Retail CVAs – the trumpeting elephant in the room
COVID-19 Market Update – 18/09/2020
12 minutes to read
Introduction
This is the 20th 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 three key themes:
- What we learned from the official ONS retail sales figures for August
- Takeaways from John Lewis’ and Next’s trading updates
- Aftermath of New Look’s latest CVA
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
• Retail sales values grow by +4.4% y-o-y in Aug
• Grocery (+3.7%) sees limited impact from ‘EOTHO’
• Non-food (-3.7%) still in negative territory
• Household goods growth (+11%) best in ca. 20 years
• Clothing sales still dire (-16.4%)
• YTD retail sales down -4.8% on same period last year
• YTD grocery sales +4.4%; YTD non-food sales -18.2%
• Spend “higher than pre-pandemic” is very misleading
• Online sales decline -2.5% month-on-month
• Online grocery sales decline -4.6% month-on-month
• Online penetration eases to 28.1%
• John Lewis swings to H1 loss of £625m
• Waitrose’s H1 sales +7.6%; John Lewis’ -9.7%
• Next upgrades FY profit guidance to £300m
• New Look’s 2nd CVA approved, but with landlord backlash.
1. What we learned from the official ONS retail sales figures for Aug
In a nutshell: further month-on-month and year-on-year growth in retail sales, but still a very long way from recovering the ground lost during lockdown. Online penetration slowly receding. Grocery remains strong, with only limited negative impact from ‘EOTHO’. Non-food recovering very slowly, but still in negative territory. Within non-food, home-related goods strong, clothing still dire.
No alarms and no great surprises: the release from the ONS was broadly consistent with last week’s from the BRC. As ever, the devil is in the detail rather than the narrative and some of the headline numbers - interpreting the release is an exercise in sifting through the significant and dismissing the spurious.
Year-on-year retail sales values (exc fuel) grew by +4.4% in Aug, for once not dissimilar to the equivalent figure from the BRC (+3.9%). Including fuel (which always distorts the headline numbers) the figure was a far more modest +1.7%. The economist-friendly narrative inevitably focused on the far less meaningful month-on-month figures, which showed growth of +0.7% (+0.4% exc fuel).
Grocery sales remained robust (+3.7% versus my prediction of +2-3%), with the government’s ‘Eat Out to Help Out’ scheme only having a slight negative impact. According to the ONS, 51.5% of grocery retailers reported a decline in footfall between 10 and 23 of Aug, but this didn’t have a material impact on overall grocery spending (+3.7% represents very marginal deceleration on the +3.8% reported in Jul).
Reading between the lines: grocery footfall down but spending levels maintained implies larger basket sizes. Effectively, consumers making fewer trips but spending more, a positive trend flagged by a number of the major grocery players, including Waitrose this week.
Household goods remained strong, with accelerating growth – year-on-year sales were up +11.0% in Aug (+9.9% in Jul), the strongest monthly growth in nearly 20 years (since Oct 2001). Breaking this down into its component sub-sectors, DIY growth accelerated to +18.8% (+10.3% in Jul), electricals +16.3% (+13.5%), while furniture was a more modest +3.8% (+11.8%).
But clear polarities remain, even within seemingly complementary sub-sectors. For example, strong growth in electricals (+16.3%) contrasts sharply with computers/telecoms (-29.8%). Within healthcare, dispensing chemists saw sales surge +48.6% in Aug (with a monthly average of +47.5% since Mar), but cosmetics slumped by a further -13.8% (with a monthly average of -21.1% since Mar).
Disappointingly, according to the ONS non-food as a whole is still in negative growth territory, contrary to the BRC figures last week. Year-on-year non-food sales declined by -3.7% in Aug. An optimist could point to the fact that this was the best monthly performance since Feb, a realist would counter that this still marked the 6th worst monthly performance since records began in 1989.
Clothing remains dire any which way you look at it. Monthly trends may be improving very slowly, but year-on-year sales were still down by a dismal -16.4% (-25.5% in Jul). Over the last six months, fashion sales have declined at an average monthly rate of -40.9%, a disaster for the one of the UK’s most oversupplied and overshopped retail sub-sectors.
Placating economists but misleading the media, the ONS persists with its narrative that retail sales are above pre-pandemic levels in February (+4.0). Statistically true, but this does not factor in the billions of pounds of spending that was lost in the intervening months. Equally, as grocery has been the main driver of growth over the last six months, it is a very damaging misrepresentation of what is actually happening on the high street. It implies a recovery that is simply not there (as yet).
Far more revealing and insightful are the year-to-date figures that the ONS included in the latest release. In the first eight months of the year, overall retail sales volumes were down -4.8% on the corresponding period last year. Food sales were up +4.4%, non-store +28.6%, but non-food sales were down -18.2%, with clothing sales -30.1%. A much more realistic picture of where we are.
Online sales continued to unwind slightly as the physical retail market slowly returns to something like full capacity. Online sales declined month-on-month by -2.5%, reducing online penetration to 28.1% (-530bps versus the high of 33.4% seen in May). Online grocery declined by -4.6% m-o-m, with penetration dipping to 10.4%. Despite all the noise around continued rampant growth, realistically the level of online grocery penetration is likely to settle at around 8-9%, before resuming a more measured growth trajectory than that seen during the pandemic.
2. Takeaways from John Lewis’ and Next’s trading updates
No alarms and no great surprises in half year trading updates from the John Lewis Partnership and Next. Some nasty numbers and a few bombshells admittedly, but such is the nature of the retail climate at the moment that it takes more than this to either alarm or surprise.
As expected, the key headline from John Lewis was that the Partnership bonus would not be paid this year for the first time since 1953 and would not be re-instated until profits exceed £150m and the debt ratio falls below four times. An unprecedented step for the Partnership that was always facing one of the most defining years in its long history, even before COVID-19 even struck.
In terms of trading, for the first half of its financial year (to 25 Jul), the Partnership swung to a pre-tax loss of £635m, compared to £192m half-year profit this time last year. On a pre-exceptional basis, pre-tax losses widened by 5.8% to £55m. Sales for the half-year period were actually up, albeit only marginally at +1.1% to £5.56bn.
The exceptional items included a £471m write down in the value of John Lewis stores. More telling in the context of understanding the full impact of COVID-19, lockdown and enforced store closures resulted in an estimated £200m of lost sales and the Partnership incurred additional costs of £50m making its stores health and safety compliant.
Predictably, there were sharply contrasting performance metrics at the two halves of the business. Over the period, Waitrose’s sales were up +7.6% overall and +9.6% on a like-for-like basis. The indication is that Waitrose has grown in line, or marginally ahead of the overall grocery market over this period (+7.1%).
Conversely, sales at John Lewis were down -9.7% overall and -9.5% on a like-for-like basis. Much has been made of the strength of John Lewis’ online business, with online sales up +73% during the period to account for 60% of sales overall. But the key takeaway is that online did not pick up the full extent of lost trade from closed stores during the period and the cost implications of the enforced migration to online were also not detailed.
The Partnership was relatively upbeat on current trading, stating that trading in the second half of the year had been “encouraging” so far and that sales momentum is “starting to build” in the reopened stores. Yet sales are reportedly down -30% on last year - and the fact that this performance is “better than expected” speaks volumes.
The merits of Partnership’s strategic course are open to debate. In my opinion, updating ‘The Never Knowingly Undersold’ price pledge was overdue (but needs cementing by greater distancing from events such as Black Friday), but the over-arching focus on driving online going forward is blinkered in the extreme. But the main challenge will be unifying Waitrose and John Lewis operationally and I remain to be convinced that this can be achieved effectively.
Equally sobering numbers from Next during the pandemic, but a more encouraging update on current trading. In the six months to 25 Jul, pre-tax profits plunged 97% to just £9m. Closure of the company’s store estate during lockdown prompted a 61% slump of in-store sales to £344.6m. Perhaps more surprisingly, online sales declined by -14% to £862.6m over the same period.
Online sales were obviously hit by a temporary suspension of services during the early stages of lockdown. Also, Next is heavily exposed to the fashion market, which has seen exceedingly soft demand over the last six months (either in-store or online). But again, the message is a clear one – online is not a straight substitute for lost store-based sales, the two channels are co-dependent.
In the past seven weeks, Next has seen an encouraging recovery in sales, driven particularly by stores on retail parks. Full price sales are up +4% YTD, comfortably ahead of a clothing market that remains firmly in negative growth territory. On the back of this performance, the business increased its full-year profit guidance from £195m to £300m. A rare good news story or a correction on (laudable) prior conservatism?
3. Aftermath of New Look’s 2nd CVA
No alarms and no surprises. New Look’s second CVA was approved this week. But not without massive contention, industry uproar and long term implication and possible backlash. Consider Pandora’s Box well and truly opened…
The facts: New Look’s CVA was formally approved by more than 75% of its creditors on Tuesday. This will safeguard the business’ 11,000+ workforce and result in no further store closures, but will see 400 of its sites switch to a turnover-based rent model, while the other 68 stores will be subject to a three-year rent holiday, but with “enhanced” landlord break clauses. But a number of large institutional landlords are believed to have voted against the CVA.
The approval of the CVA also means the comprehensive financial re-capitalisation announced on 13 Aug to extend New Look’s facilities, deliver new investment, and significantly de-leverage the balance sheet can now progress. The re-financing includes a debt-for-equity swap on New Look’s current debt – reducing senior debt from £550m to £100m – and significantly decreasing interest costs, an extension of primary working capital facilities which provide further financial support with no near-term maturities, and an investment of £40m of new capital to support the business plan.
The case for the defense: trading conditions for fashion operations could not conceivably be any worse than they are. COVID-19 notwithstanding, clothing was already one of the UK’s most ferociously challenging markets, suffering from acute over-supply through too many operators and too many stores, coupled with growing online penetration.
Consumer demand has fallen off a cliff since the onset of the pandemic. Fashion sales have now declined significantly for six consecutive months (falling by a monthly average of -40%). From a nadir of -69.5% in April, sales are still going backwards at a rate of knots (-16.4% in Aug). Market conditions could not be any tougher.
The case for the prosecution: this represents further abuse of the CVA system, effectively seeing New Look renege on legally-binding lease obligations that it signed up to of its own free will, setting a dangerous precedent for the retail market generally going forward. Despite tough market conditions, New Look’s problems are of its own making – historic private equity ownership has left it was unsustainable levels of debt and the business over-expanded and took on too many sites that it couldn’t afford.
My view: it is in the retail sector’s interests for New Look to survive rather than fail, not least for the preservation of its workforce. It is fundamentally a fairly strong brand / business dogged by past mistakes. But this marks further misuse of the CVA process, with landlords unfairly seeing no comeback on legal agreements. The whole CVA practice needs to be fundamentally reviewed and a binding code of conduct drawn up. It will indeed set a precedent for other retailers, but the switch to turnover rents is not the panacea it promises to be.
The push for turnover rents generally will undoubtedly accelerate in the wake of New Look’s latest CVA. I’ve debated before the pros, cons and complexities of turnover rents (see the Retail Note from 05/06/20). To this previous narrative, I would add the question: if a retailer (not specifically New Look, but generally) can’t be trusted to honour the legal obligations of a lease, can it be trusted to share accurate trading data (and fair reconciliation of online contribution) as part of a turnover rent agreement?
Reaction within the landlord community to New Look’s 2nd CVA has been vociferous to say the least, not only on its own grounds, but also in terms of precedent it may set. New Look may have won this particular ‘battle’, but it has burned its bridges with many landlords in the process. For many, New Look is now a deeply tarnished brand. Ultimately, its chances of negotiating concessions further down the line have significantly diminished.
But above all else, these feels like a major setback in the evolution of retailer and landlord relationships. Whereas other facets of society seem to have progressed five years on the back of COVID-19, the retail property market, depressingly, seems to be regressing by that much and more.
Stephen Springham
Partner – Head of Retail Research
+44 20 7861 1236
stephen.springham@knightfrank.com