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Three reasons retail isn't all bad

4 January 2019

No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

2018 was a tough year for some of the biggest retail names. House of Fraser, Debenhams and ASOS all suffered.

With high street footfall at its lowest since the recession, it’s hardly surprising bricks and mortar retailers are feeling the pinch. But with online players issuing nasty profit warnings too, it looks like the problem is more widespread.

Nevertheless we think there are alternative ways to invest in the sector. Supermarkets and specialist shops could be an option for those nervous about the fate of general retailers.

All investments fall as well as rise in value, so you could get back less than you invest. All quoted yield figures are variable and are not a reliable indicator of future income.

The weekly shop doesn’t stop

If purse strings are tighter, you might decide not to buy that new top. But you still need to eat.

That means supermarkets aren’t faced with the same threats as clothing retailers.

Tesco in particular has some interesting points. All the main metrics are moving in the right direction, and a successful integration of wholesaler Booker should deliver attractive cost savings.

By 2020, Tesco says it can reduce costs by £1.5bn, generate £9bn of cash from retail operations and improve operating margins to between 3.5% and 4%. Margins are currently around 2.9%. A recent supply partnership with France’s Carrefour should help – the combined scale should enable the group to squeeze suppliers on price.

It’s not all plain sailing though. Supermarkets have seen competition hot up in recent years. German disruptors Aldi and Lidl triggered a price war, plus Sainsbury's potential merger with Asda could make things worse.

In response, Tesco has launched its very own discount chain, Jack’s. That seems a sensible move, but it’s very early days - we’re yet to see how things will pan out.

In the meantime analysts are predicting a yield of 4% - significant given the dividend was cut completely just a few years ago.

There are some hurdles for Tesco to clear, but to us it looks stronger now than in the past. If it can continue to fend off its rivals and pump up those margins, it could have a lot to shout about.

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Robots are still cool

Another option for food retail is Ocado. The group’s robotic warehouses are capable of fulfilling thousands of online food delivery orders every day. Robots doing shopping for you may sound a bit far-fetched, but the prospects for investors are very real. That’s because these systems are very attractive to companies wanting to up the efficiency of their online offering.

Ocado has confirmed some hefty deals this year, including a partnership with US giant, Kroger that should see 20 sites come online within the next three years.

That’s good news for revenue, but getting those centres up and running doesn’t come cheap. So it’s unlikely we’ll see any meaningful profit for a few years yet.

With Ocado investing in the future, there’s no dividend on offer now. We think that’s the right decision at this stage, but it’s something for income-seekers to bear in mind.

All the while, Ocado’s existing business keeps growing. In its last quarter, the number of orders processed per week grew 13.1% to 320,000, helping retail revenue rise 12%. That comes as new centres in Andover and Erith provided extra capacity.

While the extra revenue is important, these new centres are more significant for another reason. If Ocado can show it’s capable of scaling up to these new sites without a hitch, it’ll surely increase the odds of more partners signing on the dotted line.

As always though, nothing is guaranteed. The online food industry is still in its infancy, and rivals like Amazon are gearing up for a slice of the action.

Overall, the fact remains more and more virtual baskets are being filled by Ocado, and excitement about the future has helped the share price rise. We think the group has a lot of merit, provided all that dough can start feeding into the bottom line.

Find out more about Ocado

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I want to ride my bicycle

Cycling is increasingly popular, as are staycations and outdoor activities.

That’s good news for companies like Halfords where like-for-like sales at the half year were up 2.5% - no mean feat in what’s supposed to be a tough environment.

An extra string to Halfords’ bow is its face to face service.

The Halfords team offer specialist advice and fitting or maintenance services. The group’s invested in training up staff. This face to face service is something online rivals, like Amazon, can’t compete with, and it encourages more people to walk through the doors.

But upgrading stores requires investment. Expected capital expenditure has been upped from £40m to £60m a year, as part of a rejuvenation plan that includes store refurbishments. It’s important to keep the stores looking fresh, but the group needs to make sure it keeps costs under control.

The shares trade on 9 times expected earnings, well below the longer term average of 11.4. That shows not everyone is convinced Halfords is doing enough to survive the general retail storm. Still, for those with a more optimistic view, the recovery potential and prospective yield of 7.2%, could look attractive. Of course there are no guarantees though.

Overall, we think Halfords is on the right road.

Still, the proof will be in the pudding - there’s no guarantee its success will continue if conditions become more testing.

Find out more about Halfords

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Hargreaves Lansdown's Non-Executive Chair is also a Non-Executive Director of Tesco.

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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Investment notes
No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

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