The key retail themes of 2016 are expect to continue into this year

The key retail themes of 2016 are expect to continue into this year

Many of the key themes that dominated the European retail scene in 2016 are expected to continue into this year, analysts believe, as retailers prepare for more currency headwinds, unseasonal weather, a continued shift to e-commerce and whatever hurdles Brexit will bring.

The last 12 months proved to be a difficult year for retailers, particularly in apparel, with UK brands such as Next and Marks & Spencer among the worst performers. They were not alone, however, as the effects of US dollar strength relative to the euro put significant pressure on margins for Swedish retailer Hennes & Mauritz (H&M) and Irish retailer Primark, Bernstein analyst Jamie Merriman explains.

As he points out, data from the Office for National Statistics (ONS) in the UK suggests the retail value of clothing was down 3.9% for the 12 months ended October 2016 – a worse performance than that seen in 2009, when sales were down by up to 1.8%. This was not isolated to the UK. Bernstein estimates like-for-like sales at H&M were down around 2% for the first nine months of its fiscal year 2016.

"Looking back, we believe the biggest factors shaping both earnings growth and share price performance in 2016 were currency, weather – many retailers blamed unseasonal weather for their poor performance –company specifics such as credit, market share and self-help, and the continued shift to e-commerce, which helped boost growth for Asos and Zalando. Looking forward into 2017, many of the same themes will continue to dominate, though we would add Brexit to our list of macro-factors to watch," Merriman notes.

Bernstein has outlined the eight factors it expects will shape the course of 2017 for the European retail sector:

  • Brexit – Consumer confidence has remained in negative territory since April 2016 and disposable income is likely to be pressured next year as cost inflation comes through.
  • Foreign exchange – Brexit precipitated a 17% fall in sterling versus the US dollar in 2016. This will drive inflation and push up costs for UK retailers who source mainly in US dollars. M&S and Primark will likely see margin headwinds, while Next is expected to lose share given its decision to pass costs on to consumers. ASOS will benefit from transaction FX tailwinds over the next two years.
  • Pricing – Retailers continue to use price as part of their competitive strategy. M&S cut prices on clothing and home products in 2016 in an effort to rebuild its value credentials – like-for-like progression in 2H16 and FY17 will reveal whether management's strategy has succeeded in winning back consumers. The analysts continue to see long-term pressure for H&M from price competition as the value fast fashion segment becomes increasingly crowded in major H&M markets.
  • E-commerce – Going forward, apparel e-commerce is seen to be a more consolidated market than physical retail, and aggregators such as Asos and Zalando are well-placed to be winners, given scale benefits and consumer preference for shopping through only a few selected websites. E-commerce is expected to be margin dilutive for most bricks & clicks retailers.
  • Space – The channel shift to online is forcing retailers to re-examine the role of physical stores. Inditex's shift to online growth will improve the company's return on investment, whereas H&M is at risk of store cannibalisation as it continues to pursue 10-15% of store growth.
  • Weather – Many retailers blamed unseasonal weather for their poor performance over the last 12 months.
  • Changes in consumer spending patterns – Unseasonable weather has driven weakness in apparel markets this year; if there is more normalised weather next year, sales will benefit from easy comparisons. Some retailers have blamed poor performance on a shift in spending to experiences over things. "We don't think this has been the biggest factor in 2016, given it is a long term trend since 1994," the analysts say. Instead: "We see weather as the key culprit in 2016, suggesting potential improvement in 2017 if weather normalises."
  • Self-help – M&S is likely to continue to lose clothing market share in the short term, given its still high share of 9.4% and a further pull-back on promotions. M&S's plan is generally back-end weighted, suggesting 2017 will be too early to tell how successful store closures will be in improving profitability.