No reward for holding forecasts – Hitting numbers and holding forecasts has provided little protection, with the majority of retail share prices down this month. Macro concerns ahead of the critical peak trading period are outweighing the positive momentum underpinning margin and cost recovery within forecasts.
Real income rises – With real income on the up as pay increases outweigh moderating inflation, the data suggests the worst is over. However, consumers have differing priorities as interest rate pressures continue to work through the system.
Benefits to margins still coming – Cost and margin tailwinds have yet to fully flow through, with freight, commodity prices and lower factory gate pricing mitigating the effect of a slower sales recovery.
Ability to spend
Rising income, different priorities – Disposable income increases are finally running higher than UK CPI (Figure 4). While a positive for potential spending power, our other charts suggest that consumer priorities lie elsewhere. The ASDA disposable income tracker takes into account income post taxes and essentials (groceries, gas and electricity bills, transport and mortgage interest payments/rent). This does not account for levels of savings which, excluding the pandemic period, have picked up to a six-year high (Figure 12), neither does it include the extent to which households are deciding to prioritise increased mortgage repayments ahead of coming off cheap mortgage deals. Looking at Figure 5, we can see the extent to which consumers have been increasing their repayments, and as a result reducing the disposable income they are choosing to allocate to discretionary spending. Retailers talk to the variable strength of consumer spending across different demographics, but once again, shopping continues to be driven by need, with a focus on value.
Unemployment edges up – The UK economy’s resilience against a recession over the past year has been underpinned by maintaining a low level of unemployment. Wage increases fundamentally erode profit margins for retailers, as store staffing makes up a large proportion of operating costs. Job vacancies are down as the rate of unemployment ticks up. Anecdotal stories from the sector are interesting too, with Next pointing out that store roles are seeing 17 applicants per vacancy, on average, compared to nine last year, with logistics roles seeing 11 applicants per vacancy compared to eight last year. Technology vacancies, a previously hot market, have fallen from 13% to 6% over the past 12 months.
Changing borrowing behaviour – Overdraft utilisation and unsecured lending have also grown in recent months, despite the increasing cost of credit, although anecdotal evidence suggests that higher APRs on car financing is impacting consumer appetite within the premium car market and premium used car pricing.
Big ticket holding up? Looking at both credit card spending data and sector wide trends, we are able to paint a clearer picture of the consumer. Housing transactions have fallen to near Covid lows, erasing the pent-up peaks seen in mid-2021. The impact of this can be seen clearly in the data, with the RMI output index showing a clear drop-in activity over the summer and contractor output reducing in both the private and public markets. Household improvements and DIY spend (Figure 28) have remained weak, but although a number of retailers in the space continue to remain resilient, with Topps Tiles# and Victorian Plumbing both continuing to report positive growth. Kingfisher has showed slowing LFL sales in line with credit card data expectations, but reported big ticket volumes are holding steady. There may be an element of lag to consumer activity, but households continue to remain surprisingly resilient.
US Consumer pressure vs UK Consumer pressure – The underlying themes of high inflation and high interest levels are shared by both consumers, but more recently the resumption of student loan payments in the US means the average university-graduated consumer has $200-300 less income to spend on a monthly basis, putting pressure on the discretionary wallet. We believe that this will further reduce the wallet-share dedicated to consumers to luxury spending; already LVMH, Kering and Richemont have suggested that the “aspirational consumer” is the reason for a muted US performance over the first quarter of this year, and we see this behaviour continuing.
Real wages increases have begun to exceed current inflation levels, which are on the way down, and should reduce pressure on the scale of wage increases next year, and on the minimum wage. This, combined with fewer job vacancies and a pick-up in labour inactivity rate should act as a further tailwind to the average retailer cost base as labour becomes cheaper.
FX rates have begun to fall again off the back of stabilising interest rates in the UK, but should not concern investors too much as inflation was the more pressing problem. In addition, container freight costs, having spiked from US$2,000 a container to US$15,000 for sea freight, are now back down at pre-pandemic levels and look to fall even further. Concerns of increased blank sailings (where shipping is cancelled because cost to sail is too high for it to be profitable) have also abated, with Asia-America trade seeing the lowest level of blank sails since the pandemic started. Air freight costs have also fallen more recently, but still remain very much elevated on pre-pandemic levels – presumably, these will normalise over time, but (fashion) retailers who rely on airfreight for the product delivery will still be feeling the burn on margins.
Commodity prices have eased, with cotton and energy both elevated on pre-pandemic levels, but still significantly lower than their 2022 peaks. We would expect the majority of retailers to have finally seen benefits of normalised energy prices flow through, with the average length of hedging being 6-18 months.
Still, factory gate pricing is down and the rhetoric from retailers is for much reduced-price inflation coming into autumn/winter and spring/summer 24. Indeed, discussions of selective price investment and of ‘re-balancing price differentials’ appear to be picking up.
Inflation by sector (CPI)
The past 12 months have been a difficult time for consumers, with general inflation peaking at just over 11% across all items. The main source of this was a surge in costs relating to housing, fuel and water (see Figure 10), which in January hit 26.7%. With this taking up 31.4% of the average basket of goods, the impact of this was further multiplied – especially in the lower income deciles of the population. Inflation has also surged by nearly 18% in the food and beverages sector, mainly off the back of lagged pandemic disruptions and significantly weaker levels of exports of food coming from Ukraine and Russia.
Although inflation has increased sharply, it has continued its sharp trend of reversal – particularly in Food and Non-alcoholic beverages (Figure 54) and Housing, Water & Fuels (figure 53). With interest rates not expected to increase too much further, the speed of disinflation may slow, but we expect the trend towards normalised levels to continue back to 3-5%. This being said, some categories are seeing lagged increases in pricing – in particular Recreation & Culture (Figure 49) does not look to have peaked yet, with Miscellaneous (figure 55) and Communications (figure 48) also showing decent inflationary pressure (although these only make up <20% of the average basket cumulatively).
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