IN THE KNOW: Home Retail To Be Hardest Hit By National Living Wage

Tue, 25th Aug 2015 11:36

LONDON (Alliance News) - Barclays has reiterated its Negative stance on the European general retail sector, saying that while the UK consumer continues to show strength, the outcome of the UK budget and higher wage inflation will hit certain retailers, most notably Home Retail Group.

The bank argued that retailers' earnings will be hit following the UK budget due to "unplanned cost pressure" resulting from long-lasting wage inflation, while UK consumers' demand will be hurt as the welfare cuts more than offset increased wage income.

In addition, higher wage inflation reopens the argument for potential interest rate increases, Barclays said, which would be bad for retailers as historically in such an environment the general retail stocks underperform.

Barclays picked out Home Retail Group as likely to be hit by wage inflation at a "disproportionate amount" compared with other retailers due to both top-line and cost pressures. As a result, it cut its financial year 2016 and financial year 2017 earnings per share estimates by 11% and 20%, respectively, downgraded its rating to Underweight from Equal Weight, and reduced its price target to 130 pence from 175p.

The bank warned that even if companies already pay above the minimum wage, increases in wages for the lowest paid employees will likely put upwards pressure on UK wages in general in order to maintain pay differentials.

"Our analysis indicates that domestically focused companies with high labour/sales ratios, low earnings before interest and tax margins, high operational gearing and highly price elastic products will be impacted the most," Barclays analyst Christodoulos Chaviaras said.

Of those, Chaviaras said Home Retail, the owner of Argos and Homebase, "has all these characteristics to a great extent." In addition, the company has a high exposure to low-income households, which are set to take the most severe hit from the net impact to disposable income from rising wages and welfare cuts.

However, Barclays calculates a less-than 5% hit to the pretax profit of other retailers. "We expect a negligible impact on ASOS and Boohoo due to their online business models, their high growth and the fact they are export oriented. Next, as a hybrid retailer with the highest Ebit margin and some price flexibility, should also experience minimal impact. Dixons Carphone and Kingfisher are multinational, which should limit the negative impact for those retailers," Chaviaras said.

Barclays said that introduction of the national living wage, which sees a 38% rise on the current minimum wage over five years to GBP9 an hour, suggests wage inflation of 6.7% per year, adding that while the profits of large multinational companies are unlikely to be hit by a recovery in UK real wage growth, domestically oriented companies will see a downturn in the benign cost environment experienced over the past seven years.

"Those firms with high labour costs, and low margins, may now start to face the effects of a margin squeeze," Chaviaras said.

Although fashion and homeware retailer Next has relatively high wage costs/sales, it benefits from a high operating margin, mitigating any impact from wage inflation. Meanwhile, Dixons Carphone has a thin margin but low cost/sales, plus as 35% of its sales come from outside the UK, this should mitigate any excess impact from UK wage inflation, Barclays said.

In addition, with online retailers such as ASOS and Boohoo, overall costs are largely correlated with their own pace of growth rather than inflation, and with a lack of stores will be less impacted by the rising minimum wage, Barclays added.

"Our analysis shows that Home Retail Group should be disproportionally hit by UK wage inflation as a large proportion of its labour force is not on living wage and the company's low margin profile doesn?t leave much room to manoeuvre. While Home Retail has been historically very successful in managing costs effectively, we doubt any price increases can be made in order to alleviate the pressure due to the commoditised nature of many of Home Retail?s products," Chaviaras said.

The analyst added that Home Retail's product cycle "doesn't look too exciting for Argos into the peak period", other than large screen branded TVs, which is a category where Argos is underpenetrated, while tablets, videogames and unbranded TVs will likely remain challenged amid increased competition from consumer electronics specialists such as Currys and John Lewis and Amazon.

However, the analyst said that Argos's new concessions within Homebase and Sainsbury's could, if successful, potentially offset a big part of the wage pressure in the financial year 2017, while an improvement in the delivery proposition could lead to meaningful market share gains, although "at a non-negligible cost".

Shares in Home Retail were trading down 2.5% at 145.90 pence Tuesday afternoon, while Next shares were trading up 2.5% at 7,660.00p, Dixons Carphone shares were up 3% at 419.30, Kingfisher shares were up 2% at 347.70p, and shares in ASOS and Boohoo were up 2.4% at 2,948.59p and 6.1% at 29.45p, respectively.

By Karolina Kaminska; karolinakaminska@alliancenews.com @KarolinaAllNews