers are still interested in spending money on “experiences” – like going to eat at a restaurant. It’s just that there are so many options these days plus the plethora of home delivery options
The next part of the report includes a breakdown of non-food (clothing, DIY/homewares, department stores) and “other” retailers (e.g. M&S, Waitrose, WH Smith and Boots) and discusses things like the future of department stores, what changes are needed to ensure long term survival and puts it all into a global context. As I said above, this will only be available for SUBSCRIBERS to Watson’s Daily.