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Retail shares – is the lockdown shift to online shopping worth the hype?

In the third part of our life-after-lockdown series, Equity Analyst Sophie Lund-Yates takes a closer look at the retail shift to online shopping and what this could mean for investors.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

What's changed?

Lockdowns mean we buy less, and retail sales volumes in the UK fell 12.8% in the three months to May. However, that drop masks a significant increase in online shopping. Online sales as a percentage of total retail sales stood at 33.4% for May.

What this means is the digital age – which was already dawning – has been brought forward. Our change in habits are here for the long-term, and this won’t be a flash in the pan.

This is an opportunity for shops. But it’s also going to require some to whip themselves into digital shape fast if they want a piece of the pie.

This article is not personal advice. If you’re unsure whether an investment is right for you, please seek advice. All investments fall as well as rise in value, so you could get back less than you invest.

Morrison and M&S – what about shops on the back foot?

Demand for supermarket delivery slots far outstripped supply in lockdown. This will have triggered a longer-term shift to online grocery shopping, because many more households have become accustomed to the service.

But not all of the supermarkets are starting from an equal footing. That could make it difficult for some to fully take part in the shifting demand patterns. Morrison’s online offering is a lot smaller than its rivals’, with just 40 of its stores geared up for deliveries.

The group has tightened its partnership with Amazon, helping the tech giant with efforts to offer same-day delivery to more areas. This is a potentially exciting growth lever, but the reality is even with this new development Morrison’s online footprint is small fry.

A mostly owned store estate does give Morrison significant flexibility, with just £72m of lease related debt, compared to the billions its rivals have built up. That means Morrison has the flexibility to throw some firepower at turning its digital fortunes around.

Lease related debt (£bn)

Sources: 2019 Full Year Results.

Investors need to keep in mind that while the digital shift has been accelerated, it will take time before there’s enough infrastructure in place to fully upend the status quo. In fact by Tesco’s estimation a whopping 85-90% of food sales still require a visit to a shop. For Morrison that means there’s some breathing room for it to get its digital house in order before it’s officially too late to the party.

So, supermarkets are still predominately bricks and mortar businesses for now, and that’s working out better for some than others.

Marks and Spencer’s food halls are very different to the bigger grocers. It relies more on city centre and travel footfall, (think nipping in to grab a sandwich rather than doing your full weekly shop). That meant food sales struggled to thrive when the nation took to panic buying.

M&S’s lack of online offering didn’t help either. However, the launch of its products on Ocado.com (of which it now owns 50%) in September should really step things up in this department.

It’s a very mixed bag when it comes to the grocers and online shopping. Investors need to be careful not to paint them all with the same brush, or assume that digital domination is going to happen overnight.

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Inditex – integral integration

We’ve said for a while that Zara owner, and biggest fashion retail chain in the world, Inditex is one of the better run retailers. We continue to think this is the case and it’s well placed to capture the swelling online tide.

Over 1000 smaller shops are going to be closed in the coming years, which equates to about 13% of the current global store estate. The group’s going to focus on bigger sites in prime locations and aims to fully integrate its online operations with physical shops. This will act as a boost to what is already Inditex’s biggest advantage – stellar inventory management.

Working capital is something all investors in retail companies should consider. This measures the difference between a company’s current assets like inventory, cash and customer’s unpaid bills, and current liabilities which will include the amount of money a company owes (its payables).

High working capital can suggest the company has too much inventory which can ultimately drag on cash flow. This is a trap retailers have to be particularly careful of. Inditex has traditionally run a very tight ship when it comes to its supply chains and stock management, meaning it doesn’t tend to tie up unnecessary cash in excess inventory.

Inventory as a percentage of sales

Sources: 2019 Full Year Results.

There are a couple of things to keep in mind though. Their optimisation programme has been brought forward because of the current crisis, and it doesn’t come cheap. A €308m provision for the changes contributed to an operating loss of €508m in the first quarter, compared to a profit of €980m last year.

And there’s also the fact coronavirus is hurting sales. Even though things are starting to pick up as lockdowns reduce, that won’t translate to standard sales volumes for some time. Inditex can handle some disruption thanks to its robust balance sheet which boasts almost €6bn of net cash. But it’s still unclear how long it will take for profits to start looking spritely.

A price to earnings ratio of 30 is also higher than the longer term average, which signals confidence for the future, but it means the share price could fall if Inditex’s ambitious plans don’t go to plan.

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British Land – can digital sales pay rent?

Lockdown closures mean commercial landlords are struggling to collect rent. For the latest round of quarterly rent collections, estimates suggest less than a quarter of what’s owed was handed over.

The shift to online was already seeing high street businesses struggling to hold onto customer footfall. Last year British Land, said that “increasingly, the true value of physical stores is as a showroom or logistics network to support fulfilment of an online sale”.

The shift to online doesn’t mark the end of physical shops, or their landlords. It marks a time of change, and those that stand to benefit are those in positions to pivot along with the shifting demand patterns.

In light of the challenges, British Land has been shrinking its exposure to retail. It’s sold £3bn of retail assets in the last five years, and focusing attention on multi use sites. These spaces, like the new 53 acre development in Canada Water in London will combine retail, leisure and office space. We think this strategy is the right way to go.

British Land's portfolio

Source: British Land 2019 Annual Report.

It’s also more important than usual that REITs (Real estate investment trust) aren’t carrying too much debt, or it makes weathering the disruption a far more onerous task.

British Land has a fairly robust balance sheet, with access to £1.3bn in undrawn borrowing facilities and cash. It also has a fair amount of headroom before it runs the risk of breaching the financial terms set by its lenders.

We’re not saying the path is going to be a totally smooth one from here. But we think British Land is in a better position than some of its peers to benefit from the changes in our high streets and retail parks.

Investors should also note the current share price is around half the group’s own estimation of its asset value per share. We think this could present opportunity for investors prepared to take a longer-term view and a higher degree of risk, but remember it also highlights the significant challenges ahead.

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Hargreaves Lansdown’s Chair is also a Senior Independent Director at Tesco plc.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. 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. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. 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. 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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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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