Put plainly, retail is to the stock market what Greece is to Europe. Such is the conviction of City folk that the foreseeable future will remain extremely challenging for retail and grocery, that shares from the sector are the most shorted stocks across the entire FTSE.
Next year will herald more of the same: challenging conditions, falling sales and profits, and more failure. What is certain is that 2012 will be an unprecedented year of change, and not only because of continuing sales volatility and a large proportion of the customer base reducing credit card bills.
Too many companies in their current form have outmoded structures. They continue to confront the headwinds of today with the balance sheets of yesteryear, carrying too much debt and too many stores. Eye-watering leverage and DAN coen prolific store rollout were the hallmarks of how private equity owners drove growth and returns in the last cycle. In hindsight – given the march to multi-channel and at a time when many retailers are focused on operating fewer, better stores – these strategies were simplistic. Attempting to turn around trading fortunes without addressing the fundamental structural issue of company foundations is like shuffling deckchairs on the Titanic.
It is an issue that some companies have begun to address and to date the Company Voluntary Agreement has been used as a strategy for store rationalisation. While this may reduce fixed costs in the short term, a CVA on its own without a genuine plan for operational change is a toothless tiger.
For many businesses the move to a future-proofed structure remains on the “to do” list – and two further catalysts in 2012 will hasten the process. Private equity-led buyouts reached something of a climax in 2007. Next year many retail businesses bought in such circumstances will need to be refinanced but a good slug of them won’t be able to. The game has changed too much and the debt these companies carry does not correspond to their trading position and will mean banks cannot renew their support. In some cases good businesses with good customer propositions risk being dragged under by outsized debts.
The second catalyst, which is connected, is that the banks are still getting their own houses in order. New rules setting revised global banking standards (“Basel III”) will in essence require them to assess risk by sector and hence reduce their loan book to retail.
This is not to say that the sector is going to hell in a handcart – far from it. There are plenty of businesses that do not have 400 stores when they should have 150, or have debts that hopelessly dwarf their profits. And there are plenty of businesses that have been born or have adapted to the multi-channel era, with the requisite (lowercost) structure, that are well positioned to handle what some have dubbed retail’s “perfect storm”.
But the legacy issues described above will be all too familiar to some mature retail businesses. The status quo cannot remain and will require grown-up conversations between companies, banks and shareholders about how businesses should be funded for the next five years.