The long view of retailing

Are retailers delusional?

I picked up a book at a jumble sale last week. It’s quite a novelty reading from paper.

I bought “The Art of the Long View”, by Peter Schwartz, an old edition published in 1991 because it promises insights into two interests that have hitherto proved incompatible, investing and the future.

Schwartz has written a number of books on futurism and runs a business consultancy. Its bulletin is a good read too.

Value investors have a vexed relationship with the future. We know it’s all that matters, but we don’t believe it’s predictable. A framework for thinking about the future that doesn’t involve predictions might help.

So, and I’m only ten fascinating pages into the book, I’m intrigued he endorses an Arab proverb:

He who predicts the future lies even if he is telling the truth

And I’m enthused by his explanation that scenario planning is not about extrapolating current trends into the future, one of the cardinal sins investors make, but presenting alternatives.

The end result, is not an accurate picture of tomorrow…

He says…

but better decisions about the future.

How, exactly, I have yet to discover, but his first example of where scenario planning might have helped reminded me strongly of the situation retailers face now.

He describes the crisis overtaking the advertising industry in the 1980’s. Anyone could see the growing popularity of new communication technologies, cable TV, videocassettes, fax machines and email that would drain audiences and revenues from network television. No-one could say how the future would play-out but it was obvious that advertising agencies were facing radical change or a serious diminution of their businesses.

By 1987 the shock had hit, profits were declining and staff were laid off. Yet most of the ad agencies Schwartz talked to wouldn’t join his study of the industry’s future:

To judge from our conversations with them, they are afraid of what they might learn, as if the cost of ignorance was smaller.

Recently I relocated operations to Cambridge’s remarkable public library (its new, three storeys high, and bigger than Tesco. Although I don’t like making predictions I doubt many more will be made like it).

The library is in Lion Yard, a new retail development in the centre of the City, and I’ve shifted temporarily so I can observe retailers and their customers. Already I’ve seen shoppers queuing around the block to buy the new iPhone from the Apple Store, while the shops opposite, Vodafone and 3, who’d also opened early and devoted their window-space to advertising the iPhone 4s, were populated only by bored-looking members of staff.

Lion Yard is populated almost exclusively by mobile phone shops, fashion stores, and John Lewis, which sells both. The apparent glut of shops, many of them empty when I walk past, makes me wonder whether John McElligott of the rather fearsomely named Value Stock Inquisition blog is right when he says.

I am of the opinion that the UK has way too much retail real estate.

He cannot understand Argos owner Home Retail’s strategy. Sales at Argos are falling, but within that internet and telephone orders for collection or home delivery are growing in significance (46% of sales). McElligott would like to see retailers like Argos shedding stores and the expensive leases that come with them, but Home Retail is opening and refurbishing more. It sounds as if the company thinks the falling numbers of customers visiting its showrooms is temporary.

I profiled Home Retail rather more favourably last December, but still didn’t add it to the Thrifty 30.

As well as the future, value investors have a vexed relationship with retailers at the moment. They look cheap, but keep getting cheaper. Some like Schroders’ Value Perspective team, think the sectors continuing decline is unjustified, and in particular those companies with strong balance sheets should profit investors in years to come. It’s a classic value case.

Home Retail is in an undervalued retailer with a strong balance sheet according to Schroders, although McElligott thinks its actions, a generous dividend and store openings (and share buybacks presumably) put the balance sheet at risk.

An alternative scenario is the Internet is draining customers and retailers are either going through fundamental change or a permanent diminution of their business.

We can’t predict how it will pan out, but would be very wary of companies that appear to be planning for business as usual, when business may never be the same again.

14 Comments

John McElligott October 21, 2011 at 12:57 pm

Hi Richard. I dont disagree with much of your post on iii. My point on retail estate stems precisely from the growth of alternative modes of shopping. To my mind, many UK retailers are suffering from similar problems, some of which are cyclical, and others (such as internet retailing) which are more secular. Given the amount of increasing amount of Home Retails sales going through the web/phone, I am wondering whether an accelerated store closure programme would be in order, and instead focusing on more on the direct route. In towns and locations in the UK and Ireland that I am fmailiar with, it seems to me that there are areas where Argis stores are in reasonably close proximity to each other.
Some companies (maybe like Game Group, I think) are likely to be hurt via the net. Home Retail seem to have embraced it and the strategy seems to be working – but is diluted due to a harsh economic cycle and a high retail cost base. It has many characteristics that I am seeking, but the balance sheet and cashflow IMO are carrying too many lease obligations that are more than likely not delivering in terms of value. I think that balance sheet analysis must include an analysis of off-balance sheet liabillities. In this case, they seem high to my mind.

Finally, I am not a fan of share buybacks in general. I think (but hindsight is wonderful), that it was a poorly judged move in the present economic climate. I stand over my comment on the dividend – it is not resently well covered by cashflow, and I imagine that it would have deteriorated further during the year. I notice that management were not keen to defend the dividend on the conference call a few days back. That maybe no bad thing.
Thanks
J

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- Richard Beddard October 21, 2011 at 2:26 pm
  
  Hi John, I agree with you about lease obligations in general, although I was surprisingly sanguine about Home Retail’s leases in July 2010: http://blog.iii.co.uk/home-retail-is-best-of-the-big-retailers/ I think was reassured because it was unindebted, while being conscious that’s not necessarily enough.
  
  I’m generally in favour of buybacks if the company is undervalued. Trouble is by not adding it to the Thrifty 30 portfolio I’ve indicated that I’m not confident enough that it is – bearing in mind all we’ve said!
  
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Calum October 21, 2011 at 1:05 pm

You may be interested to know that Debenhams is another one planning a big expansion of stores. It has around 150 in the UK (only 45 of which are “core) and suggested capacity was 240. The company has had a lot of success in turning the “brand” round with more private label designer stuff and growing market share but the idea of another 90 or so stores makes me pretty uneasy. It may be that the price of high street shops was bid too high in the past decade and so there will be scope for operating with lower fixed costs…but I am not too convinced. (DEB is in the Valuhunteruk portfolio).

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- Richard Beddard October 21, 2011 at 2:11 pm
  
  Hi Calum, do you know if new leases are being negotiated at significantly lower cost? I suppose there is a classic contrarian rationale – that now, or soon, or whenever leases have fallen in value, is the right time to buy (putting aside the changing retail business model for now!)
  
  Reply
  - John McElligott October 21, 2011 at 2:14 pm
    
    Richard, Not in relation to DEB, but the HOME conf call the other day went into some detail regarding the value now available on lease renewal and renegotiation. I will dig out the figures, but it was interesting.
    
    Reply
    - Richard Beddard October 21, 2011 at 2:29 pm
      
      Thanks, that would be interesting
      
      Reply
  - Calum October 21, 2011 at 3:23 pm
    
    Yes, 9 leases were renegotiatied for a net inflow of some £30m (the overall operating leases are some £4bn and 6 were renegotiated the year before). Even though I have some DEB (and MKS) it doesn’t seem too plausible that they will be able to renegotiate enough leases to make themselves profitable if everything goes wrong. On the other hand, someone is going to have to lease the property and a lot of them can only be used by retail companies so it may turn out that property owners take most of the pain.
    
    Reply
    - Richard Beddard October 21, 2011 at 4:48 pm
      
      Thanks Calum.
      
      Reply
John McElligott October 21, 2011 at 5:04 pm

Rent Reductions from Home Retail.
q6c on Conf Call for reference.
15 Argos stores had leases renogiated for an average rent reduction of 10%, but the range is very wide. For example, the largest rent uplift was 50%, while the largest rent reduction was 25%. The see rent inflation of 2%, but dominated by inflation in out of town and very little inflation in town rents.
Hope that helps. If I was a property company with retail exposure (eg Land Securities), as Callum has indicated, there maybe headwinds coming.

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- Richard Beddard October 21, 2011 at 5:17 pm
  
  Thanks John. Now I don’t know what to make of that information! If anything. Leases, like pensions, are the bane of my life. They complicate everything.
  
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Monevator October 22, 2011 at 8:51 am

On the bricks and mortar theme, Town Centre Securities might be worth a look Richard. I think it’s a great looking share, but it’s very hard to put your money into shopping in the centre of Leeds in the current climate!

The way people buy mobile phones from shops does make me wonder if there’s a natural cap on Internet retailing. Phone buyers are often young, net savvy, etc, yet they flood the stores.

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- Richard Beddard October 23, 2011 at 9:14 am
  
  Thanks for the suggestion Monevator.
  
  I’m sure there is a cap on Internet shopping, I just think its high enough to make retailing significantly more competitive than it was before. My son actually bought a computer game from Game yesterday because he couldn’t want to wait for it to arrive in the post but if high street retailers become increasingly dependent on big events (release of blockbuster games, smartphones) their businesses become increasingly precarious as far as I can see.
  
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Weekend reading: 11% real returns for a decade from shares? October 22, 2011 at 11:25 am

[...] The long view of retailing – iii blog [...]

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Paul Gold November 6, 2011 at 3:24 am

Argos is the largest general-goods retailer in the United Kingdom and Ireland with over 800 stores. It is unique amongst major retailers in the UK in that it is a catalogue merchant. It primarily displays goods by catalogue, from which customers make their selections to purchase, pay, and then collect the items from an in-store collection desk or have the item delivered to their home, similar to defunct US retailer Montgomery Ward. Together with sister company Homebase, it today forms part of the Home Retail Group. The question is that without change, will Argos suffer the same fate as Montgomery Ward?

Argos owns numerous brands including Elizabeth Duke Jewellery and Watches, Alba, Bush,[ Chad Valley and many others, so who knows, with brands such as these, maybe they can keep their heads above water.

Argos was once a FTSE 100 Index constituent in its own right but is today represented by its parent company Home Retail Group in the FTSE 250 Index.

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