Despite inflationary pressures and a cost-of-living crisis that is squeezing consumers’ real disposable income, shares in household name retailers with nationwide physical store footprints have rallied hard since the back end of 2022.

They include British retail institution Marks & Spencer (MKS), variety goods discounter B&M (BME), cut-price greeting cards seller Card Factory (CARD), athleisure specialist JD Sports Fashion (JD.) and quilts, cushions and curtains seller Dunelm (DNLM), all retailers whose sizeable brick and mortar store footprints are proving a help rather than a hindrance amid the ongoing reversal of lockdown effects and customers’ return to
in-store shopping.

Consumers still like the convenience of online shopping, but the e-commerce boom triggered by the pandemic has waned because people clearly missed the in-store shopping experience during lockdowns.

As Shore Capital recently pointed out, the pandemic ‘accelerated pure-play [online] participation arguably beyond its natural resting position, which has meant that normalisation has seen stores outperform pure-play’.

Investors have cottoned on to the fact that physical stores are better able to handle the challenges of returns than online-only operators and can see that with weak retailers continuing to disappear from the high street, the strongest retailers will only emerge stronger from the cost-of-living crisis with enhanced market share.

And while the consumer outlook remains unpredictable, shoppers are showing resilience in the face of higher food and energy bills and rising interest rates, while retailers’ inflationary pressures are easing.

MIXED CONSUMER PICTURE

According to the latest ONS retail sales figures (21 April), volumes fell by a bigger than expected 0.9% month-on-month in a washout March as the wallets of inflation-weary shoppers felt the strain.

But the consumer outlook isn’t completely gloomy if you look beyond March. Strong months earlier in the year mean sales volumes rose 0.6% quarter-on-quarter over the three months to the end of March, the first three month rise since August 2021.

And on the GfK measure, UK consumer confidence rose by six points to -30 in April, continuing its trajectory of improvement since September 2022, suggesting people are feeling better about their personal finances.

PHYSICAL RETAILERS ON THE STOCK MARKET

Probably the most obvious play on brick and mortar retail is Associated British Foods (ABF), owner of budget fashion purveyor Primark, whose online presence is limited to ordering products which can be collected in store.

Management is worried about the impact of high inflation and higher interest rates on the consumer and is guiding for slower growth at Primark, but the cut-price clothing seller’s strong value proposition means it is well-placed to continue taking market share.

Sector bellwether Next (NXT) has a large online footprint these days, but the decision not to abandon its high street presence has proved astute with physical stores bouncing back into fashion. In its financial year to January 2023, Next’s online sales fell 2% whereas physical shop sales surged 30% higher, albeit the pandemic boost means online sales are up 40% over three years.

Next has laid the foundations for further growth by developing its website as a hub for third parties to sell their brands while making its stores more relevant via click and collect services. Led by CEO Simon Wolfson, the FTSE 100 retailer has also been gobbling up distressed brands including Made.com, Joules and Cath Kidston. Despite concerns the retailer has gone ex-growth, management recently insisted Next has ‘far more ideas and opportunities for long-term growth than it has had for some time.

‘And while the year ahead looks very challenging, we are not facing the kind of long-term structural obstacles that we have overcome in the past eight years.’

Marks & Spencer trades on 10.1 times forward earnings and is attracting positive earnings revisions. Steered by CEO Stuart Machin, the high street stalwart has rediscovered its mojo and recently announced a near half a billion-pound investment to open new stores that it says are ‘core’ to its aim of becoming the UK’s leading omnichannel retailer.

Others benefiting from the return of customers to the high street include Card Factory, the greeting cards-to-gifts specialist which is one of few retailers delivering an upgrade cycle.

Other physical retailers that have rallied strongly include WH Smith (SMWH) and fellow FTSE 250 constituent Dunelm. Now a global travel retailer rolling out stores in international airports, WH Smith’s first-half results (20 April) were ahead of expectations and the books, tech products and snacks seller continues to capitalise on the post-Covid recovery in passenger numbers.

While it is closing stores in the legacy high street business, WH Smith is well positioned in the current environment where rents are falling given its average lease length is under two years. It has around 450 leases due for renewal over the next three years.

Dunelm delivered (20 April) better than expected sales of £423 million for the third quarter ended 1 April 2023, up 6% year-on-year and ahead of the consensus forecast sales growth of 4.5%. During the quarter, Dunelm saw good demand for its new spring collections, resulting in broad-based growth across all categories in stores as well as online, and stressed that the new stores it has opened this year, including larger and smaller formats, continue to perform ahead of expectations.

Brick and mortar retailers enjoying value credentials with shoppers include cut-price books, arts, crafts and toys seller The Works (WRKS) and Shoe Zone (SHOE:AIM), the cash-generative budget footwear retailer.

KEY RETAIL METRICS

Key metrics to study with this sector include like-for-like sales, an indicator of rising or falling demand for a retailer’s products, as well as gross margin, calculated by dividing gross profit by revenue and multiplying the figure by 100 to get a percentage.

High gross margin retailers have more of a buffer to handle rising costs as this usually means their wares are in demand from consumers, implying an ability to put up prices without hurting demand.

Free cash flow is also worth watching, as high levels of cash flow generation provide a retailer with capacity to invest in its stores and product range and fund dividends. Inventory levels are also worth keeping an eye on.

Bloated inventories can signal slowing demand for a retailer’s products or that said shopkeeper has ordered the wrong goods; high inventories can prove costly to warehouse and negative for future margins as excess stock needs to be sold at a discount to get rid of it.

CAN I PLAY THE BRICK & MORTAR REVIVAL THROUGH FUNDS?

While there is no UK equivalent of the SPDR S&P Retail ETF in the US, investors can gain some diversified exposure to top retailers through funds. Investment trust Mercantile’s (MRC) top 10 holdings include Watches of Switzerland (WOSG), Dunelm and WH Smith, while Mike Ashley-controlled Frasers is the biggest holding in the Aurora (ARR) and Artemis Alpha (ATS) trusts.

Keith Ashworth-Lord recently bought back Next for CFD SDL UK Buffettology (BF0LDZ3), having sold the retailer in April 2020 in response to lockdown. Ashworth-Lord argues Next’s retail store performance is ‘no longer a constraint on profits and its estate has some of the shortest lease commitments in the sector’, while recent acquisitions of businesses out of administration like Joules and Made.com ‘add to the growth story’.

Also offering an exposure to the in-store shopping revival is Simon Murphy’s VT Tyndall Real Income Fund (BYX0D61), invested in sofa seller DFS Furniture (DFS) and WH Smith.

TWO STOCKS TO BUY

FRASERS (FRAS) 779p

Investors seeking a lowly-valued yet resilient retailer which continues to roll out new stores whilst growing sales online should buy Mike Ashley-controlled conglomerate Frasers (FRAS). Best-known as the company behind value-for-money trainers and tracksuits seller Sports Direct, Frasers has moved beyond its sporting goods roots. It is behind brands ranging from luxury designer fashion chain Flannels and department store House of Fraser to Evans Cycles, GAME and Jack Wills with strategic stakes in the likes of Hugo Boss and Mulberry. Frasers is becoming Nike’s ‘partner of choice’ in the European sporting goods market. While the retailer doesn’t pay a dividend, it has a reputation as an excellent capital allocator that uses its free cash flow for acquisitions as well as share buybacks. According to Stockopedia, Frasers trades on prospective price-to-earnings ratios of 10.2 and 9.4-times for its 2023 and 2024 financial years respectively.

PETS AT HOME (PETS) 391p

A strong recent rally leaves Pets at Home (PETS) trading on a PE of 18.5 for full year 2024, but it is worth paying up for the UK’s leading pet care business. The pet food, accessories and vet services specialist is a play on the resilient, growing pet care market, underpinned by humanisation and premiumisation trends. Covid engendered a pet ownership boom, sign-ups to the retailer’s Puppy and Kitten Club continue at pace. A recovery for physical retail plays into Pets at Home’s full pet care proposition to customers through its nationwide store base, online business, subscriptions, and grooming and veterinary services, which combined with a broad product range and sharp pricing is enabling the business to win market share.

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