uk retailers snapshot: why have margins remained so strong?

 Nov. 2015 UK RETAILERS SNAPSHOT:
WHY HAVE MARGINS REMAINED SO STRONG?
• The growth of e-commerce among major store-based retailers.
• Trends in inventory turnover (i.e., how many times retailers sell their
stocks per year) and how they coincide with trends in ecommerce.
• The overall noncorrelation between extra costs of doing business
and operating margins.
• The apparent increase in gross margins among top-tier retailers,
and how they may be insulating their bottom lines from the costs
being piled onto them.
DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 1
Nov. 2015 UK RETAILERS SNAPSHOT: WHY HAVE MARGINS REMAINED SO STRONG? FBIC Global Retail & Technology has compiled a dataset of financial metrics for 14 of the UK’s top apparel retailers. This report offers a snapshot of how these data can be analyzed in order to yield business insights. We have used our retailer data to primarily analyze one issue: the performance of operating margins in the context of downward pressure from e-­‐commerce and fast fashion. This report covers: • The growth of e-­‐commerce among major store-­‐based retailers. • Trends in inventory turnover (i.e., how many times retailers sell their stocks per year) and how they coincide with trends in e-­‐commerce. • The overall noncorrelation between extra costs of doing business and operating margins. • The apparent increase in gross margins among top-­‐tier retailers, and how they may be insulating their bottom lines from the costs being piled onto them. About Our Coverage Our dataset covers the 14 biggest UK-­‐domiciled apparel specialists, department stores and home-­‐shopping retailers with a strong presence in apparel. The data ranges from top-­‐line sales figures to operating profit by segment. These are the companies in our coverage: Figure 1. Company Coverage Apparel Specialists Department Stores Home-­‐Shopping Retailers Marks & Spencer (Incl. Food) John Lewis Partnership (Incl. Waitrose) Shop Direct Next Debenhams ASOS Primark (ABF and Primark Stores) House of Fraser (House of Fraser Stores and Highland Group Holdings) Arcadia Group (Taveta Investments) Sports Direct JD Sports Fashion New Look Group Matalan River Island Source: FBIC Global Retail & Technology Market Trends Have the Potential to Hit Margins We see two key trends in the retailing of fashion: the growing share of sales taken by e-­‐commerce and the increased emphasis on faster fashion, i.e., more frequently changing ranges. As we show in the graphic below, both of these trends have the potential to impact fashion retailers’ operating margins, due to higher costs and the heightened risks of taking write-­‐downs on stock. But we think the e-­‐commerce trend is far more significant, as it can hit margins both directly, through greater investments and costs, and indirectly, through greater stock risk. DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 2
Nov. 2015 Figure 2. Potential Direct and Indirect Hits to Margins
Source: FBIC Global Retail & Technology The Context: E-­‐Commerce Is Growing E-­‐commerce is a growth channel for almost all retailers, and we estimate that our sample of 14 companies have seen their share of Internet commerce grow from 11.8% in 2010 to 20.5% in 2014. Figure 3. E-­‐Commerce as Share of Top Retailers’ Total Sales 25 E-­‐Commerce Share of Top Retailers E-­‐Commerce Share of Top Store-­‐Based Retailers* 20 20.5 18.4 16.2 % 15 10 13.8 11.8 13.4 14.9 11.7 9.2 7.5 5 0 CY2010 CY2011 CY2012 CY2013 CY2014 Graph excludes Arcadia Group and River Island due to absence of data. *Excluding ASOS and Shop Direct. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 3
Nov. 2015 For multi-­‐channel retailers, the Internet’s contribution to sales in 2014 ranged from 4% at Matalan to more than one-­‐third at Next. Among the multi-­‐channel names, five drove up the Internet’s share of sales by more than 10 percentage points in the period from 2010 through 2014. Three of those are department store retailers—Debenhams, House of Fraser and John Lewis Partnership—each of which has reported surging online sales. Figure 4. E-­‐Commerce as Share of Sales (2014) and Percentage-­‐Point Change in Share of Sales (2010–14) E-­‐Commerce as % of Sales, 2014 Change in E-­‐Commerce as % of Sales, 2010-­‐14 120 25 20.0 80 20 14.4 13.7 60 10.7 100.0 40 15 10.6 9.6 84.0 20 0 12.1 38.0 10 7.6 25.2 2.1 18.6 18.0 0.0 15.4 14.2 13.5 6.2 5 3.3 4.3 %-­‐Point Change % of Sales 100 0.0 0 Graph excludes Arcadia Group and River Island due to absence of data. *Percent of sales is 2013 data. Percentage-­‐point change is for 2010–13. **E-­‐commerce figure is for Next Directory in total, including catalog sales. ***Includes food retail, i.e., Waitrose and M&S Food. Source: Company reports/FBIC Global Retail & Technology The Direct Costs of Doing Business Online Surging online sales are not all good news for store-­‐based retailers, given the costs of doing business online. First, investment in the infrastructure necessary to offer a smooth multi-­‐channel service can be substantial. M&S, for instance, spent around £200 million on its dedicated e-­‐commerce distribution center at Castle Donington. Second, the costs of delivery and returns add to everyday operational costs, particularly given the pressures on retailers to offer these services for free. Return rates typically average 15%–20% at multi-­‐channel retailers, but they can be higher for pure plays, trade sources have advised FBIC Global Retail & Technology. We would expect to see these direct costs reflected in operating margins for those retailers whose sales are migrating online. In other words, e-­‐commerce should be making retailing slightly less profitable for legacy players. DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 4
Nov. 2015 An Indirect Cost of E-­‐Commerce? Inventory Turnover Is Falling We think there could be indirect costs associated with e-­‐commerce, too, in terms of companies’ ratios of inventory to sales. As we chart below, a fall in average inventory turnover among our top 14 retailers in recent years has coincided with the steady increase in the online channel’s share of their sales. This correlation cannot be taken as a confirmation of cause and effect, but it is logical to conclude that e-­‐
commerce has contributed to the declining ratio of sales to stocks. Here is why: Online retailing typically results in an extension of product ranges, with brick-­‐and-­‐mortar retailers offering “online exclusives” to rival the choice found at pure plays such as Amazon and ASOS. If stores stock slower-­‐selling or more niche lines, they risk depressing inventory turnover rates. At the same time, and in a similar way, if they move to fast fashion—with its shortened windows for selling on-­‐trend stock—they may push down their ratio of sales to inventory. Source: RiverIsland.com Among our sample of 14 top retailers, the average inventory turnover rate has fallen consistently over the review period, bringing greater risk of stock obsolescence and consequent markdowns in-­‐store, as well as income statement write-­‐downs. Figure 5. Top 14: Average Annual Inventory Turnover Rate (Left Axis) vs. E-­‐Commerce Share of Retailers’ Aggregate Sales (Right Axis) 20.5 7.1 7.2 6.8 25 7.3 18.4 20 16.2 13.8 11.8 6.7 6.9 15 6.3 6.4 10 Inventory Turnover 6.0 E-­‐Commerce Share (%) Average Turnover Mulbple 7.6 5 E-­‐Commerce Share of Revenues* 5.6 0 CY2010 CY2011 CY2012 CY2013 CY2014** The turnover multiple is the nonweighted average of the top retailers. The e-­‐commerce average is weighted, i.e., the aggregate of the top retailers. *Average based on aggregate data for 12 of the 14 retailers—no data was available for Arcadia Group and River Island. Includes ASOS, which is 100% online, and Primark, which is 0% online. **Calendar year 2014 inventory turnover excludes Shop Direct (no data) and so is the average of 13 companies. 2014 e-­‐
commerce share of revenues includes an estimate for Shop Direct. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 5
Nov. 2015 Source: Next.co.uk As a result of the factors discussed above, we see Internet retailers such as ASOS, with its “long tail” of fast-­‐
fashion inventory, as bearing the greatest risk of stock obsolescence. ASOS adds more than 3,000 new lines each week, and boasts that it stocks more than 80,000 lines in total—all while having a distinct positioning as an in-­‐style, fast-­‐fashion retailer. Meanwhile, brick-­‐and-­‐mortar retailers, including Next, now commonly offer online exclusives to bolster their offering and compete with pure plays. As retailers race to offer ever more product online, which they often sell in shorter seasons, the potential for them to build up unsold stock grows. Markdowns on product and write-­‐downs in income statements are likely outcomes. Figure 6. Top 14: Inventory Turnover Rates, 2014 Turnover Mulbple 11.5 11.3 10.5 8.8 7.8 6.8 6.6 6.3 5.8 4.7 3.8 3.2 2.9 2.9 *Includes food retail, i.e., Waitrose and M&S Food. **2013 data. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 6
Nov. 2015 Source: Matalan.co.uk Yet There Is No Correlation Between E-­‐Commerce and Lower Margins We have established that e-­‐commerce has the potential to dent operating margins, both directly and indirectly. Yet, as we show below, aggregate operating margins of the top store-­‐based apparel retailers have not been hit as e-­‐commerce has accounted for a growing share of their sales. This noncorrelation appears counterintuitive. The data below are for 10 store-­‐based retailers from our top 14 total. Figure 7. Major Store-­‐Based Retailers: Aggregate E-­‐Commerce Share of Sales vs. Aggregate Operating Margins 16 14.9 E-­‐Commerce as % of Store-­‐Based Retailers' Sales Store-­‐Based Retailers' Aggregate Operanng Margins 14 13.4 11.7 % 12 10 8 9.0 9.2 8.1 8.3 7.9 8.4 7.5 6 CY2010 CY2011 CY2012 CY2013 CY2014 Of the top 14 retailers in our sample, 10 are represented: the graph excludes nonstore retailers ASOS and Shop Direct, as well as Arcadia Group and River Island, for which no data are available. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 7
Nov. 2015 A potential explanation for this lack of correlation is offered by another segment of our dataset: the top 14 retailers are, in aggregate, growing their gross margins. The growth is slight, but consistent. Gross margins increased steadily in each of the years 2011 through 2014. So, it is possible that retailers are recouping the expenses involved in selling online through the cost of goods sold. The data below are for our top 14 in total, so the operating-­‐margin figures differ from those shown above. Figure 8. Top 14: Aggregate Gross Margins and Operating Margins 35 32.2 31.1 Gross Margin Operanng Margin 32.5 31.9 32.9 30 25 % 20 15 10 8.4 7.8 6.9 8.3 7.6 5 0 CY2010 CY2011 CY2012 CY2013 CY2014* *Calendar year 2014 excludes Shop Direct data from calculations, as profit data for that year are not available. Source: Company reports/FBIC Global Retail & Technology Gross-­‐margin growth is a current and well-­‐documented story at M&S general merchandise, but our data point to a similar story at some other top retailers. For instance, Next has grown its margins considerably, despite the fact that about one-­‐third of its sales are now being transacted online. And home-­‐shopping retailer Shop Direct has grown its gross margins, even as online sales reached approximately 84% in 2013, the latest year for which data are available. So, it looks as though some legacy retailers are building the growing costs of fashion retailing into their gross margins. Figure 9. Top 14: Gross Margins, by Retailer (%) CY2010 CY2011 CY2012 CY2013 CY2014 %-­‐point change, 2010–14 M&S Total 37.2 36.8 36.9 36.6 37.6 0.4 M&S UK GM 52.1 51.4 51.8 50.7 52.6 0.5 John Lewis Partnership 33.7 33.4 33.4 33.4 33.8 0.1 Next 29.3 30.4 31.8 33.2 33.6 4.3 Primark 19.4 17.0 16.0 19.1 19.1 -­‐0.3 Arcadia/Taveta Investments* 13.9 4.4 10.0 10.9 10.0 -­‐3.9 Sports Direct 45.4 46.5 48.7 52.8 45.9 0.5 Debenhams 13.7 13.4 13.6 13.1 12.1 -­‐1.6 Shop Direct 35.8 36.0 37.4 39.4 N/A N/A JD Sports 49.5 49.2 48.7 48.7 48.6 -­‐0.9 New Look 53.9 50.9 52.9 52.7 52.7 -­‐1.2 Matalan 17.0 11.4 12.3 11.8 13.3 -­‐3.7 ASOS 49.1 50.9 50.5 51.8 49.7 0.7 House of Fraser/Highland Group Holdings 59.1 58.2 58.1 58.8 58.6 -­‐0.4 River Island 20.1 16.9 17.7 15.7 20.8 0.7 *Arcadia Group figures are based on accounts for Taveta Investments, which describes itself as “an intermediate holding company.” Therefore, its profit data should be treated with caution. Source: Company reports/FBIC Global Retail & Technology DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 8
Nov. 2015 In Conclusion UK stores have been at the forefront of the shift to multi-­‐channel retailing, and this is reflected in our data, which show that more than 20% of sales for the top apparel retailers were transacted online in 2014. E-­‐
commerce adds direct costs to doing business, however, in terms of investments and everyday operating costs. The channel adds pressure for retailers to change fashion ranges more frequently, and it has the potential to indirectly add costs, too, due to the risks of stocking more lines. So, the top British retailers have done well to sustain operating margins—in total, the operating margins of the top 14 have proved remarkably consistent in recent years. And aggregate gross margin among these retailers has been creeping up, suggesting they are recouping costs by bolstering gross profits. We see three possible explanations for this trend: • Retailers have been increasing the markup on the goods they sell. • They have been sourcing more cheaply without passing on savings to shoppers (this is the current M&S model). • They have been changing their sales mix in favor of higher-­‐margin products—such as by selling more private label products and fewer third-­‐party branded goods. Deborah Weinswig, CPA Executive Director—Head of Global Retail & Technology Fung Business Intelligence Centre New York: 917.655.6790 Hong Kong: +852 6119 1779 deborahweinswig@fung1937.com Filippo Battaini filippobattaini@fung1937.com Marie Driscoll, CFA mariedriscoll@fung1937.com John Harmon, CFA johnharmon@fung1937.com Aragorn Ho aragornho@fung1937.com John Mercer johnmercer@fung1937.com Shoshana Pollack Shoshanapollack@fung1937.com HONG KONG: 10th Floor, LiFung Tower 888 Cheung Sha Wan Road, Kowloon Hong Kong Tel: 852 2300 2470 NEW YORK: th
1359 Broadway, 9 Floor New York, NY 10018 Tel: 646 839 7017 jingwang@fung1937.com LONDON: 242-­‐246 M arylebone Road London, NW1 6JQ United Kingdom Tel: 44 (0)20 7616 8988 Steven Winnick Kiril Popov kirilpopov@fung1937.com Jing Wang stevenwinnick@fung1937.com FBICGROUP.COM DEBORAH WEINSWIG, EXECUTIVE DIRECTOR–HEAD OF GLOBAL RETAIL & TECHNOLOGY DEBORAHWEINSWIG@FUNG1937.COM US: 917.655.6790 H K: 852.6119.1779 CN: 86.186.1420.3016 Copyright © 2015 The Fung Group. All rights reserved. 9