Retail and Hospitality – how could they fare in lockdown 3.0?

A year of coronavirus disruption has hit some sectors harder than others. With another economic deep-freeze now in full swing, how heavily scarred are these businesses? And how well have they adapted to the new world?

Assessing the damage

We think the lasting damage done to businesses over the last year can be split into two distinct types. First, the damage done to company balance sheets – meaning cash used up and new loans taken on. And second, how the virus and lockdowns have affected business models and how they operate.

We’re not focusing on the profits lost over the last year, which in some sectors are considerable. Instead we’re comparing the condition of a company today, with the same company 12 months ago. Is the business fundamentally worse off today? If so by how much, and is that reflected in the share price?

This article isn't personal advice. If you're not sure if an investment is right for you make sure you ask for advice. All investments can go up and down in value so you could get back less than you put in. Past performance is not a guide to the future.

Investing in individual companies isn’t right for everyone. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Hospitality – on hold

The hospitality sector has been in hibernation for large parts of the last year. Pubs, restaurants and hotels were banned from opening during the peak of the pandemic, and operated at reduced capacity when they’ve been open.

Unprecedented declines in revenue are unwelcome in any industry, but the hospitality sector comes with particularly high fixed costs. Hotel, restaurant and pub chains can rent their properties or buy them outright with debt. Either way, interest and/or rent needs to be paid whether the building is open to customers or not.

This has affected a few big names in hospitality like Whitbread (owner of Premier Inn), JD Wetherspoons, and Restaurant Group (which owns Frankie & Benny’s and Wagamama’s among others).

All three companies have seen their book value (asset value minus liabilities) fall. However, Restaurant Group has suffered far more than the other two.

The financial half covering the first 6 months of 2020 saw a -2.9% drop for JD Wetherspoon (January to July), -7.1% for Whitbread (February to August) and -48.6% for Restaurant Group (December to June).

Remember these figures should not be looked at in isolation. You should look at the bigger picture.

That’s largely down to the fact Restaurant Group’s properties are leasehold, whereas both Whitbread and Wetherspoon own a majority of their properties.

Restaurant Group has had to take huge write-downs in the value of its rental estate. A lease on a property that’s no longer worth operating as a restaurant is worth nothing to the group. Although, an empty freehold property can still be sold off to raise money or used as collateral against new loans. This can help keep financing costs down.

The advantage of freehold property is a big change from a few years ago.

When times are good, there’s a rush to open new sites. Buying each new property is an expensive approach, which can slow down expansion. Leasing properties on the other hand requires little cash up front and keeps rapid expansion relatively low cost.

When outlets are shutting, the story’s very different. Early breaks on rental agreements come with financial penalties and the cost of unexpected closures can be significant.

When it comes to facing the next wave of lockdown, the hospitality sector is deeply divided. All companies have suffered, but those who own lots of property have tended to fare better. We also think access to cheap finance, thanks to the property they own, should set them up to make the most of any eventual recovery.

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Retail – Winners and losers

The retail sector is quickly dividing into those able to operate in a digital world, and those who rely on footfall for business. High streets have fared worse than out of town retail parks, with December footfall down 49.5% in town centres, compared to 46.1% overall.

That collapse has already hit the weakest names on the high street, with companies like Debenhams and Topshop already in liquidation or administration. However, publicly listed retailers have generally fared better. In fact, some have thrived through this period.

We’ve seen particular strengths in specialist retailers like Halfords and Pets at Home. While retail remains the driving force behind both businesses, management have focused on the services they offer – whether through MOTs or pet grooming. These services are harder to deliver digitally, giving these companies an edge over online rivals.

Essential business status has kept both businesses operating this year and they’ve both managed to grow revenues during the pandemic. Because of this, net debt has fallen and their financial position has become stronger.

It’s a different story for a pureplay clothing retailer like Ted Baker. Non-essential retailer status and aggressive online competition has seen their revenue collapse.

The group’s had to issue new shares and sell its headquarters building to bring debt under control. Without those steps, debt would’ve stayed broadly unchanged even as profits collapsed (increasing the burden of interest payments).

Valuations have changed to reflect the new conditions – Ted Baker shares have fallen substantially compared to increases in both Pets and Halfords’ share price – we think that reflects a fundamental shift in the way the retail works.

While high street shopping will continue to have a place, the shift online is seismic. Retailers who offer a specialist service or experience are better placed to deal with online competition both during and after lockdowns in our view. The fact lots also have stronger balance sheets going into the third lockdown only helps.

With the pandemic dragging on for nearly a year now, it’s become less about surviving lockdown and more about thriving in lockdown. Another nation-wide lockdown is detrimental to Retail and Hospitality no matter how you slice it. But those that have used the past few months to their advantage have an opportunity to pull ahead of the competition.

HL’s non-executive Chair is also a non-executive director at Whitbread.

This article is not personal advice or a recommendation to buy, sell or hold any investment. If investors are not sure of the suitability of an investment for their circumstances, they should seek advice. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv.

These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future and investments rise and fall in value so investors could make a loss.

This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing.

Please see our full non-independent research disclosure for more information.

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