No retail “winners” whatsoever?
COVID-19 Market Update – 01/05/2020
10 minutes to read
Introduction
This is the sixth 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:
- Amazon’s profit bombshell
- Key messages from the Next update
- What we learned from Sainsbury’s FY update
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
- Amazon warns that global operating income of ca. $4bn will be wiped out in Q2
- $4bn will be invested in adapting the business to COVID-19 measures
- This was despite a 26% surge in global sales in Q1
- Next warns that fall in sales as a result of the COVID-19 has been “faster and steeper”
- Next Retail sales YTD down -52%, Online sales YTD down -32%
- Next FY group sales expected to decline by between -30% and -40%
- Online only picking up part of the slack of lost store-based sales
- Next’s sales decline partially offset by cost savings of £760m - £805m
- Re-opening larger, OOT stores will be prioritised when the lockdown is lifted
- No significant consumer re-bound anticipated when stores do re-open
- Sainsbury’s sales grow +12% in 7 weeks to 25 April
- Food sales compensate for weakness in other categories e.g. clothing -53%, GM -22%
- Expects to incur additional annual costs of ca. £500m this year
- Business rate holiday gives savings ca. £450m and a call for permanent reform
- Argos’ sales grow +9% in 7 weeks to 25 April
- Argos’ trading patterns very erratic e.g. +63%, -1%/-10% pre- and post-lockdown
- Question marks as to the permanence of enforced recent behavioural patterns.
1. Amazon’s profit bombshell and wider implications
Any lingering notion that any aspect of the retail market was benefitting from the COVID-19 crisis has been put firmly to bed by Amazon’s trading update. With many countries globally in varying states of lockdown and many physical stores undergoing enforced closure, there has been an inevitable flight to online. But even the main beneficiary of this displacement of demand has issued a significant profit warning.
Amazon’s top line growth was predictably very strong in Q1 (to 31 March). Net global sales grew by +26% (+27% at constant currency rates) to $75.5bn. However, there was a marginal impact on the bottom line, with operating income dipping -9% to $4bn. But the Q1 figures only covered the initial onset of the pandemic in many markets – Q2’s and beyond will provide a more telling picture of the full impact.
The business warned that anticipated operating profits of $4bn in Q2 are likely to be wiped out entirely, as it ramps up staffing levels (175,000 additional employees have been hired) and the business adopts appropriate measures in its warehouses to protect the welfare of its workers (PPE equipment such as100 million face masks for employees, more than 1,000 thermal cameras and 31,000 thermometers) and the effect of “less-efficient” processes that allow for social distancing.
On the one hand, there is an element of a “charm offensive” in the narrative, the company looking to counter question marks over its CSR credentials (e.g. in France, it was forced to temporarily close its warehouses for failing to satisfy authorities). But on the other hand, it lays bare the huge cost implications that even the largest retail businesses face in responding to the COVID-19 crisis.
COVID-19 aside, Amazon’s profit warning has far wider implications. Assuming an ongoing high growth trajectory, Amazon would be expected to generate broadly $100bn in sales in Q2. Yet make barely a penny in profit on those sales. Unprofitable capacity on this scale within the retail industry will weigh heavily on most other operators.
2. Key messages from the Next update
No less dramatic the trading update from Next this week. In generic terms, the strongest retailers and those best equipped to ride out the crisis have the five following generics – a strong brand, astute leadership, the right product, a seamless multi-channel strategy and a robust balance sheet. Next is one of the few UK retailers to tick all five of these boxes, but its defenses are nevertheless being shaken to the core.
As with other post COVID-19 updates, the numbers themselves are not totally irrelevant, but are generally subordinate to the wider narrative – an honest appraisal of the realities of life on the retail frontline.
The trading update (covering the period from 26 January to 25 April) warned that the fall in sales as a result of the coronavirus has been “faster and steeper” than it anticipated in March. The effects of the coronavirus had been worse than anticipated on its revenues, and the brand was now anticipating lower sales for both the first and second halves of the year. For the year to date (to 25 April), full-price retail sales have fallen -52% and online sales -32%, while total full-price sales including interest income have fallen -38%.
Alarming as these trading figures are, they need to be put into the context of the wider market. Retail sales figures from the ONS showed that after months of anemic growth (at best), clothing sales fell off a cliff in March (-36%). Even online clothing (where Next is a key player) saw sales decline -16% month-on-month (-4% year-on-year). Consumers are simply not spending on clothing, even the very best fashion retailers (e.g. Next, ASOS, boohoo, Primark, H&M, Inditex) are suffering.
The transparency of their weekly sales reporting makes for truly fascinating reading. By way of summary:
- For the first 4 weeks of the period (starting 26 Jan) - sales were up marginally on last year
- For 2 weeks from w/c 23 Feb - sales were up week-on-week, but down year-on-year
- For 2 weeks from w/c 8 March - sharp tail-off in both store and online sales (proportionate)
- W/c 22 March - minimal store contribution as lockdown implemented (24 March), online down
- W/c 29 March – “ground zero” – no store or online sales as both channels closed
- W/c 5 April – online partially re-opens and makes a very minor contribution to sales
- For 3 weeks from w/c 12 April - online grows as capacity increases, but contribution still significantly down on usual levels.
The key message being that even when it hits full capacity, online will not recoup lost store-based sales.
While acknowledging that “it’s hard to think of a time when the outlook for sales and profit has been more difficult to predict”, the business set out three revised FY full-price sales scenarios, which model full-year falls of -30%, -35% and -40% (consistent with John Lewis’ worst case scenario of a -35% drop in sales). In cash terms, this would equate to lost sales of between £1.3bn to £1.66bn. The scenarios also detail how it may offset a proportion of lost sales through cost savings of between £760m - £805m.
The narrative also cautioned against the likelihood of a bounce back when the lockdown is finally lifted. The business said it would be “better able to adapt” its larger stores for social distancing and so will prioritise those for reopening ahead of smaller stores. Even then, it “anticipates that it will take some time for customers to return to normal shopping habits and that sales will be subdued when trade commences”.
A sobering reflection on the rest of the retail market generally. Any easing of the lockdown from next week will be phased and is likely to see retail warehousing sites given priority. But it will take considerable time for sales to return to anything like “normal” levels (18 months – 2 years?). And implementing social-distancing measures adds considerable extra cost to retailers’ operating models. Sadly, in some instances, substantially lower sales and higher operating costs will even make stores more financially viable closed than trading.
3. What we learned from Sainsbury’s FY update
Sainsbury’s FY results underlined and reinforced what we already know about grocery sales trends in light of the COVID-19 pandemic through earlier updates from Tesco and data from industry bodies such as Kantar and the ONS.
As with Tesco, the actual FY results were something of a sideshow to updates on current trading and expectations going forward. The business posted a -2% decline in underlying pre-tax profit to £586m in the 52 weeks to 7 March, with overall profit before tax rising +26% to £255m. Group sales edged down -0.1% to £32.4bn (-0.6% on a like-for-like basis) although this masked a much stronger performance from the core food business in the second half.
Sales patterns have been disrupted considerably in the face of the lockdown. Food sales jumped +48% in the week to 21 March amid pre-lockdown stockpiling. Over a longer timeframe, food sales rose +12% in the seven weeks to 25 April, in comparison with a more modest +2% rise in the nine weeks to 7 March. But these stellar sales figures do not tell the whole story.
While food sales were strong, these were partially counterbalanced by hefty declines in other (higher margin) product categories, namely clothing (-53%, compared to Tesco’s -70%) and general merchandise (-22%). NB these figures refer to Sainsbury’s stores only and exclude Argos.
There was also sobering confirmation of the addition costs incurred in continuing to trade under social-distancing compromises. The business forecasts “a profit impact of over £500m due to significant costs associated with protecting customers and colleagues, weaker fuel, general merchandise and clothing sales and lower financial services profitability”. This would only be partially offset by £450m of business rates relief (another astoundingly high figure). It stated that provided lockdown restrictions have eased by the end of June, it expects its underlying full-year profit to March 2021 to be broadly flat.
Outgoing CEO Mike Coupe reiterated the retail industry’s wider hopes that the pandemic will prompt a fundamental reform of the business rates system, poignantly referencing the fact that even with a rates holiday on stores, Sainsbury’s will still pay more business tax on its other properties this year than Amazon.
Sales patterns at Argos (like Next, a key non-food multi-channel operator) were equally erratic. Sales were up +0.4% in the nine weeks to 7 March, but accelerated to +9% in the seven weeks to 25 April. This masks huge weekly peaks and troughs. For example, in the week prior to lockdown (to 21 March), Argos’ sales surged by +63% as customers equipped themselves for an extended period of home working. But in the first two weeks post lockdown (when the business was reduced to an online-only operation), sales were down -1% and -10% respectively.
CEO Mike Coupe also flagged shopper behavioural changes during the pandemic. Of course, there was a well-documented flight to online, although like Dave Lewis, his counterpart at Tesco, Mr Coupe made no hard commitment to permanently ramping up online capacity: “the jury is out on the volumes of online groceries, but again I suspect that once people get into the habit of ordering groceries online, it is likely to be sticky.” Like Tesco, Sainsbury’s also reported significant increases in basket size, with people shopping in-store purchasing “roughly twice what they would have normally bought”.
Other commentators have been quick to assume that enforced changes to shopping behaviours in recent weeks will become permanent ones. In reality, these changes are anything but a one-way street. Many consumers may have tried online grocery for the first time and are converts. Others may have tried it out of necessity and are not convinced. Other die-hard online grocery shoppers may have been forced to revert to stores and have actually enjoyed the experience and have been re-converted. There are too many moving parts to assume that enforced changes are a shape of things to come.
No real retail “winners” from the pandemic. “Essential” retailers that have had “the luxury” of trading through the lockdown such as Tesco and Sainsbury’s have seen sales spike, but costs rocket as they trade under compromised conditions. A similar story at online pure-plays such as Amazon, seemingly immune to store-based lockdown. Other online pure-play stars such as ASOS and boohoo suffering at the hands of soft consumer demand. Best-in-class operators such as Next rocked to the core. All these businesses will survive the crisis, but what does that say for less well-positioned and able operators?