Financial Times - Why investors have largely shelved retail shares
They are defensive, they generate stacks of cash, they are highly consolidated and much better run than they used to be. So why do investors not want to own UK supermarkets, which have underperformed the wider market for more than a decade?
I have pondered this question for many years and studied it more forensically in the past three as FT’s retail correspondent. The answer involves margins, misplaced investments and barriers to entry. I can add to that a gut feeling, one shared with fund manager Terry Smith, who in 2014 wrote a column expounding at length why he would not buy shares in Tesco.
At the time, the supermarket group was reeling from accounting errors, the discovery of horse meat in beefburgers and the rather careless loss of thousands of customers to discounters Aldi and Lidl. Its shares had fallen by almost two-fifths in a year, and looked superficially cheap.
Having re-read Smith’s article, one sentence leapt off the page: “There are many reasons why I am unlikely to ever own a retailer in the Fundsmith Equity Fund”. He didn’t go into further detail. But it looks a good call.
Over the past 20 years, on a total return basis, neither the supermarkets nor the larger general retailers have beaten the FTSE All-Share index.
It is hard to find individual major retailers that have outperformed the index over a long period, let alone the kind of “cash compounders” that value investors like Smith seek out.
Tesco’s market value today is not much different from what it was when some of Smith’s investors were urging him to buy the “bargain” stock nine years ago. Over 20 years it has returned less than half what the All-Share index has (including dividends). Rival J Sainsbury has generated an almost identical performance.
It is the same across other parts of the industry. Names that are part of the fabric of Britain’s high streets and retail parks have been deeply uninspiring investments.
B&Q owner Kingfisher — whose total returns lag behind the index by 43 per cent over two decades — is worth roughly the same now as it was as a sprawling retail conglomerate two decades ago. Two of the three businesses offloaded as part of that journey, Woolworths and Comet, have since gone bust.
At electricals retailer Currys it is as if the Carphone Warehouse merger never happened. Dixons and Carphone were worth a combined £3bn in 2014. The successor company is currently capitalised at around a quarter of that sum.
Sports Direct’s market value is 50 per cent higher than its initial public offering price in 2007 — but that equates to a relatively meagre compound annual gain of 3.65 per cent.
Marks and Spencer, a turnround story that has been running for most of this millennium, is one of only two retail stocks to have underperformed the index by more than 50 per cent over five, 10 and 20 years.
The (short) list of 20-year winners contains two obvious success stories: Next, run by cerebral and meticulous chief executive Lord Simon Wolfson throughout the period; and JD Sports, which has ridden the athleisure wave from north-west England around the globe. It too was run by one individual — Peter Cowgill — for almost all that time.
There are a few surprises. Asos was more famous in 2003 for selling celebrity kitsch like Robbie Williams’s underpants or the chairs from the Big Brother house than Gen-Z fashion. But if you’d bought the penny stock back then you’d have made over 150 times your money — even after its recent troubles.
Its dowdy high street shops might be the butt of jokes on social media, but WHSmith’s share price performance is a lot smarter — delivering total returns almost 1.5 times the market.
Then there is Games Workshop. You may not be familiar with the grimdark or the eternal struggle between Chaos and the Imperium of Mankind, but beating the index more than tenfold over two decades is straight out of the realms of fantasy.
It is much easier to stumble over the corpses of fallen titans. Take Matalan, a stock market darling in the early noughties. Last week it was recapitalised in a deal that resulted in John Hargreaves losing control of the business he founded in the 1980s. Whole cohorts of bondholders had their investments wiped out.
Fashion retailer French Connection — remember fcuk? — was all the rage around the same time. It was taken private in 2021 for just £29mn. Superdry, worth well over £1bn in the relatively recent past, is now worth £125mn. A takeover last year probably saved Ted Baker from a similar trajectory.
And of course there was Debenhams, the plaything of private equity. It collapsed in late 2020, around the same time as Sir Philip Green’s Arcadia empire.
Why have so many retailers been such bad investments?
The number of retail barons who started trading out the back of a van or on a market stall — Boohoo’s Mahmud Kamani, Hargreaves, carpet king Lord Harris, The Range founder Chris Dawson, pound shop pioneers Steve Smith and Chris Edwards to name a few — provides a clue.
Barriers to entry have always been low, and the internet lowered them further. As a result, competition is ferocious and turnover of businesses high.
Retail expanded over many years as disposable incomes and access to credit increased, but the pursuit of growth at home and empire building overseas led to bouts of over-investment, first in store estates and now arguably in the infrastructure of ecommerce.
If big strategic errors or the occasional operational snafu could be cushioned by ample profit margins, they might not have mattered so much.
But they cannot. Margins in retail were never fat and in recent years they have got thinner. Supermarkets typically have operating margins of between 3 and 5 per cent — far less than the Unilevers and Procter and Gambles that dominate Smith’s flagship fund.
Fashion does a bit better, with a well-run retailer such as Next or Primark creeping into double digits.
Market leadership does not necessarily enhance profitability. Currys, which dominates the UK electricals market, is aiming to inch back up to 3 per cent by 2025. Nor does scale. Mighty Amazon, a quarter century into its quest for global domination, typically makes between 2.5 and 4 per cent in its North American retail operations.
The meteoric rises and stunning collapses of companies, the colourful characters and the constant capacity to surprise were all things that made the sector hugely entertaining to write about. But as an investor, they are the sorts of things that would keep me awake at night.
This is a sector where consumers, not shareholders, have profited the most. Retail does produce some investment winners, but not many — and they are often not the companies you would expect.
The author is the former FT retail correspondent.