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FTSE 100 moves higher but Halfords leads retailers lower on outlook fears

Discussion in 'Market News' started by Lily, Mar 21, 2016.

  1. Lily

    Lily Forum Member

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    Analysts at UBS point to cautious consumer environment and Amazon worries

    Leading shares are edging higher despite a fall in the oil price and renewed fears that the UK may vote to leave the European Union.

    But retailers are under pressure as analysts at UBS warned of a more cautious outlook for the high street, with uncertainty over Brexit and slower wage inflation, as well as foreign exchange effects and the growing impact of Amazon. It said:

    We take a more cautious view on the UK general retail sector over the next 12 months as short-term uncertainty over Brexit and wage inflation is compounded by foreign exchange issues and the increasing impact of Amazon on the sector. The most important transactional currency for UK general retail is the pound/dollar and, with a range of 1.55 to 1.25, we calculate that theoretical sector earnings impact for 2017 could be between +20% and -40% from current spot rates before any mitigation or price increase. History suggests a significant degree of mitigation is possible but, in our view, given the significantly net importing nature of UK retail, the uncertainty will weigh on valuation. After four years of outperformance we believe that the above-average sector valuation may normalise as earnings growth slows in the face of the above headwinds.

    Cheaper online competition is not something new for Halfords and the focus on service and fitting has provided a degree of insulation from this threat. Amazon may be able to further penetrate some of these categories especially with same-day delivery, but we think on balance there will be larger problems at other retailers. The foreign exchange issue however is significant and the prices will likely have to be passed through to the consumer to maintain margins and with the threat of increased competition this may be hard. On costs the company has been quite open on the impact of minimum wages but it is constraining earnings growth.

    Given more challenging conditions over the next few years (pureplay capacity, sterling weakness, wage pressures), we are downgrading.. estimates. We now assume -1% General Merchandise like for like in 2017 and flat in 2018, and cut gross margin estimates by 25 basis points in 2017 and 50 basis points in 2018 given some increase in supply chain costs. The industry may seek to pass this through (as it did successfully five years ago), but the recent value/volume data for the sector suggest less pricing power. As per the last comments from M&S, we assume that Living Wage costs can be absorbed in 2017 although there may be some risk further out. 2017 estimated earnings per share declines by 5% and 2018 by 9%.

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