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Retail vs online shopping – time’s up? Or are times just changing?

We take a closer look at the retail landscape and whether online shopping will really be the death of physical retail.

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.

All information is correct as at 30 June 2021 unless otherwise stated.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. 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.

Physical retail isn’t dead – it’s changing

Sophie Lund-Yates, Equity Analyst

It would be foolish to deny the challenges faced by bricks and mortar retailers. Declining footfall was already hitting headlines when the pandemic struck, which of course made things a lot worse. Retail figures from February 2021 show clothing retail volumes were down 50.4% compared to pre-lockdown.

But there’s a strong argument to suggest retail isn’t dying, it’s evolving. And like any revolution, it’s messy. And there will be casualties. We’re in the messy bit now, as high streets and shopping centres work out how to re-calibrate.

Dixons Carphone – you can’t put a price on service

Service is the strongest argument in my opinion. The likes of Amazon, and pretty much any purely online delivery service for that matter, don’t offer a face-to-face service. There are certain items customers will always want to talk to a knowledgeable assistant about.

Things like a new laptop, washing machine or TV. That’s where the likes of Dixons Carphone, soon to be known as Currys, comes in. Despite UK and international store closures and restrictions, Dixons’ full year electronics sales actually rose 14% in the last year (to April 2021), helped by online sales more than doubling to £4.5bn. That’s no doubt been helped by the 24-hour ShopLive proposition, which connects shoppers to real life colleagues for product demonstrations.

While that might sound like a point in favour of the shift to online, I don’t think that’s the case. In fact, the attempt to replicate face-to-face service online only highlights the unique selling point of physical stores. Ultimately, Currys PC World is the sort of shop a lot of consumers will still want to physically visit to talk to someone about their products.

Dixons revenue by divison

Scroll across to see the full chart.

Source: Dixons Carphone 2019/20 company accounts.

The shift to home working and home improvement spurred by the pandemic should also be a long-term tailwind. There’s a lot resting on the face-to-face unique selling point though, because Dixons’ operating margins are a bit thin for comfort, at just under 2% at the end of the last financial year. A shop full of helpful assistants is what should, in theory, allow the group to charge higher prices and keep online competitors at bay. This is far from guaranteed, and while there is potential for growth, we’d like to see margin progression come sooner rather than later.

Of course, Dixons Carphone isn’t the only retailer offering face-to-face service. There are plenty of others. Companies in the business of pet care, or car gadgets spring to mind. The challenges probably aren’t over for even these bricks and mortar players – but as the high street shakedown continues, these types of shops should be more resilient than others. Crucially, I think they’ll still have a physical presence in the decades to come.

Inditex – honey, I shrunk the store estate

The amount of physical retail space is likely going to shrink dramatically in the coming years. But that doesn’t mean all shops are going out of business.

The savvier fashion chains are moving to make the shops dual purpose, acting as a hybrid between online and physical shopping. The world’s biggest clothing retailer, Zara owner Industria De Diseno Textil (known as Inditex), is one such company – €2.7bn is being funnelled into digital and inventory innovation.

The idea is that shops should act as a central distribution centre for online sales, rather than working as a separate entity. It already has a state-of-the-art inventory tracking system, which tracks which items are popular in real time. Inditex’s stores and online business are now working in tandem, feeding off one core inventory system.

This is an admirable system – it makes sense for retailers to stock fewer items. Quite simply, it’s madness to stock 20 of every size, for every item anymore, like some retailers are still doing. Those shops that don’t get tough with their inventory are the ones likely to fail.

Inditex inventory position

Source: Refinitiv Eikon, dates given as at January each year.

Comparing inventory growth to revenue growth is one way to see if a company has a good handle on its stock levels. Excess inventory not only suggests inefficient buying practices, but it can seriously damage profits. As the graph shows – even though revenue fell off a cliff thanks to the pandemic, inventory as a proportion of sales didn’t spike too dramatically. I think this makes Inditex much stronger than its peers.

The other big part of surviving the high street revolution is grasping the nettle and consolidating store estates. Inditex is in the process of closing 1,000-1,200 smaller stores, representing 5-6% of group sales.

Of course, risk isn’t eliminated for Inditex, or its peers. Huge strategy shifts come with the risk of getting things wrong, or in some cases, as we’ve seen with struggling department stores, moving too slowly.

It’s especially important to consider this when looking at share price valuations – the market’s currently quite excited about some better-placed retail stocks like Inditex, which heightens the risk of short-term volatility.

It won’t come as a surprise to hear that financial strength is key. Even the more resilient names need to have enough flexibility to stomach some ups and downs. The Spanish group had net cash of €5.8bn at the end of the first quarter, which isn’t to be sniffed at.

My verdict

Physical retail is here to stay. It will be on a smaller, much slicker scale, but it will endure. The current volume of bricks and mortar shops can’t be sustained, but we aren’t going to see a wash out of all physical shopping experiences.

There are real concerns about what the future of the sector will look like. That means for those prepared to do some digging, and accept external risk, there could be real opportunity.

Software is eating retail

William Ryder, Equity Analyst

In 2011 Marc Andreessen, co-founder of the venture capital firm Andreessen- Horowitz, wrote an influential article called Why Software is Eating the World. He argued that:

“Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale.”

This was in 2011, and Andreesen has since looked eerily prophetic.

Online Retail Penetration in the UK

Source: ONS, 28/06/21, all retailing excluding automotive fuel.

Even before the pandemic, online retail had been rising rapidly as a percentage of total spend. Between January 2008 and December 2019 online sales rose 553%, which works out to an annual growth rate of 17%. Since then online sales have risen another 64%.

We don’t know whether online retail penetration will fall back to its pre-pandemic trend or continue its rise from here. But it seems reasonable to suggest it will continue to grow in the long run.

Caveat venditor – boohoo is coming

Caveat emptor – Latin for “buyer beware” – has a long history in English law, but it was also one of the major hurdles for online shopping. Could buyers be confident they’d get what they ordered? Would the order be delivered in reasonable time? Could it be returned easily if there was a problem?

Trust was a big issue in the early days of online shopping, but we’ve grown much more comfortable with it over time. Now, it’s incumbent sellers that must beware a new breed of competition.

boohoo is a fast fashion ecommerce giant which personifies the new world of retail in more ways than one. boohoo can offer the latest looks at affordable prices thanks to its online platform and growing stable of brands. The business is based upon “test and repeat”, where flexible supply lines allow it to test new products and quickly make and distribute more of anything selling well.

boohoo revenue and cash profits

Source: boohoo company accounts. boohoo financial year runs to the end of February.

One of the biggest advantages online retailers have is a lack of rent payments. Nothing demonstrates this better than boohoo’s purchase of the Debenhams brands. In its final annual report, Debenhams reported almost £2.2bn worth of contractually obligated rent payments due in the next ten years, a legacy of long leases signed in better days. Tellingly, boohoo didn’t touch the store estate when it bought the brands.

But boohoo has also demonstrated a darker side of fast fashion. Last year an independent report into boohoo’s supply chain found “serious examples of unacceptable working conditions and poor treatment of workers (including illegally low pay)”.

Supply chain mismanagement of this sort reflects poorly on the business, especially when flexible and fast responses to changing fashions are a key part of the investment case. boohoo has since taken steps to correct the problems which, if successful, should create a better governed company.

Entrée Ocado

Food is a bit of a laggard when it comes to online shopping. The gap between online food retail penetration and everything else is either a massive opportunity or a castle in the sky.

Online Retail Penetration by Sector Pre-Pandemic

Source: ONS, to 31/12/2019.

Unlike clothing, which goes out of fashion, food just goes off. This makes grocery delivery logistically difficult, but software is starting to eat what we eat too.

Entrée Ocado. Ocado is really two businesses – the 50% owned joint venture with Marks & Spencer, which is basically an online supermarket, and Solutions. The Solutions business charges third parties to use Ocado’s technology platform, providing end-to-end logistics services to grocery businesses around the world.

The technology is based on hyper-modern Customer Fulfilment Centres. The group’s largely automated warehouse management system “orchestrates the movements of proprietary-design ‘bots’ across the top of a grid structure called ‘the Hive’”.

Ocado reckons this system cuts the labour time needed to assemble a 50- item order from 74 minutes to just 15.

Unfortunately, the growth of the Solutions business has required Ocado to stump up a lot more cash than investors were expecting, and profitability has lagged expectations. These are long-term projects though, aimed at securing a strong or even dominant position in the global grocery delivery market. But we’d still like to see more deals, relatively less investment and stronger profits soon.

My verdict

Carl Benz applied for a patent for his “vehicle powered by a gas engine” in 1886 and there are still horses today. But I think we can all agree that, since then, the economic contribution of the horse drawn buggy hasn’t quite matched that of the car.

In the film “Other People’s Money” Danny DeVito gives a speech to shareholders in a company struggling against new technology:

“We’re dead alright. We’re just not broke. And you know the surest way to go broke? Keep getting an increasing share of a shrinking market. Down the tubes. Slow but sure.

You know, at one time there must’ve been dozens of companies makin’ buggy whips. And I’ll bet the last company around was the one that made the best goddamn buggy whip you ever saw. Now how would you have liked to have been a stockholder in that company?”

Now, Danny DeVito is an actor reading from a script so his investment ideas should be taken with a substantial pinch of salt. But only hobbyists and the Amish still drive buggies, and the last best buggy whip company has become a byword for a bad investment in obsolete technology. It doesn’t matter how good your whips are if everyone’s driving a car.

If online shopping continues to take an ever increasing share of the market, which I suspect it will, I’ve no doubt the best physical retailer will be the last one standing. But how would you like to be a shareholder in that company?

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for advice. All investments fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future.

Unless otherwise stated estimates are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments and income they produce can 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.


Explore our Investment Times summer 2021 edition for more articles like this.

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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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