JS/Argos – masterstroke or mistake?

COVID-19 Market Update – 13/11/2020
Written By:
Stephen Springham, Knight Frank
11 minutes to read

Introduction

This is the 24th of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note explores two key themes:

- What we learned from the latest BRC retail sales figures
- Implications of Sainsbury’s downsizing of the Argos portfolio

Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.


Key Messages

  • Festive shopping starts early
  • Retail sales grow y-o-y by +4.9% in Oct
  • Anecdotal evidence of a pre-lockdown surge
  • Nov will be a lull, despite online growth
  • Nov retail sales likely to down in low single digits
  • Online penetration likely to be 40%/50%+ in Nov
  • A major surge of pent up demand likely in Dec
  • Demand on collision course with social-distancing compliance
  • Calls for a relaxation of trading hours fully justified
  • Argos standalone portfolio to reduce to ca. 100 sites by 2024
  • Residual sites will be dual-purpose supply chain spokes
  • Major evolution of the multi-channel model
  • But store cuts are potentially too deep
  • Cost-cutting important, but shouldn’t set agenda
  • Multi-channel operators at risk of sacrificing USPs


1. What we learned from the latest BRC retail sales figures

The BRC’s retail sales data confirmed what we believed and the retail industry hoped for – an early start to the festive season, albeit one that has since been derailed by a 2nd lockdown.

Total retail sales increased +4.9% in the four weeks to 31 October, albeit against a very benign comp (sales were down -0.3% in the same period the previous year). This marked a slight deceleration in growth, with September sales ahead by +5.6%. October’s figures were against a backdrop of rising regional restrictions, before a full lockdown came into force in England from 5 November. Like-for-like sales (excluding temporarily closed stores and including online sales ) increased +5.2%, a slightly more nebulous number.

On a three month basis, grocery sales increased by +5.8% (+5.2% like-for-like). Total non-food sales grew +4.0% (+5.7% like-for-like), with inevitable polarities between in-store and online (for those that still believe there is a hard dividing line). Over the three months to October, in-store sales of non-food fell -11.4% on a total basis (-9.0% like-for-like). Online non-food sales rose +39% over the same period and online penetration increased from 31.7% in October 2019 to 42.3% this October.

In terms of performance by sub-sector, more of the same, with home-based categories such as furniture and electricals remaining strong. In contrast, fashion sales remain wretched. The BRC pointed out that it saw a trend of early festive spending coming through, with an acceleration of growth in toys and baby equipment a clear indication of this.

That was then, this is now. This is a perennial issue with retail sales figures from whatever source, the data is always lagging. According to the BRC, the 2nd lockdown in England will “throw away” any progress that has been made and estimates that £2bn of sales per week will be lost this month.

The retail sales figures for November are unlikely to be released until well into December (the BRC’s on the 8th, the official ONS ones not until the 18th). My own very tentative predictions made in last week’s Retail Note remain unchanged – growth of grocery of ca. +5-6%, but a high single digit decline in non-food resulting in a net low single digit decline in overall retail sales.

For much of November, online channels will virtually have the market to themselves, so penetration will inevitably surpass the 33.9% high water mark we saw during the first lockdown. And Black Friday will largely be an online-only “event”. That online penetration surpasses 40% (50% even?) will dominate headlines, but the fact that net retail sales growth will be in negative territory again underlines the fact online does not absorb anything like all the slack from lost store-based sales.

When all is said and done, the days leading up to the 2nd lockdown (2-4 November) are likely to prove amongst the strongest of the whole month, with consumers taking to the high street in droves ahead of enforced closures. An anecdotal observation for now, but one that will surely be borne out in footfall data.

And expect a similar surge, multiplied by a million, in early December when lockdown is lifted (all being well). A strong October, a lull during a “make-do-and-mend” online-only November, followed by a surge in December (starting at the beginning of the month, rather than just last minute) – this is the anticipated trading pattern for the festive period in 2020 (and please can the media desist from calling it the deeply unimaginative ‘Golden Quarter’?)

But there is a major pinchpoint here – when they do re-open, stores will still have to adhere to strict social-distancing practices. A constraint at the best of times, this will be a major headache in the likely event of a substantial December surge in customer traffic and this is potentially a major issue if pent-up consumer demand is to be successfully released. High demand is on a collision course with necessary compliance.

Relaxation of existing trading laws is one compromise solution and it is no surprise that retailers are already calling for it. Extending Sunday trading laws beyond the current six hours is an absolute bare minimum. The debate for and against this has raged for a long time, but surely there can be no argument to it happening on a temporary basis this December, in light of what the retail sector has had to endure this year? But surely is a dangerous word…

2. Implications of Sainsbury’s downsizing of Argos

Newsflow of retailers’ streamlining their store portfolios is constant. However, Sainsbury’s announcement last week regarding its intentions with Argos was particularly significant, not just in terms of scale but also what it says about the current direction of travel of the retail industry. And why, in my opinion, it is a strategic mistake.

The headlines were unequivocally stark. Sainsbury’s is putting 3,500 jobs at risk by simultaneously closing 420 Argos stores by 2024 and phasing out in-store meat, fish and deli counters. Draconian measures amplified by the fact they accompanied seemingly robust half year trading figures - retail sales (exc fuel) rose +7.1% (+6.9% on a like-for-like basis), with grocery and general merchandise sales up +8.2% and +7.4% respectively. On an underlying basis, pre-tax profit rose +26% to £301m.

Of course, there are very valid counter arguments. On the potential job cuts, Sainsbury’s said it has an “excellent track record” of finding alternative roles for colleagues, having retained 90% of staff when it acquired Argos back in 2016. And the Argos closures are not a one-way street, with the number of implants in Sainsbury’s stores undergoing significant increase.

A bit more colour on the last point. Sainsbury’s will add a further 150 Argos shop-in-shops to its supermarkets, of which there are currently 315. On top of that, it will add a further 200 more basic collection points, on top of the current 296. But the planned Argos store closures will ultimately leave just 100 standalone stores in total, a far cry from the 845 at time of acquisition.

Sainsbury’s original acquisition of Argos for a hefty £1.4bn raised eyebrows and divided opinion in equal measure. Detractors pointed to considerable differences in market positionings / customer bases (a view to which I personally do not subscribe) but the consensus was significant Argos store closures were likely. What was initially a trickle has now accelerated to a deluge and prompts the question of why pay £1.4bn for a business and then seemingly run it into the ground.

My take as to why Sainsbury’s acquired Argos in the first place distils into three key motivations: the most transparent one was to massively enhance its online and multi-channel capability (Sainsbury’s seriously lagging behind Tesco and Asda in this area at that time). The two other main motivations far less obvious to the casual observer: Argos having much better international sourcing terms in non-food (especially with China) and also an often-overlooked Financial Services business. There was more to the deal than met the eye. And it wasn’t just to fill up surplus space in supermarkets, whatever others may say.

Cue feverish speculation within the property community as to which stores will be amongst the ‘chosen 100’ residual standalone sites. There is unlikely to be a definitive list on this (perhaps not even within Sainsbury’s HQ) so anxious landlords and would-be investors (and agents) are likely to be left guessing for some time to come.

Interestingly, it would appear that disposals are being driven far less by metrics that usually determine property decisions – rent, occupancy cost, lease events, trading performance. These will, of course, have some bearing, but the main driver is likely to be alignment of any store to other supply chain capability. If a store trades in close proximity to either a large distribution hub or a significant spoke, it is far more at risk of closure than one that is located in a supply chain “weakspot”.

On the one hand, this thinking is pioneering, a milestone even in the evolution of multi-channel retailing. With much of the retail narrative still depressingly binary in plotting online versus physical stores, this is actually the complete synthesis. Outlets effectively operating as a dual purpose retail store and online fulfillment spoke. A key message to those looking to repurpose retail warehousing to industrial space – there is potential for a hybrid model inbetween.

Which obviously begs the question as to why I think it is a strategic mistake. I have absolutely no issue with this direction of travel whatsoever, but I fear the rationalisation runs far too deep and may ultimately be driven more by cost concerns than the business is admitting. Babies being thrown out with the bathwater, if you will.

There is no doubt that Argos fared much better during the 1st lockdown than many believed, perhaps even defying Sainsbury’s management’s expectations. In Q1 (covering the 16 week period to 27 June) all standalone stores were closed, yet Argos achieved sales growth of +10.7% mainly through online. There is a risk that this prompted fresh question marks over the value of its stores and that decisions on the shape of the portfolio going forward were made on the basis of a retail backcloth that wasn’t just unprecedented, it was frankly weird.

Given the preference for supply-chain infilling sites, very few standalone Argos stores are likely to remain in town centres or on high streets – most will be on retail parks. Again, there is inherent risk in this. Pre-COVID, Argos’ sales breakdown was broadly: Walk-In (i.e. pure store) 36%, Click & Collect (i.e. multi-channel) 38%, Home Delivery (i.e. online) 26%. By closing as many stores as it is proposing, the business risks losing a significant portion of walk-in sales. And as Next has highlighted, sales from a closed store do not gravitate to your online business.

The proposed store closures will also leave coverage gaps that may negatively affect the click & collect side of the business. A large multi-channel retailer such as Argos should clearly have no gaps in its geographic coverage, but it does in that not all of its product inventory is available for home delivery, many products are purely click & collect. If those click & collect points aren’t there anymore, there is a risk of lost business. Sure, there may be alternative pick up points somewhere nearby (e.g. a Sainsbury’s store), but forcing customers to go out of their way defeats the object of convenience.

Less of a property issue, but the closure of food counters is also significant. This marks a major U-turn on the direction of travel of the grocery industry since it emerged from it ‘period horribilis’ five or six years ago. A renewed emphasis on fresh food and wider roll-out of enhanced fresh food counters was both a way of making supermarkets far more ‘experiential’ (to use popular parlance) and a key point of differentiation from the no-frills approach of the discounters.

Sainsbury’s decision to axe its food counters has left many other retail analysts bewildered, especially given its perceived status as the most ‘upmarket’ of the Big 4 operators. But said retail analysts tend to major more on the aesthetics of foodstores and ‘softer side’ of grocery retailing, without really understanding the hard finances that lie beneath. Sainsbury’s, of course, has full visibility on this and will inevitably derive significant cost savings by phasing them out.

The common denominator between both moves is inevitably cost, which is on the one hand understandable, but on the other hand, more than slightly perturbing. Clearly, there is an onus for retailers to effectively manage costs, particularly in a COVID-19 ravaged world where even “essential” retailers such as Sainsbury’s have been severely affected. But costs should not set a retailer’s agenda, as seems to be the case here.

Physical stores are multi-channel retailers’ key points of differentiation and competitive advantage over Amazon et al. Stores should not be the “fall guy” in the desperate embrace of a less profitable (unprofitable?) online model. Worryingly, retailers such as Argos, John Lewis and Dixons Carphone risk giving up what USP they have in a desperate attempt to compete on Amazon’s playing field.