Investing in retail – where investors could find opportunity

The retail industry has been through a lot over the past few years and now feels like a good time to take a closer look.

Inflation is a prevailing theme we can’t ignore. Many forecast that rising prices aren’t likely to be as temporary as central banks first thought, it’s taken a toll on sentiment in several sectors. None has been more obvious than retail. Rising input costs, coupled with less willing consumers have created an environment that’s difficult to say the least.

UK retail sales volume index

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Source: ONS March 2022 Retail Sales.

But a blanket statement saying inflation is bad for retail doesn’t tell the whole story. The challenges that rising costs present can’t be understated, but there are other trends within the retail space worth watching.

With that in mind, here’s a look at how retail is holding up, and where investors could find pockets of opportunity.

This article isn’t personal advice. If you’re not sure what’s right for you, seek advice. All investments can fall as well as rise in value, so you could get back less than you invest.

In the lap of luxury

Luxury goods retailers tend to be relatively well protected from inflationary headwinds. Their high-net worth customers aren’t as sensitive to price increases, so passing on increased input costs shouldn’t come at the expense of volumes. Brand power in this segment is everything. Most of the items sold are status-symbols, so higher prices increase their perceived value.

On top of being somewhat insulated from a pullback in consumer spending, luxury retailers are also benefiting from a post-pandemic return to normality.

For those in the market for high-ticket holidays, a luxury shopping experience is often on the agenda. For some brands that means up to half of their sales come from customers travelling outside their home market. That means as travel resumes, so will high-end shopping sprees.

There are some headwinds to watch though. The resurgence of Covid-19 and resulting lockdowns in China threaten to dampen the prospects among retailers. While different brands have different levels of exposure to the region, China makes up roughly 21% of the world’s luxury goods market. Disruption there will have a meaningful impact on the sector in the near term.

The cost of eco-friendly shopping

Perhaps the most interesting trend to watch as inflation persists is consumers’ preference toward eco-friendly goods. Consumers are increasingly concerned about their impact as they shop. But at the end of 2021, surveys showed price still outweighed ESG concerns for the majority of shoppers.

As inflation’s hit everyone’s bank account even harder since that time, it’s possible that sustainability has slipped even further on the list of priorities.

That creates something of a conflict when it comes to how the retail landscape is shaped. If inflation continues at such pace, a willingness to spend more on eco-friendly products could start to wane.

It could also prompt companies themselves to abandon their own pledges to reduce their impact as the cost to maintain these initiatives weighs.

While there’s no evidence of a reversal on this front, it’s something worth watching as the cost of living squeeze gets even tighter. It could put environmental concerns on the backburner and leave many brands rethinking their strategy.

Supermarket sweep

Grocery stores have benefited from the past few years with restaurants closed or operating at reduced capacity. But now the world is reopening, going out to eat remains at the top of consumers’ list of priorities. Supermarkets are left to fight for the scraps.

To make matters worse, grocers are now competing heavily on price, which is eating into margins. With household budgets spread thin, price wars are inevitable as shoppers look for the best deals to give their wallets a break.

It’s unlikely sales conditions will ever be as favourable as they were during the pandemic, but supermarkets could see a bit of relief as costs continue to rise.

Eating out is going to get a lot more expensive. In addition to rising food prices, the cost to employ staff is also ballooning. Customers could start to retreat back to entertaining at home to keep costs down.

That would bode well for affordable luxury items like pre-made meals and higher-quality offerings that could take the place of dinner out.

Making the most of what you’ve got

Affordable luxuries like a takeaway coffee or premium cuts of beef might fare well as the cost of living rises. But actual luxuries, like a new TV or kitchen remodel, are likely to be cut from the shopping list.

Throughout the pandemic, household savings rose sharply as government stimulus and fewer expenses helped families hoard cash.

Household savings (% of disposable income)

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Source: OECD 2021 household savings indicator.

But the prospect of double-digit inflation on the horizon has many families rethinking plans to splash the cash. US consumers, for example, are becoming increasingly hesitant about purchasing big-ticket items for fear of financial hardship down the line.

That could hurt a wide variety of retailers, but those who rely on appliances and electronics could be hit hardest. It’s also likely to sting car-makers as people hold on to their current ride until they feel more secure.

Needs must

Regardless of the environment, there are certain things people will always buy. From loo roll to cleaning products, the boring basics will always have some level of demand.

For those with a strong brand name, price rises are more palatable because customers are willing to pay a bit more for something they know and trust. This is especially true for items that consumers might consider higher risk, like medicines and cleaning products.

Food, on the other hand, could see private labels start to eat into market share as bargain-hungry consumers look for ways to stretch their pounds.

Petcare is another staple that will likely ride out inflationary headwinds. More than half of UK adults now own a pet, and all of those furry companions need to eat.

But how well man’s best friend dines out is another question.

Pet humanisation, a trend that’s seen owners go over the top spending on premium food and extra vet visits, could start to trail off.

The bottom line for investors

The market can be accurate when it comes to pricing in risks. But under-loved sectors are often a good place to find an opportunity if you take the time to look.

There’s no question that retail is risky right now, and those who aren’t struggling under the weight of rising costs are few and far-between. But the entire sector shouldn’t be disregarded, especially with a long-term view in mind.

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